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Monday, August 7, 2006

Forget What You Know About Fair Value


FAS 157 seeks to eliminate the confusion when measuring fair value

If you haven’t been keeping up with your FASB news, the definition of fair value has changed.

Historically, fair value was thought of as an entry price (e.g., the price to purchase an asset or settle a liability); however, recent standard FAS 157 defines fair value as the "exit price," that is, "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." Although FAS 157 was effective for fiscal years beginning after November 15, 2007, implementation was delayed until fiscal years beginning after November 15, 2008 for non-financial assets and liabilities.

Since FAS 157 seeks to clarify how to measure value and provide consistency, comparability, and transparency of fair value measurements, companies will need to rethink how to measure fair value and increase the disclosure of how fair value is determined. Companies or industries that hold large amounts of financial assets and liabilities will be the most immediately impacted. However this will have some impact on virtually all companies.

FAS 157 establishes specific requirements to define the market that an asset or liability should be measured in. It also establishes appropriate valuation techniques and three levels of fair value (see below), which also have specific requirements.

  • Level 1 - Quoted Market Prices in Active Markets
  • Level 2 - Other than Quoted Market Inputs
  • Level 3 - Unobservable Inputs

The key for companies is not to wait until it is time to file or be audited. Begin reviewing financial assets and liabilities to determine the appropriate measure of fair value as soon as possible. While some assets and liabilities are easy to measure, for example stocks traded on the NYSE, others will be more difficult, for example a note receivable from a non-public entity.

The upside is, for most companies, the cost associated with measuring fair value will be relatively small, since most companies have relatively small pools of affected assets and liabilities, and they will generally be fairly easy to measure. However, for larger companies or companies with significant holdings in affected assets or liabilities the cost of determining fair value may be significant.

Even if a company is not in the financial services industry, it’s important to understand the new way of looking at fair value and understand the way in which fair value is measured for assets and liabilities. Armanino is able to assist with understanding the requirements of FAS 157, determining fair value, particularly for assets and liabilities that are more difficult to measure, and with disclosure requirements.


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