Transcript Document

Fair Value Measurement (SFAS 157)
Kaipo Doorley
Amper Politziner and Mattia
Agenda – Topics Covered
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Fair Value Issues
Fair Value Framework
Fair Value Disclosure Requirements
Alternative Investments
Audit Considerations
Recent Standard Setting Activity
SEC Update
FV Issues - The Fair Value “Movement”
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Moving toward everything eventually being “initially”
measured at fair value
Less and less use of cost-based measures for financial
instruments
 SFAS 115, 133, 155, 156, 159
 Held to maturity debt securities and APB 18 are
exceptions
Nonfinancial instruments generally still use historic cost
with impairment testing
FV Issues – Problem and Possible Solution
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The Problem – Reliability of measures
 Different parties could get inconsistent measures
 Possible for management to influence measures
The (Partial) Solution – SFAS 157
 Detailed definition of “fair value” for use in accounting
 Does not expand use of fair value
 Provides guidance to make fair value measures more
consistent and understandable to investors
 Requires disclosures to help users understand reliability of
inputs
Financial statement users still prefer fair value while
management and auditors do not believe the “market” is always
the most accurate reflection of a transaction/account
FV Issues – The Good News
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The Good News
 For most securities, decrease in value are being
reported as they occur
 Impairment of other assets are being recognized
 Despite difficulty, companies/auditors have been able
to come up with values
 FV disclosures are helpful to users (Level 3 assets, etc.)
 Fair Value has been around for a very long time and
now there is one definition of fair value
• Valuation specialists and certain industries have dealt with
fair value for years and have expertise and insight
FV Issues – The Bad News
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Impairment models are inconsistent
Some tests are impossible (other-than temporary)
Standard-setters being pressured to back off
Many implementation issues/question on 157
 FASB’s VRG and staff working
 Some FSPs raise more questions than answers
Tendency to apply “rules” instead of principles
 Looking to transactions that aren’t representative
 Supporting pricing service estimates
Hard to convince auditors that losses are temporary
The timing of SFAS 157 and the economic crisis
Fair Value Framework - Definition
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Definition of Fair Value – Exit Price not Entry Price
 What could you sell for in an orderly transaction
 Assume exit in principal or most advantages market
Marketplace participant assumptions, not entity specific
 Looking to the market should reduce management bias
and promote consistency (in concept)
 “Marketplace participants” are knowledgeable,
independent parties willing and able to transact
Transaction costs are not part of fair value
Always include credit risk if inherent in asset/liability
Fair Value Framework - Measurement
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Step 1: Determine the unit of account (based on
accounting/reporting rule driving measurement)
 Stand alone asset/liability or group of assets
 For example is the unit of account a “reporting unit”
being tested for goodwill or a single equity security
recorded as available for sale
Fair Value Framework - Measurement
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Step 2: Highest and best use (market participant view)
 In-use (used with a group of assets/liabilities to maximize
value)
 In-exchange (stand alone basis)
 For example a market participant is a real estate developer
and purchases a construction company for:
• In-use: Integrate the company’s PP&E
• In-exchange: Operate the company as a stand alone
entity
 Must be physically possible, legally permissible and financially
feasible to the market participant
 The reporting entity’s current or intended use of the
asset/liability does not matter
Fair Value Framework - Measurement
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Step 3: Determine principal or most advantageous (based on
highest and best use)
 Principal market has the greatest volume and activity
 In the absence of a principal market, the most advantageous
market in which the “reporting entity” would sell the
asset/transfer the liability with the price that maximizes
amounts received and minimizes amounts paid
 Based on market principal/most advantageous market the
reporting entity identifies (not specifically) market
participants
 The market and market participants should be evaluated at
recognition and re-evaluated at each measurement date
 Inactive market and disorderly transactions discussed later
Fair Value Framework - Measurement
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Fair value hierarchy
 Prioritizes inputs to the valuation technique used to
measure fair value
 Level 1 – quoted prices (unadjusted) in active markets
for identical assets and liabilities
 Level 2 – inputs and other quoted prices included in
Level 1 that are observable either directly or indirectly
 Level 3 – unobservable inputs reflecting the reporting
entity’s own assumptions about market participant
assumptions
Fair Value Frame Work - Measurement
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Characteristics of Level 1 Inputs
 Transactions occur with sufficient frequency and
volume to provide pricing information on an ongoing
basis.
 Reporting entity has ability to access
• Alternative pricing methods (e.g. matrix pricing) may be
used as a practical expedient
• Alternative pricing method results in a lower level
measurement
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After-hours trading or news events
• Not required, but should be considered
Fair Value Frame Work - Measurement
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Characteristics of Level 2 Inputs
 Quoted prices for similar assets or liabilities in active
markets
 Quoted prices for identical or similar assets or liabilities
in markets that are not active
 Inputs other than quoted prices that are observable
(e.g. yield curves)
 Market-corroborated inputs: Derived principally from
or corroborated by observable market data by
correlation or other means
• Adjustments necessary to corroborate inputs may result in
Level 3 measurement
Fair Value Frame Work - Measurement
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Characteristics of Level 3 Inputs
 Unobservable inputs used to the extent that observable
inputs are not available
• Includes assumptions about risk, developed based on best
information available without undue cost and
effort
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Data used to develop the inputs should be adjusted if
there are contrary data indicating market participants
would use different assumptions
FV may be determined based on the best available
information in the circumstances
Fair Value Framework - Measurement
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Valuation techniques consistent with market, income
and/or cost approaches shall be used to measure FV
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Market Approach – Uses observable prices and other relevant
information generated by market transactions involving identical or
comparable assets or liabilities
Income Approach – Converts cash flow or earnings to a single
present amount (discounted) . Value indicated by current market
expectation about future amounts
Cost Approach – Amount that would currently be required to
replace the service capacity of an asset (current replacement cost)
Use valuation techniques that are appropriate in the
circumstances and for which sufficient data are available
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Single or multiple techniques may be appropriate depending on the
circumstances.
Fair Value Disclosure Requirements
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Assets and liabilities measured at FV on a recurring basis
 Disclose the level of inputs used (tabular format)
 Level 3 inputs rolled forward
 Valuation techniques – annually (see FSP updates)
Assets and liabilities measured at FV on a nonrecurring
basis
 Same as above AND
 The reasons for the measurement
Note FASB fair value disclosure project discussed later
Alternative Investments
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What is an alternative investment?
AICPA Practice Aid
AICPA Draft Issue Paper
Specific Issues for Alternative Investments
FASB FSP 157-g Estimating the Fair Value of Investments
in Investment Companies That Have Calculated Net Asset
Value per Share in Accordance with the AICPA Audit and
Accounting Guide, Investment Companies – Issued
Monday June 8,2009 and comment period ends July 8,
2009
 Will be effectiv3e immediately upon release
Alternative Investments – Specific Issues
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Defining markets/market participants
Factors in deciding whether a market is active
Evaluating transactions
 Transparency
 Relevance
 Distressed
Determining fair value of interest in alternative
investments
Unique Elements of Private Equity
Consideration of use of NAV as a practical expedient
 FASB issues FSP FAS 157-g
Audit Considerations
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Auditing standards
 If market assumptions not available, an entity may use
own assumptions as long as no contrary data that
market participants would consider
 Auditor must understand the entity’s process for
determining fair value and relevant controls to develop
an audit approach
 Use of specialists
 Auditor must find the assumptions reasonable and the
valuation methods appropriate and properly applied
 Consideration of variances from period to period
Audit Considerations (cont’d)
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Non-Authoritative Guidance
 AICPA Toolkit for Auditing Fair Value Measurements and
Disclosures
 Auditor must understand the entity’s process for
determining fair value and relevant controls to develop
an audit approach
 Use of specialists
 Auditor must find the assumptions reasonable and the
valuation methods appropriate and properly applied
 Consideration of variances from period to period
 Practice Issues for Non-Issuers
Recent Standard Setting Activity
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FSP FAS 157-4 (fair value measurement)
FSP FAS 157-f (fair value of liabilities)
FSP FAS 107-1 and APB 28-1 (fair value disclosures)
FSP FAS 115-2 and FAS 124-2 (OTTI of debt securities)
Ongoing FASB Projects
 Fair Value Disclosure Project
 Financial Instruments Project
 Recoveries of Other-Than-Temporary Impairment
(Reversal) Project
Recent Standard Setting Activity – FSP 157-4
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FSP FAS 157-4, Determining Fair Value When the Volume
and Level of Activity for the Asset or liability Have
Significantly Decreased and Identifying Transactions That
Are Not Orderly
 Superseded FSP FAS 157-3
 No longer just relates to financial assets
 Despite a significant decrease in market activity for an
asset, the objective of fair value measurement remain
 Provides factors to consider for significant decrease in
volume and level of activity
 When market activity significantly declines, further and
more robust analysis required
Recent Standard Setting Activity – FSP 157-4
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FSP FAS 157-4 (cont’d)
 Requires additional disclosures of fair value
measurements
• For interim and annual periods the inputs and valuation
technique(s) used to measure fair value and a discussion
of changes in valuation techniques and related inputs, if
any, during the period
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Major security types shall be based on the nature and
risks of the security. Disaggregation of financial
instruments are much greater and a listing is included
in the FSP
Effective for periods ending after 6/15/09
Recent Standard Setting Activity – FSP 157-4
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FSP FAS 157-4 (cont’d)
 Provides circumstances that may indicate a transaction
is “NOT” orderly
• If not orderly, place little if any weight
• If orderly, consider transaction price and weight
depends on facts and circumstances
• If not sufficient information available to determine
whether orderly or not, the transaction price may
not be determinative of fair value
 Use of broker quotes and pricing services not
precluded, but a reporting entity must evaluate the
quote
Recent Standard Setting Activity – FSP 157-f
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FSP FAS 157-f, Measuring Liabilities Under SFAS 157
 FASB is redeliberating a proposed FSP to provide
additional guidance on determining the fair value of
liabilities
 A proposed FSP was issued in May for comment
 Generally estimate fair value of liabilities as you would
estimate fair value of an asset
 However, should not make any adjustments due to
restrictions on the transfer of a liability
Recent Standard Setting Activity – FSP 157-f
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FSP FAS 157-f, Measuring Liabilities Under SFAS 157
 FASB is redeliberating a proposed FSP to provide
additional guidance on determining the fair value of
liabilities
 A proposed FSP was issued in May for comment
 Generally estimate fair value of liabilities as you would
estimate fair value of an asset
 However, should not make any adjustments due to
restrictions on the transfer of a liability
Recent Standard Setting Activity – FSP 107-1
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FSP FAS 107-1 and APB 28-1, Interim Disclosures about
Fair Value of Financial Instruments
 Applies to all public companies
 Applies to fair value disclosures for any financial
instruments that are not currently reflected on the
balance sheet at fair value
 Requires disclosures on a quarterly basis, providing
qualitative and quantitative information about fair value
estimates for financial instruments not measured on
the balance sheet at fair value
 Effective for periods ending after 6/15/09
Recent Standard Setting Activity (cont’d)
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FSP FAS 115-2 and FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments
 Applies debt securities scope in to SFAS 115
 If FV < CV (amortized cost), instrument is impaired
 If an entity intends to sell or more likely than not will
be required to sell before recovery, all OTTI recognized
through earnings
 If entity does not intend to sell and it is not more likely
than not, OTTI is separated into (a) credit loss and (b)
amounts related to other factors
 Credit loss through earnings and the rest through OCI
 Note covered in greater detail
Recent Standard Setting Activity (cont’d)
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Fair Value Disclosure Project
 FASB recently added a project to its agenda to improve
disclosures of fair value measurements
 Project will consider additional disclosures, such as:
• Sensitivities of measurement to key inputs
• Transfers of items between the fair value hierarchy
levels
• Levels of aggregation
• Expected timing for this project is year end 2009
Recent Standard Setting Activity (cont’d)
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Financial Instruments Project
 Financial Instruments: Improvements to Recognition
and Measurement – Joint project of the IASB and FASB
 Project objectives:
• Simplify reporting to improve decision usefulness and
understandability
• Determine which financial instruments should be recognized at
fair value and which financial instruments would be recognized at
a different measurement attribute
• Address impairment, hedging, fair value option, and financial
statement presentation issues
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Expected timing for this project is by year end 2009
Recent Standard Setting Activity (cont’d)
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Recoveries of Other-Than-Temporary Impairment
(Reversal) Project
 Objective of this project is to consider allowing an
entity to recover, through earnings, a previously
recognized OTTI loss when evidence exists that an
impairment loss has reversed
 Another objective of this project is to converge with
IFRS with regard to the accounting for recoveries of
OTTI
 Expected timing for this project is by year end 2009
SEC Update
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SEC Staff Views of Fair Value Measurements
SEC Staff Letters – Financial Asset Impairments
Hot Topics Related to Fair Value Measurements
 Control premiums
 Discount rates/WACC
 Valuation of restricted stock
 Use of valuation Specialists
 Limited scope engagements
Questions?
“The material contained in
this presentation is for
general information and
should not be acted upon
without prior professional
consultation.”