FAS 157 (Fair Value Measurements) – – FAS 157 (Fair Value Measurements) The New Framework for The New Framework for Developing Fair Value Estimates Developing Fair Value Estimates by by Gary R. Johnstone, CFA, C.P.A./ABV Gary R. Johnstone, CFA, C.P.A./ABV
Presentation to Accounting Firm Presentation to Accounting Firm Presentation Overview Presentation Overview � Fair Value � Fair Value – – A Brief Retrospective A Brief Retrospective � Fair Value � Fair Value – – FAS 157 (Fair Value Measurements) FAS 157 (Fair Value Measurements) – – the the “ “Current Current” ” Guidance Guidance � Objective: Improve and Codify Fair Value Measurement Guidance to � Objective: Improve and Codify Fair Value Measurement Guidance to Improve Consistency and Comparability Improve Consistency and Comparability � Establishes proper approaches to measurement (i.e., a framework) � Establishes proper approaches to measurement (i.e., a framework) � Provides for Enhanced Disclosures � Provides for Enhanced Disclosures � Framework � Framework – – Graphical Representation of New Framework Graphical Representation of New Framework � Even more Current Guidance from FASB � Even more Current Guidance from FASB – – FSP FAS 157 FSP FAS 157- -3 (October 3 (October 10, 2008) – – Valuing Certain Financial Assets in Inactive Markets Valuing Certain Financial Assets in Inactive Markets 10, 2008)
Presentation to Accounting Firm Presentation to Accounting Firm Fair Value – – Pre Pre- -FAS 157 Retrospective FAS 157 Retrospective Fair Value � � Fair Value is not a new concept! Fair Value is not a new concept! � � Fair Value has been used in financial reporting for many decades Fair Value has been used in financial reporting for many decades, principally for , principally for financial assets like marketable securities (fair value = fair market value based on arket value based on financial assets like marketable securities (fair value = fair m market transactions). Some past general guidelines were as fol market transactions). Some past general guidelines were as follows: lows: � � Receivables valued at Receivables valued at present values present values less allowance. less allowance. � Plant and equipment at � Plant and equipment at replacement cost replacement cost for similar capacity asset. for similar capacity asset. � Other assets including Land and natural resources at � Other assets including Land and natural resources at appraised value . appraised value . � Nonmarketable securities at � Nonmarketable securities at appraised value appraised value . . � � Notes payable and long Notes payable and long- -term debt at term debt at present value present value of amounts to be paid. of amounts to be paid. � � Remember: If an asset can not be reliably measured, it is not an asset per GAAP asset per GAAP – – Remember: If an asset can not be reliably measured, it is not an i.e., auditors and users are looking for reliable estimates of value to be presented in alue to be presented in i.e., auditors and users are looking for reliable estimates of v the financial statements. Note how subjectivity and judgment is the financial statements. Note how subjectivity and judgment is required for most of required for most of these fair value calculations. these fair value calculations.
Presentation to Accounting Firm Presentation to Accounting Firm Pre- Pre -FAS 157 Retrospective FAS 157 Retrospective - - continued continued � � Recall the environment for financial reporting and valuation Recall the environment for financial reporting and valuation � Private Securities Litigation Reform Act of 1995 � Private Securities Litigation Reform Act of 1995 � Provided some safe harbors for accounting firms, investment bank � Provided some safe harbors for accounting firms, investment bankers and company ers and company management that were getting sued for alleged material misrepresentations to entations to management that were getting sued for alleged material misrepres investors. investors. � � Enron Enron – – Mid Mid- -2001 2001 � On October 17, 2001, Enron announced that its third � On October 17, 2001, Enron announced that its third- -quarter results were negative quarter results were negative due to one due to one- -time charges of over $1 billion. Enron management claimed the l time charges of over $1 billion. Enron management claimed the losses osses were mostly due to investment losses, along with charges such as about $180 about $180 were mostly due to investment losses, along with charges such as million in money spent restructuring the company's troubled broadband trading unit. dband trading unit. million in money spent restructuring the company's troubled broa � � Enron asserted that the broadband unit alone was worth $35 billi Enron asserted that the broadband unit alone was worth $35 billion, a claim also on, a claim also mistrusted. "I don't think anyone knows what the broadband opera mistrusted. "I don't think anyone knows what the broadband operation is worth," tion is worth," said Todd Shipman, an analyst at Standard and Poor’ ’s. s. said Todd Shipman, an analyst at Standard and Poor � Sarbanes � Sarbanes – – Oxley Act of 2002 Oxley Act of 2002 � Introduced major changes to the regulation of financial practice � Introduced major changes to the regulation of financial practice and corporate and corporate governance governance � Addressed the issue of Lack of Auditor Independence with regard � Addressed the issue of Lack of Auditor Independence with regard to valuation services to to valuation services to clients. clients.
Presentation to Accounting Firm Presentation to Accounting Firm Statement of Financial Accounting Standard No. 157 Statement of Financial Accounting Standard No. 157 (Fair Value Measurement) (Fair Value Measurement) � FAS 157 is the new guidance on the measurement of fair value for � FAS 157 is the new guidance on the measurement of fair value for assets and liabilities. Most companies adopted FAS 157 in the assets and liabilities. Most companies adopted FAS 157 in the beginning of 2007. beginning of 2007. � The Financial Accounting Standards Board ( � The Financial Accounting Standards Board (“ “FASB FASB” ”) first considered ) first considered applying fair value to financial assets and liabilities as far back as 1999 applying fair value to financial assets and liabilities as far b ack as 1999 (FAS 159). (FAS 159). � In 2001, FASB affirmed its ultimate goal of requiring essentiall � In 2001, FASB affirmed its ultimate goal of requiring essentially all financial y all financial assets and liabilities to be measured at fair value in financial statements. assets and liabilities to be measured at fair value in financial statements. � Fair Value project added to FASB agenda in June 2003 � Fair Value project added to FASB agenda in June 2003 � Exposure Draft issued in 2004 � Exposure Draft issued in 2004 � � 100 Comment Letters Received 100 Comment Letters Received � Final Statement (FAS 157) issued in September 2006 � Final Statement (FAS 157) issued in September 2006 � IASB has exposed FAS 157 for comment with view toward convergenc � IASB has exposed FAS 157 for comment with view toward convergence by e by 2010 2010
Presentation to Accounting Firm Presentation to Accounting Firm FAS 157 (Fair Value Measurement) FAS 157 (Fair Value Measurement) � Under FAS 157, � Under FAS 157, “ “Fair Value Fair Value” ” is defined is defined as follows: as follows: The price that would be received to sell an asset or paid to transfer a The price that would be received to sell an asset or paid to tra nsfer a liability in an orderly transaction between market participants at the at the liability in an orderly transaction between market participants measurement date. measurement date. FAS 141 (June 2001) defined fair value as “ “the amount at which an asset the amount at which an asset FAS 141 (June 2001) defined fair value as (or liability) could be bought (or incurred) or sold (or settled) in a current (or liability) could be bought (or incurred) or sold (or settled ) in a current transaction between willing parties, that is, other than in a forced or transaction between willing parties, that is, other than in a fo rced or liquidation sale. liquidation sale.
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