Fair Value Accounting Gets Additional Guidance

||Fair Value Accounting Gets Additional Guidance

Fair Value Accounting Gets Additional Guidance

The Financial Accounting Standards Board (FASB) issued Statement 157 entitled “Fair Value Measurements” on September 15, 2006. The statement defines fair value, establishes a framework for measuring fair value in generally accepted account principles (GAAP), and expands disclosure about fair value measurements.

The statement does not require new fair value measurements, but it amends existing guidance where fair value is already part of GAAP. There are currently over 40 other pronouncements that require fair value measurements. Some of these pronouncements had inconsistent measurements, particularly when quoted market prices were not readily available.  The new pronouncement is therefore expected to simplify GAAP’s existing complexity.

Under the new rules, fair value is an exchange price in an orderly transaction between market participants to sell the asset or transfer the liability. The price is an exit price in a market transaction, not the price for the reporting entity to purchase the asset or assume the liability (an entry price). Consequently, fair value is not a reporting entity-specific measurement that takes into account unique circumstances of the entity that is preparing the accounting measurement.

The standard continues to recognize commonly-accepted valuation approaches, namely the various cost, market, or income-based calculations. However, to increase consistency, the standard provides a hierarchy of preferred methods based on the available market data. The hierarchy is as follows:

1.    Quoted prices in active markets for the identical asset or liability being measured. In this situation, the price is readily ascertainable without serious analysis, and is not to be adjusted for size.

2.    Observable data that is usually interpreted by an appraiser. This includes (i) market transactions for similar assets, (ii) data from small/inactive markets, and (iii) inputs that directly correlate with economic data affecting the items being valued.

3.    Unobservable data that comes from the entity’s own data or economic models. If material to the financial statements, this measurement will likely require a skilled appraiser (called Type 3 in the pronouncement).

Footnote disclosures include (i) the assets ands liabilities reported at fair value, (ii) the means and information sources used to determine fair value, (iii) for Type 3 measurements, a reconciliation of the beginning and ending balances, and the related gains and losses involved, and (iv) changes in the valuation approaches and assumptions compared to the prior year.

The effect of this statement will increase as the FASB continues to require additional fair value reporting. Calendar year companies are required to fully adopt the statement in their interim and December 31, 2008 financial statements, although earlier adoption is encouraged.

Fulcrum Inquiry is a licensed CPA firm. We perform business and business-related appraisals.

 

2019-01-14T16:08:48+00:00Valuation and Appraisal|

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