FASB Issues FAS 157: Fair Value Measurement
September 15, 2006
On Sept. 15, 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurement” (FAS 157). The new standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. FASB states FAS 157 “does not expand the use of fair value in any new circumstances.”
How FAS 157 Changes Current Practice
FAS 157 will change current practice by:
Defining fair value: “Fair value 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.”
Requiring certain methods to be used to measure fair value: measured as a market-based measurement, not an entity-specific measurement, based on assumptions market participants would make in pricing the asset or liability. FAS 157 establishes a three level hierarchy for measuring fair value, described further below.
Expanding disclosures about fair value measurements
Three Level Hierarchy
Entities are to use inputs for measuring fair value according to the three level hierarchy established in FAS 157, using the highest level possible (e.g., Level 1) if such inputs are available, and if not, going to the next lower level. The three levels for measuring fair value are:
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include:
a. Quoted prices for similar assets or liabilities in active markets;
b. Quoted prices for identical or similar assets or liabilities in markets that are not active, that is, markets in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers (for example, some brokered markets), or in which little information is released publicly (for example, a principal-to principal market);
c. Inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, loss severities, credit risks, and default rates);
d. Inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated inputs).
Level 3 inputs are unobservable inputs for the asset or liability.
Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.
However, the fair value measurement objective remains the same, that is, an exit price from the perspective of a market participant that holds the asset or owes the liability.
Therefore, unobservable inputs shall reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk).
Unobservable inputs shall be developed based on the best information available in the circumstances, which might include the reporting entity’s own data.
In developing unobservable inputs, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions.
However, the reporting entity shall not ignore information about market participant assumptions that is reasonably available without undue cost and effort. Therefore, the reporting entity’s own data used to develop unobservable inputs shall be adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use different assumptions.
Effective Date and Transition
FAS 157 is effective for financial statements issued for fiscal years beginning after Nov. 15, 2007 and interim periods within those fiscal years.
Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year.
FAS 157 is to be applied prospectively as of the beginning of the fiscal year in which it is initially applied, with certain exceptions listed below:
o Exceptions requiring retrospective treatment are for certain financial instruments requiring retrospective treatment, including financial instruments previously measured using a blockage factor, financial instruments previously measured using transaction price in accordance with FAS 133, and hybrid financial instruments previously measured using transaction price guidance set forth in FAS 155.
The transition adjustment, measured as the difference between the carrying amounts and the fair values of those financial instruments at the date FAS 157 is initially applied, should be recognized as a cumulative-effect adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for the fiscal year in which FAS 157is initially applied.
FAS 157, “Fair Value Measurement” [this link is to the complete version of FAS 157 posted by FASB Sept. 20, 2006, including Appendix E]
FASB Summary of FAS 157
FASB Press Release announcing issuance of FAS 157
Prepared Sept. 16, 2006 by Edith Orenstein (firstname.lastname@example.org), Director, Technical Policy Analysis, Financial Executives International (FEI). This summary does not represent FEI opinion, unless specifically noted above.
FASB Issuing Proposed FSP On Fair Valuing Bus Comb And Impairment
September 13, 2006
At its Sept. 13, 2006 board meeting, the Financial Accounting Standards Board (FASB) voted 4-3 to issue for public comment proposed FASB Staff Position (FSP) No. FAS No. 141-b, 142-e, and 144-b, “Fair Value Measurements in Business Combinations and Impairment Tests.”
The proposed FSP would amend FAS 141, 142, and 144 to clarify existing guidance on fair value measurements in those standards, and would be effective until the reporting entity adopts FAS 157, “Fair Value Measurements” – which was said to be “in production” and to be issued soon. Further details are on pg. 11 of the board handout.
Financial Guaranty Insurance, FIN 46R for Investment Companies
Also discussed at the September 13 FASB board meeting was Financial Guaranty Insurance revenue recognition and acquisition cost allocation (pages 1-6 of board handout).
Additionally, FASB voted 4 to 3 to clear AcSEC’s proposed SOP, Clarification of the Scope of the Audit and Accounting Guide, Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies. (In clearing the SOP, various board members noted it would be important to consider interaction with FASB’s upcoming Fair Value Option standard.)
However, FASB did not yet support issuance of a related proposed FSP - FSP FIN 46 (R)-d, “Application of FASB Interpretation No. 46(R) to Investment Companies” - pending further analysis. FASB Chairman Robert Herz said he wanted to be sure the FSP would not create a way to “inadvertently circumvent” FIN 46R. Details are on pages 7-10 of the board handout.
Prepared Sept. 13, 2006 by Edith Orenstein (email@example.com), Director, Technical Policy Analysis, Financial Executives International (FEI), based on listening to the webcast of the FASB meeting. This summary does not represent FEI opinion, unless specifically noted above
FASB Fair Value Option to Remain ‘Optional’
September 6, 2006
On Sept. 6, 2006, the Financial Accounting Standards Board (FASB) redeliberated its proposed Fair Value Option (FVO) standard, based on comments received on the related Exposure Draft (ED).
Fair Value Option will remain ‘optional’
The board reaffirmed the FVO standard would permit - but not require - Fair Value (FV) measurement to be elected for certain financial assets and liabilities, maintaining the “optionality” of the standard. (NOTE: certain other standards already require FV treatment for certain financial assets and liabilities.)
Fear of a “free-for-all,” but commitment to incremental movement toward fair value
Under the FVO standard, companies would be required to designate election of FV at the date the related financial asset or liability is recognized, with the election made on a contract-by-contract basis (subject to further guidance the staff will draft on what “contract” means). The board also agreed not to specify eligibility criteria. Some board members expressed concern that the standard would create a “free-for-all” as to what is carried at fair value and what is not, but the board essentially agreed to continue on its current incremental path (via the FVO standard) toward potentially requiring fair value measurement for all financial assets and liabilities (as part of a broader, longer term project).
Designation will be required in the standard; documentation up to preparers/auditors
Although the board will require designation of use of the FVO at the date the financial asset or liability is recognized, they will not set forth documentation requirements in the standard. Board members noted documentation is something that should be discussed between preparers and their auditors.
Changes to proposed disclosure requirements
The board agreed to revise the FVO proposed standard (vs. the earlier ED) as follows:
o Clarify that the entity is required to disclose information sufficient to users about changes in fair value for those items for which the FVO has been elected rather than disclosure of the effect on earnings resulting from election of the FVO.
o Require an entity that is reporting a financial liability at fair value and has experienced a significant change in creditworthiness during the reporting period to disclose an approximation of the amount of change attributable to its creditworthiness that is included in current period earnings.
o For only the fair value measurements that, in their entirety, fall within Level 3 of the fair value hierarchy defined in the soon to be issued Fair Value Measurement (FVM) standard, the FVO standard will:
(a) require disclosure of the method and significant assumptions used to estimate fair value and
(b) encourage disclosure of quantitative information about the market risks of instruments that is consistent with the way it manages or adjusts those risks.
Additional information on issues discussed relating to the FVO is available on pages 5-12 of the September 6 FASB board handout.
Derivatives Disclosures Project Will Not Address Financial Statement Presentation
Separately discussed at the September 6 board meeting was FASB’s Derivatives Disclosures project.
The board agreed not to expand the current scope of the project to include financial statement presentation and classification. However, the FASB may include a question in the “Notice to Recipients” in the Exposure Draft, asking if the proposed disclosure tables meet users’ needs, or if they need a “better trail” into how derivatives are presented in the financial statements. Additional issues discussed on the Derivatives Disclosures project are outlined on pages 1-4 of the September 6 FASB board handout.
Prepared Sept. 6, 2006 by Edith Orenstein (firstname.lastname@example.org), Director, Technical Policy Analysis, Financial Executives International (FEI), based on listening to the webcast of the FASB meeting. This summary does not represent FEI opinion, unless specifically noted above.