Fair Value Measurements

Nov 4th, 08

FASB Statement 157 provides enhanced guidance for using fair value to measure assets and liabilities (both financial and nonfinancial). The standard defines fair value, expands disclosures about fair value measurements, is effective for financial statements issued for fiscal years beginning after November 15, 2007, and is to be applied prospectively. This guidance applies whenever other standards require assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. The Statement defines fair value as “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.” The main components of the Statement include:

A hierarchy for all fair value determinations:
Level 1 – quoted prices in active markets for identical assets and liabilities
Level 2 – available indirect information such as quoted prices for similar assets and liabilities in active markets or quoted prices for identical or similar in inactive markets
Level 3 – generally based on entity’s own assumptions and best information available
Valuation techniques for small nonpublic entities:
Current Market Price – includes recent trades for same assets, for similar assets, etc
Current Replacement Cost – amount paid currently to replace the same or similar asset
Discounting Future Cash Flows – present value of net cash flows expected to be realized from an asset either from continued use or its eventual disposition (discounted net realizable value, etc)
Disclosures – required to be in tabular format
Fair value measurements at the reporting date
Input level used to measure fair value – separate by level of input
For level 3 measurements – reconciliation of beginning and ending balances, presenting separately changes due to realized and unrealized gains and losses; purchases, sales, issuance, and settlements; and transfers in and out of Level 3
For level 3 measurements – amount of total gains and losses that are caused by changes in unrealized gains or losses for those assets and liabilities held at the reporting date – include details of where those gains/losses are reported in the income statement
Valuation techniques used to measure fair value
Example disclosure:
Assets measured at Fair Value on a Recurring Basis:

		Fair Value Measurements at Reported Date Using:
Description	12/31/xx	Quoted prices in active markets for identical assets (Level 1)	Significant Other Observable Input (Level 2)	Significant Unobservable Inputs (Level 3)
Common Stock	100	80	20
Derivatives	60	25	15	20
Real Estate	10			10

In February 2008 the FASB issued Staff Positions 157-1 and 157-2 which partially deferred the effective date for one year (fiscal years beginning after November 15, 2008) for certain nonfinancial assets and liabilities. The deferral does not apply to financial assets and liabilities A financial asset is defined as “cash, evidence of ownership interest in an entity, or a contract that conveys to one entity a right to receive cash or another financial instrument from a second entity or to exchange other financial instruments on potentially favorable terms with the second entity.” A financial liability is defined as “contract that imposes on one entity an obligation to deliver cash or another financial instrument to a second entity or to exchange other financial instruments on potentially unfavorable terms with the second entity.”

The FASB also issued Staff Position 157-3 in October 2008 which provides additional clarifiaction for the application of Statement 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value when the market for that financial asset is not active.