Fair Value Measurements

ASC 820 (FAS 157) Fair Value Disclosures

Acct 414

ASC 820 (FAS 157):Definition of Fair ValuePrice 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

An exit price notion for a hypothetical transaction; may or may not equal actual entry priceNot adjusted for transaction costsNot based on value to current owner or

company-specific assumptions

Entry price vs. Exit priceMaterials &

Labor Markets

Manu-facturer

Wholesale Market

DealerRetail MarketConsumer

2nd Hand Market

FASB’s Solution: “highest and best use”

Statement 157:Approach to Measuring Fair Value

THE ASSET OR LIABILITY

Indicated ValueUnit of Valuation

Market ParticipantAssumptions

Fair ValueMeasurement

F/S Presentation and Disclosure

Inputs to Valuation TechniquesAttribute Value to Asset or Liability

at Unit of Account Level

Highest andBest Use

Exit Market

ValuationPremise

Unit ofAccount

Unit ofValuation

FAS 157 - Exit Market

First Choice:Principal market is the market with the greatest volume and level of activity for asset or liability

If there is no principal market :

Most advantageous market maximizes the amount that would be received for the asset or minimizes the amount that would be paid to transfer the liability, considering transaction costs

• The market in which the ENTITY would sell the asset or transfer the liability

Market ParticipantAssumptions

Highest andBest Use

Exit Market

ValuationPremise

FAS 157 - Market Participant Assumptions

Market participants are buyers and sellers in the exit market (other entities with whom the entity would transact)

• A fair value measurement should be determined based on the assumptions market participants would use in pricing the asset or liability, including assumptions about (measurement) risk, highest and best use (if asset), and nonperformance risk (if liability)

Market ParticipantAssumptions

Highest andBest Use

Exit Market

ValuationPremise

Unit of Valuation

Market ParticipantAssumptions

Highest andBest Use

Exit Market

ValuationPremise

In-use or in-exchange

Use by market participants that maximizes value of asset (or asset group)

• The unit of valuation depends on the highest and best use of the asset, which establishes the valuation premise used to measure the fair value of the asset

Statement 157:Approach to Measuring Fair Value

THE ASSET OR LIABILITY

Indicated ValueUnit of Valuation

Market ParticipantAssumptions

Fair ValueMeasurement

F/S Presentation and Disclosure

Inputs to Valuation TechniquesAttribute Value to Asset or Liability

at Unit of Account Level

Highest andBest Use

Exit Market

ValuationPremise

Unit ofAccount

Unit ofValuation

FAS 157 - Inputs to Valuation Techniques

Market participant assumptions are incorporated in the fair value measurement through the inputs to valuation techniquesObservable inputs

Developed based on market data obtained from sources independent of the reporting entity

Unobservable inputs Developed based on the best information available in the

circumstances, subject to cost-benefit constraint

A fair value measurement should maximize the use of observable inputs

From:Refining Fair Value Measurement,Miller, Paul B. W.; Bahnson, Paul R.. Journal of Accountancy, Nov2007, Vol. 204 Issue 5, p30-36,

Statement 157 - Fair Value Hierarchy

Level 1 Quoted prices in active markets for identical assets/ liabilities (unadjusted); no blockage factors (Price x Quantity)

Level 2 Other observable inputs—include quoted prices for similar assets/ liabilities (adjusted) and market-corroborated inputs

Level 3 Unobservable inputs—entity’s own assumptions about market participant assumptions, including assumptions about risk, developed based on the best information available in the circumstances (subject to cost-benefit constraint); might include the entity’s own data

Last Step - Disclosures

Fair ValueMeasurement

F/S Presentation and Disclosure

THE ASSET OR LIABILITY

Indicated ValueUnit of Valuation

Market ParticipantAssumptions

Inputs to Valuation TechniquesAttribute Value to Asset or Liability

at Unit of Account Level

Highest andBest Use

Exit Market

ValuationPremise

Unit ofAccount

Unit ofValuation

FAS 157 - DisclosuresExtensive disclosures to indicate the “quality”

of fair value measurements by the 3 categories of inputs

For regularly re-valued assets & liabilities:

FAS 157 - DisclosuresFor regularly re-valued assets & liabilities that

use a lot of Level 3 unobservable inputs – there is more:

FAS 157 - DisclosuresFor assets & liabilities not regularly revalued:

The steps to FV measurement1. Identify asset or liability being measured (unit

of account)2. Determine the exit market3. Identify the market participants in the exit

market4a. Determine the highest and best use for an

asset or nonperformance risk for a liability being valued

4b. Determine the valuation premise (in-use vs. in-exchange) based on highest and best use for an asset group of assets, reporting unit, or business being valued.

4c. Determine the unit of valuation based on the highest and best use and the valuation premise

The steps to FV measurement5. Determine a value for the unit of valuation

based on market participant assumptions and other market-based inputs, and apply one or more appropriate valuation techniques5a. If applicable, impute value determined in

Step 5 to the unit of account6. Classify inputs used in Step 5 as Level 1, 2,

or 3 and then classify the fair value measurement in its entirety to prepare SFAS No. 157 disclosures

Let’s look at HW#3Problem 3 – using level 1 & 2 inputs to

determine fair value of bondsLet’s look at Bond 2:Term = 6 years, rating = BBB

Note: this is probably “level 2” since we don’t have an EXACT quotation for a market price for the exact bonds the company is holding

Bond 2: Term = 6 years, rating = BBB

Term (in years)

AAA AA A BBB BB

2 103.85 103.56 102.71 102.37 100.29 5 103.66 102.53 101.45 100.17 98.50

10 101.64 100.29 99.56 98.54 91.98 20 95.66 91.49 90.00 89.10 82.06

Standard & Poor's Bond Ratings

$1,000 face value * .99844 (approximation) = $998.44 fair value

Let’s try another one, $1000 Bond: Term = 8 years, rating = A

Term (in years)

AAA AA A BBB BB

2 103.85 103.56 102.71 102.37 100.29 5 103.66 102.53 101.45 100.17 98.50

10 101.64 100.29 99.56 98.54 91.98 20 95.66 91.49 90.00 89.10 82.06

Standard & Poor's Bond Ratings

HW #3 (small groups okay)The first two problems are related to

understanding the “fair value option”You will also practice fair value disclosures

Problems 4 and 5 will let you try your hand at creating the disclosure tables required under ASC Topic 820Use the “handout” files to get examples from FASB or

find them in the FASB codificationThere are also examples are in Appendix 17C in

textbookTo this assignment, you will attach the FAIR VALUE

part of the HW#2 serial bond problem