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© Grant Thornton LLP. All rights reserved. Statement 157 Measuring the Fair Value of Financial Assets Market participants Unit of account Inputs to valuation techniques Unit of valuation Highest and best use / valuation premise Principal or most advantageous market Exit price Fair Value FV Hierarchy
© Grant Thornton LLP. All rights reserved. The Public’s View of Financial Statements?
© Grant Thornton LLP. All rights reserved. Recap of Statement 157 Definition of fair value The price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (Statement 157, paragraph 5) Definition assumes a hypothetical transaction at the measurement date, considered from the perspective of a market participant Market participants must be… –Independent of reporting entity –Knowledgeable –Willing to transact, but not forced to do so –Able to transact
© Grant Thornton LLP. All rights reserved. Why Fair Value? GAAP Qualitative Characteristics 1.Relevance – Can make a difference to user’s decisions by improving their capacities to predict or by providing feedback on earlier expectations. May vary from user to user. 2.Reliability – The quality of information that assures that information is reasonably free from error or bias, faithfully represents what it purports to represent and is verifiable. 3.Comparability – Can be compared with similar information about other enterprises. 4.Consistency – Can be compared with similar information about an enterprise across time
© Grant Thornton LLP. All rights reserved. Why Fair Value? Tension Between Reliability and Relevance FASB “has required greater use of fair value measurements in financial statements because it perceives that information as more relevant to investors and creditors than historical cost information...The board has been mindful of reliability concerns associated with fair value measures, particularly when such measures may not be able to be observed in active markets and greater reliance must be placed on estimates of those measures.” Source: Todd Johnson, “Relevance and Reliability,” The FASB Report, February 28, 2005.
© Grant Thornton LLP. All rights reserved. Why Fair Value? Relevance 22% of total intangibles value is reported on the balance sheet
© Grant Thornton LLP. All rights reserved. Why Fair Value? Relevance American businesses, investors, regulators and policymakers are flying blind. The United States is now in an intangible economy, but financial reporting and accounting systems can’t deal with intangibles. Our business reporting system is, in many ways, not even adequate for the Industrial Age, let alone the Information Age. As a consequence, business, investment and economic policy decisions are being made “in the dark” (to quote the title of a recent study).” Source: In the Dark: What boards and executives don’t know about the health of their businesses, a survey by Deloitte in cooperation with the Economist Intelligence Unit, October 2004,.
© Grant Thornton LLP. All rights reserved. Summary of FAS 157 Concepts Market participants Unit of account Inputs to valuation techniques Unit of valuation Highest and best use / valuation premise Principal or most advantageous market Exit price Fair Value FV Hierarchy
© Grant Thornton LLP. All rights reserved. Recap of Statement 157 Fair Value Hierarchy LevelTypes of InputsReliability 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities Highly reliable/ Verifiable 2 Inputs other than level 1 inputs that are either directly or indirectly observable (Valuation techniques – observable inputs) Moderately reliable 3 Unobservable inputs developed using the reporting entities’ estimates and assumptions, which reflect those that market participants would use (Valuation techniques – unobservable inputs) Less reliable/ Subjective
© Grant Thornton LLP. All rights reserved. Market participants This is a vital consideration, particularly with respect to the valuation of intangible assets and reporting units – concluded values will depend on issues such as the type of MP: Strategic buyers: often share some of the same synergies as the buyer, as well as the same intentions with respect to abandonment of acquired assets Financial buyers: often do not share synergies or buyer intentions
© Grant Thornton LLP. All rights reserved. Recap of Statement 157 Observations from applying Statement 157 The key concepts in Statement 157 are interrelated Statement 157 requires judgment Actual transaction price may not be fair value (exit price) Determination of the market participant is vital to the fair value measurement. The highest and best use concept requires entities to think about how a market participant would use the asset, not just how the entity uses the asset.
© Grant Thornton LLP. All rights reserved. Recap of Statement 157 Observations from applying Statement 157 The purpose of fair value hierarchy is to (1) prioritize the inputs to valuation techniques, not the valuation techniques themselves and (2) provide users with disclosure about the reliability of the fair value measurements. Fair value measurements that include adjustments to level 1 or level 2 input or utilize significant level 3 inputs are areas where there is a greater need to utilize a valuation specialist.
© Grant Thornton LLP. All rights reserved. Challenges in applying Statement 157 Consistency from reviewer to reviewer Consistency from period to period Long term versus short term equity risk premium versus credit spread Control premium – based on transaction versus market participant synergies Reconciling the public market capitalization to the aggregate values of the business reporting units Litigation risk in Fair Value accounting
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