1. Presented by Alfred M. King, CMA,CFM October 6, 2008
Fair Value GAAP vs. IFRS
Presented by
Alfred M. King, CMA,CFM
October 6, 2008

2. Convergence or Conversion of GAAP-IFRS
World is going towards one set of accounting standards but is IFRS truly uniform?
United States conceded that IFRS is more widely used, so U.S. will change – but when?
Securities and Exchange Commission:
Currently allows foreign filers to use IFRS
Starting in voluntary adoption of IFRS by U.S. Companies
Starting in mandatory adoption of IFRS by all public companies – private companies will follow!

3. Problems with Convergence
Principles vs. Rules – Is this distinction a myth?
Business complexity = complex rules
Will IFRS have to adopt ‘Rules’ over time?
Funding and Membership in IASB
What happens if our SEC disagrees with IFRS?
Transition
Training of preparers – option for early adoption by large companies
Training of auditors

4. Fair Value vs. Fair Market Value
There are real differences among:
Fair Market Value (not used for financial reporting)
Fair Value – GAAP
Fair Value – IFRS
Difference in concept of Fair Value between GAAP and IFRS has not been resolved

5. Exit Value – GAAP Concept
“¶5. 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.”
This concept works for financial instruments and does not work for tangible and intangible assets

6. Fair Value – IFRS Concept
“Fair Value is the amount for which an asset could be exchanged, a liability settled, or an equity instrument granted could be exchanged between knowledgeable, willing parties in an arm’s length transaction” [IFRS 2, Appendix A]

7. Exit Value
GAAP concept of valuing something at what it could be sold for today, to a ‘market participant’ works only if there is a market with market participants
U.S. and EU experience recently with sub-prime securities indicates that often there is no market, and no market participants willing to make a market

8. How to Value When There Are No Participants
FASB set up levels 1 through 3
Level 1 – quoted prices
Level 2 – no direct quotes but similar assets
Level 3 – all other
Valuation specialists are always working in Level 3
Level 3 allows for Income Approach and Cost Approach but these are considered “entity specific values” and are 2nd class!

9. Entity Specific Values
“Highest and Best Use” is the premise of value in all cases, e.g. parking lot in downtown Manchester has to be valued for development
Highest and Best Use will depend on who is going to use the asset and what they will do with it – Could you develop the site?
If not, you would offer less than would a developer who would buy the land based on his assessment of the real estate market

10. Fair Value - IFRS Considers both buyer and seller
IASB would like to ‘converge’ their definition with U.S. SFAS 157
About half the IASB members, however, are uncomfortable with how the U.S. definition is working in practice
Theoretically, at least, IASB believes the U.S. concept may be correct but not how it is applied

11. New FV Definition from IASB?
No decision until 2009
May not converge with U.S. SFAS 157
May stick to its definition
If that happens, quite likely that U.S. will converge to the IASB (!)
FASB is very aware of the problems they have created with Market Participants and Exit value

12. “Defensive Value” Common problem in Business Combination
Seller and Buyer each have competing brand names
Buyer wants to move Seller’s product line to use the Buyer brand name
Buyer won’t use the Seller’s brand
Buyer, however, would not sell Seller’s brand name to anyone else

13. What Is The Value of a Brand Name That Will Not Be Used?
A Financial Buyer would use the Seller’s brand name
Under U.S. definition of Fair Value whoever the buyer is we value the brand name on what someone else would pay for it, or a value in use to them
Now if the Strategic Buyer will not use it we still have to place a high value on it

14. “Day 2 Problem”
So for the Strategic Buyer we have to value the brand name as though someone would use it, even if it is never going to be used.
It is obvious that the real Fair Value, once there is no more advertising and marketing, is going to go down rapidly
The buyer will have an early impairment!

15. Solution to the Day 2 Problem
Have to change the definition of Fair Value to get away from rigid application of Exit concept
IASB looks as though their ultimate definition of Fair Value will likely be such that this problem may not be there
“Value in Use” still makes a lot of sense and may provide better information to users
IASB may permit, or even require in some cases, Value in Use

16. Fair Value and Impairment: Key Differences FASB vs. GAAP
Real Estate
Investment property
Agricultural/biological
IFRS permits/requires periodic revaluation up or down
U.S. GAAP absolutely prohibits write up
In U.S. this is a one-way street. Can take impairment loss but never an impairment gain – or even write back up to previous amount

17. IFRS Permits Revaluations
A literal reading of IFRS suggests that if they want to, companies can revalue other assets – for example intangibles
Brand Names
Patents
Will U.S. companies take advantage of this?
Look at Fair Value Option (SFAS 159)

18. Fair Value Option
Companies are permitted to revalue LIABILITIES if they wish
Banks and financial institutions have had to write down investments because of credit problems in the economy
SFAS 159 permits them to designate liabilities for same Fair Value treatment
So if a company’s credit rating drops, they can record a ‘GAIN’ which may offset the Fair Value loss on the investments – Bear Stearns example

19. Fair Value Option (2)
U. S. Investment Banks did take advantage of this rule, and literally wrote down the ‘value’ of their own bonds
If those debts will be ultimately repaid at Par (100 %) companies will have to reflect a LOSS to write up the liability
This accounting is hard to explain!!
The worse you do the better you look
The better you do the worse you look

20. My Conclusion
If U.S. companies adopt IFRS they will be at least tempted to write up all sorts of intangible assets to reflect their ‘true’ Fair Value
What will this do for valuation specialists?
Lots more work!
What will this do for the integrity of financial statements?

21. Asset Impairment
Impairment indicators are essentially the same between GAAP and IFRS
IFRS writes down to Fair Value when FV is less than carrying value
No intermediate cash flow test
IFRS looks to the higher of:
Net selling price (exit value)
Value in Use (entity specific)

22. Asset Impairment (2) United States has three different methods
SFAS 144 for fixed assets and intangibles
SFAS 142 for indefinite life intangibles
SFAS 142 for testing goodwill
SFAS 144 calls for a determination as to whether the SUM of all future cash flows, NOT DISCOUNTED is equal to or larger than carrying value
Can never write back up once loss recognized

23. Research & Development
‘Research’ expensed in both systems
‘Development’ is capitalized in IFRS and expensed in GAAP
Under SFAS 141R, purchased In-Process R&D will be capitalized, but further expenditures will be expensed
Basic question:
Is the true Fair Value of R&D properly measured based on costs incurred?

24. Valuing Liabilities and Contingencies
Rules calling for what you could pay someone to take on your liabilities makes no sense
Should allow companies to determine the Present Value or Expected Value of what they anticipate paying to settle liabilities and contingencies
GAAP values contingencies only in a Business Combination

25. Can We Value Contingencies?
Contingent payment in a Business Combination
Settle Environmental Liabilities
‘Fair Value’ of lawsuits
New SFAS 141R requires this

26. Revenue Recognition GAAP has over 200 items in the literature
IFRS is very general
Revenue Recognition is a big item at least in the U.S.
FASB looks to ‘Fair Value’ as one way of measuring Revenue Recognition.
Suzie’s sweater example

27. Is There Such a Thing as The Fair Value?
The value of an asset depends on who is going to use it, and for what purpose
How can anyone write a set of rules that provides ‘consistency’ among preparers and yet reflects economic reality?
FASB and IASB would like a “one size fits all” solution in terms of defining Fair Value
This can not be done!

28. Where Are We Going? Personal views:
Recent problems in valuing subprime assets will slow down move to increased Fair Value
Convergence of IFRS and GAAP will be much harder (and slower) than anticipated
LIFO problem
Different versions of IFRS
Demand for Fair Value by Security Analysts will continue and even increase

29. The Future of the Valuation Business

30. Please feel free to contact me for information at any time:
Questions?
Presentation by:
Alfred M. King, CMA, CFM
Vice Chairman,
Marshall & Stevens, Inc.
Please feel free to contact me
for information at any time: