Fair Value Accounting
FASB Statement No. 157, Fair Value Measurements
Fair value accounting (a.k.a. mark-to-market) is a way to measure assets and liabilities that appear on a company’s balance sheet and income statement. Measuring companies’ assets and liabilities at fair value may affect their income statement. FASB issued FAS 157 in 2006 to be effective for fiscal year 2008. Huge losses reported by financial firms on subprime assets have led to a debate over the implementation of FAS 157 in circumstances where markets collapse and price inputs aren’t readily available.
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Fair value headlines
Fair value suspension not likely
Cox indicates direction of final report to Congress
The SEC is not likely to recommend a suspension of the highly controversial fair value accounting rule in its report to Congress in January. SEC Chairman Christopher Cox indicated the direction of the SEC in a speech at an AICPA conference telling attendees that financial reporting should not be compromised to meet the needs of other.
Bankers plea for fair value action from Treasury
FEI & U.S. Chamber request fair value delay from FASB
The American Bankers Association (ABA) sent a letter last week to U.S. Treasury Secretary Paulson that recommends immediate steps to be taken to avoid unnecessary hits to financial institutions’ capital.
Credit crisis roundtables continue as fair value debate rages on
AICPA urges SEC to support FASB as standard-setter
FASB and the International Accounting Standards Board (IASB) have scheduled three roundtables around the globe to identify financial reporting issues highlighted by the global financial crisis.
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What is fair value accounting?
Fair value accounting (a.k.a. mark-to-market) is a way to measure assets and liabilities that appear on a company’s balance sheet and income statement. Measuring companies’ assets and liabilities at fair value may affect their income statement. FASB issued FAS 157 in 2006 to be effective for fiscal year 2008. SFAS 157 defines in one place the meaning of “fair value.”
Why is it important today?
Huge losses reported by financial firms on subprime assets have led to a debate over the implementation of FAS 157 in circumstances where markets collapse and price inputs aren’t readily available. In the current crisis, banks and investment banks have had to reduce the value of the mortgages and mortgage-backed securities to reflect current prices. Those prices declined severely with the collapse of credit markets as mortgage defaults escalated.
What does SFAS 157 apply to?
The fair value accounting standard SFAS 157 applies to financial assets of all publicly-traded companies in the U.S. as of Nov. 15, 2007. It also applies to non-financial assets and liabilities that are recognized, or disclosed, at fair value on a recurring basis.
Beginning in 2009, the standard will apply to other non-financial assets. FAS 157 applies to items for which other accounting pronouncements require or permit fair value measurements except share-based payment transactions, such as stock option compensation.
What are the three pricing input levels?
The term inputs is used in FAS 157 and is used in applying various valuation techniques (approaches). Inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk.
To increase consistency and comparability in fair value measurements and related disclosures, SFAS 157 created a fair value hierarchy. The hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels.
The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1), and the lowest priority to unobservable inputs (Level 3).
What is the definition of Level 1 inputs?
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. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.
What is the definition of Level 2 inputs?
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. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs would include, for example, quoted prices for similar assets or liabilities.
What is the definition of Level 3 inputs?
Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs should 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 should remain the same; that is, an exit price from the perspective of a market participant that holds the asset or owes the liability.
Unobservable inputs should 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 should be adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use different assumptions.
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