Fair Value Issues

Recent Developments in Valuations

For Fair Value Accounting

The fair value accounting disclosures continue to become an important aspect of the financial statements of businesses in the United States. This fair value accounting topic continues to receive a lot of discussion that has caused much valuation controversy. These valuations may include analyses of all different types of assets, real property and business interests. The valuation analyst should understand that these valuations will most likely be subject to thorough evaluation and scrutiny by the client’s auditor. Consequently, the professionals who rely upon fair value valuations should understand current issues relating to this type of work.

1. Banks to “Mark to Market” Financial Instruments - In August 2009, the Financial Accounting Standard Board (“FASB”) proposed that all financial instruments should be marked to market on banking entities financial statements. This fair value disclosure could cause banks to recognize loan losses faster than they did in the past. Under the current requirements, the financial institutions are permitted to elect to disclose eligible items as fair value. The change would require all financial institution’s loans and other receivables to be reported at fair value.

2. What is Fair Value? - In the three years after the issuance of SFAS 157 (ASC 820), the definition of fair value is still not clear to many valuation analysts. The actual definition 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.” However, the valuation industry still seeks guidance for what “orderly transactions” are and who is a “market participant.” In addition, valuation analysts seek guidance with regard to the analysis of “highest and best use.” In real property appraisals, this concept is fairly straightforward. But, there can be questions relating to equity security and intangible assets

3. Need for Disclosure on the Use of Level 3 Valuation Inputs – In August 2009, FASB issued an exposure draft of a proposed Accounting Standard Update. In this exposure draft, the FASB proposes disclosure improvements about fair value measurements and the use of Level 3 unobservable valuation inputs. The proposed disclosure is any significant effect on the fair value measurement if the business has “reasonably possible alternative inputs.” The disclosure would be what the total effect is on the fair value measurement. This is also referred to as the “sensitivity disclosure.” Furthermore, the business would have to disclose the amount of significant transfers and the reason for the transfers in and out of Level 1 and Level 2 fair value measurements.

4. Measuring Liabilities at Fair Value – In August 2009, FASB issued an Update titled “Disclosure – Measuring Liabilities at Fair Value.” The FASB believed that there could be a lack of observable market information to measure the fair value of a liability. Consequently, the update addresses how to measure the fair value of a liability in a hypothetical transaction when restrictions prevent a transfer. The update also clarifies the use of or more valuation technique that uses the quoted price of an identical liability that has been traded, the quoted price of similar liabilities that have traded or an alternative valuation technique such as an income approach that computes the present value of cash flows.

The FASB continues to provide fair value accounting technical guidance. As U.S. GAAP and international GAAP continue to converge, the need for a clear understanding of fair value accounting issues will increase and valuation analysts who practice in this area must keep current.