FAS 157 - Fair Value

Fair Value
Measurements
SFAS 157
(973) 822-2220
Overview
Exceptions
Unit of Accounting
Market-based Measures
Considerations
Exit Price
Market Participants
Orderly Transaction
Highest Use / Principal Market
Transaction / Transportation
Fair Value Assets Fair Value Liabilities
Fair Value Approaches

Market Income Cost
Fair Value Hierarchy

Level I Level II Level III
Unit of Valuation
Reporting Requirements
Transition
2
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
3
Overview: SFAS 157 “Fair Value”
I. Reasons:
A. Over 60+ FASB standards depend upon fair value
measurements
B. Fair value definitions/approaches differ
C. Fair value definition/guidance has been limited
D. Has experienced an increased demand from users
4
1) Issues:
A. Different definitions and guidance in measurement of fair
value in various standards has led to inconsistency and
added to complexity in GAAP.
1. Statement 157 is principal guidance on fair value
measurements
B. Need for more transparency in financial statements
regarding fair value measurements.
KEYPOINT
• SFAS 157 does not require any new fair value
measurements, but provides guidance on how to
measure fair value.
5
1. Overview:
A. Defines fair value for financial reporting
B. Approach for measuring fair value is established
C. Disclosures about fair value are enhanced
D. Effective for fiscal years beginning after November 15,
2007 (2008 for a calendar year-end entity)
KEYPOINT
• Applies when other FASB standards require fair value
6
(i) SFAS 157: Definition of Fair Value
A. Defined:
“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.”
7
1) Current Applications
1. SFAS 115
Investment securities
2. SFAS 133
Derivative assets and liabilities
3. SFAS 141
Certain assets and liabilities measured at fair value in a
business combination (land and intangible assets)
4. SFAS 142 & 144
Assets measured at fair value for an impairment test (long-
lived assets held for sale and goodwill)
8
i) Use of SFAS 157 in the future
A. SFAS 157 shall apply to all future FASB statements that
require or permit fair value.
B. Upcoming statements:
1. Business Combinations (141-R) will require fair value
measurements for most assets and liabilities acquired,
including:
a. Contingent consideration
b. Acquired contingent assets and liabilities
c. Liabilities for restructuring or exit activities
2. The Fair Value Option for Financial Assets and Financial
Liabilities will permit fair value measurements
a. Notes and mortgage receivables (assets)
b. Issued debt (liabilities)
c. Cost and equity method investments
d. Certain insurance contracts
9
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
10
SFAS 157: Exceptions “scoped out”
I. The following exceptions were made to fair value
measurements or similar measurements for transactions
involving:
A. SFAS 123R
Share-based payments
B. SAB 101/104, SOP 97-2, SOP 98-9, and EITF 00-21
Vendor-specific objective evidence and software revenue
recognition
C. ARB 43
Inventory (accounted for in accordance with ARB 43)
KEYPOINT
• SFAS 107 and FIN 45 – the Statement does not remove
any practicability exceptions that currently exists in
GAAP.
11
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
12
Unit of Accounting
I. Unit of Accounting
A determination of whether as asset or liability that is
measured at fair value is either:
A. A stand-alone asset or liability, or
B. A group of assets and/or liabilities; depends on the unit of
account which is determined in accordance with other
applicable accounting standards.
1. Unit of account:
Establishes the asset or liability that is being measured at
fair value for purposes of financial reporting
2. Unit of valuation
Establishes whether the asset or liability is measured at fair
value within a larger group
KEYPOINT
• Attribute the indicated fair value of the group to the
asset or liability.
13
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
14
Considerations: Market-based Measures
I. Market-based Measures vs. Entity-specific Measures
A. Fair value is a market-based measure, not an entity-specific
measure.
B. The highest priority to quoted prices in active markets
C. Permits the use of unobservable inputs for situations in
which there is little, if any, market activity for the asset or
liability being measured.
KEYPOINT
• A company should consider:
i. Risk inherent in a particular valuation technique (such as an option pricing model) and/or
ii. Risk inherent in the inputs to the valuation technique
iii. A valuation technique should include an adjustment for risk (if market participants would
include such an adjustment in pricing a specific asset or liability)
15
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
16
Exit Price
I. Definition of Fair Value: Exit Market
A. Exit Price
1. Price in hypothetical transaction to sell an
asset or transfer a liability
2. Price at which a company would sell or
otherwise dispose of its assets or pay to settle
a liability (i.e., an exit)
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Exit Price
1) Entry Price
1. Not price in actual transaction to acquire an asset or assume
a liability
2. Not the market price that a company acquires or assumes a
liability (i.e., not an entry)
KEYPOINT
• The exit price concept is based on current expectations about the future inflows
associated with the asset and the future outflows associated with the liability from the
perspective of market participants.
• A fair value measure should reflect all of the assumptions that market participants
would use pricing the asset or liability
 Example: An adjustment for risk inherent in a particular market
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Exit Price
A. Transaction Costs
1. Not adjusted for transaction costs
KEYPOINT
• Financial institution industry will likely elect early adoption due to the SFAS
157 requirement, “Not Adjusted” for transaction costs.
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Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
20
Market Participants
I. Market Participants
Buyers and sellers, in an exit market (other entities with
whom the company would transact), that are
independent (unrelated / SFAS 57), able, and willing to
transact
A. Skepticism of a risk averse buyer.
B. Fair value should reflect how market participants would
value the asset, even if market participants would use the
asset differently than the owner’s intended use.
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Market Participants
1) Fair value measurement should be determined based on
assumptions market participants would use in pricing
the asset or liability, including
A. Assumptions about risk
B. Highest and best use (if asset)
C. Nonperformance risk (if liability)
• Fair value measures use the perspective of a market participant and their assumptions used
to price an asset or liability.
• Determining market participant assumptions will require management to use a significant
amount of judgment.
• Note: Management is permitted to use their own data to measure the fair value of an asset or
liability, however, such data should be adjusted if there is reasonably available information
that indicates market participants would use different assumptions.
22
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
23
Orderly Transaction
I. Orderly Transaction
A. Presumes that an asset or liability is exposed to the market
to allow for usual and customary marketing activities.
B. Not based on a transaction that is a forced sale, a
liquidation transaction, or a distress sale.
C. Based on an orderly transaction reflecting market
conditions on the measurement date.
D. In the absence of an actual transaction, the fair value is
measured based on a hypothetical transaction between
market participants and reflects market participant
assumptions.
24
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
25
I. Fair value measurement assumes transaction occurs in the
principal (or most advantageous) market:
A. Step 1
1. Principal market
The market with the greatest volume and level of activity for asset or
liability
B. Step 2
1. Most Advantageous Market
If there is no principal market, look to the most advantageous
market
a. Most advantageous market
Maximizes the amount that would be received for the asset, or
b. Minimizes the amount that would be paid to transfer the liability,
considering transaction costs
26
KEYPOINT
• Determining the appropriate market is done from the perspective of the
company, thereby allowing for differences among companies and the markets
in which those companies transact.
• If there is a principal market for the asset or liability, the price in that market
should be used to measure fair value even if the price in a different market is
potentially more advantageous at the measurement date.
• The principal market should represent the most advantageous market and
company is not required to continuously evaluate multiple prices for an asset
or a liability in order to determine the most advantageous market
• Summary: The price from the most advantageous market should be
used only when there is no principal market for the asset or liability.
27
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
28
I. Transaction Costs
A. Definition
Incremental direct cost to sell an asset or transfer a liability (similar
to cost to sell in Statement 144)
1. Example: Broker’s commissions and fees
B. Include in Fair Value:
No. Follow other GAAP for how to account for transaction costs.
1. Note: If no GAAP guidance, then expense.
II. Transportation Costs
A. Definition
The costs incurred to transport the asset or liability to (or from) its
principal (or most advantageous) market.
B. Include in Fair Value:
Yes, if location is a characteristic of the asset or liability (a
commodity such as oil).
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KEYPOINT
• The cost of transporting a physical-commodity from its current location to the
market should be deducted in the computation of fair value that is based on the
price in that market.
• A broker’s commission to access an equity securities market should not be
considered in measuring the fair value of an equity security.
30
Transaction Costs: Illustration 1
ILLUSTRATION 1
• Gearty Inc. holds Foxy Co. stock, which trades on two exchanges (Gearty Inc.
can access both the New York and London markets)
• The stock price and transaction costs at the measurement date:
Exchange Quoted Stock Price Transaction Costs Net

New York $52 $(6) $46
London $50 $(2) $48
• What is the fair value of Foxy Stock?

• If New York is the principal market = $52
• If London is the principal market = $50
• If no principal market, since London’s price (net of
transaction costs) is the most advantageous result = $50
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Transaction Costs: Illustration 2
ILLUSTRATION 2
• Multiple active markets for financial assets with observance different prices
Transaction
Market Price Transaction Costs Net Amount
A $76 $(5) $71
B $74 $(2) $72
• Market A
If Market A is the principal market for the asset, the fair value measurement based on
Market A price ($76)
• Market B
If neither market is the principal market for the asset, the fair value measurement based
on Market B price ($74) because that market is the most advantageous market for the
asset, considering transaction costs
KEYPOINT
• Fair value measurement is NOT adjusted for transaction costs
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Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
33
Fair Value Assets
I. Rule
A. The fair value for an asset is the asset’s highest and best use from
the perspective of market participants which would maximize a
company’s future cash inflows
B. Note: The company’s intended use of an asset is not necessarily
indicative of the highest and best use as determined by a market
participant.
II. Rule
A. The fair value measure is not an entity-specific measure that
reflects only the company’s expectations for the asset.
KEYPOINT
 Fair value “in use”
• The highest and best use of an asset is in-use if the asset would provide maximum
value to market participants through its use with other assets as a group.
• The in-use valuation is still a market-based measure determined based on the use of
the asset by market participants, not a value determined based solely on the use of the
asset by the company (not an entity-specific measure).
34
Fair Value Assets
1. IPR&D: “In-use” vs. “in exchange”
A. Example: Foxy Co. acquires IPR&D project:
B. Highest and best use/valuation premise
1. In-use:
a. When IPR&D project would provide maximum value to
market participants through its use together with other assets
as a group
b. Use encompasses use as a completed project or as a locked-
up project
c. Provide defensive value
2. In-exchange:
a. When IPR&D project would provide maximum value to
market participants through its non use
b. Discontinue development
35
Fair Value Assets
(i) Special Rules
A. Investment Block Discounts
1. Definition:
A blockage factor is a discount applied to the security price
to reflect the lack of trading volume in the market for the
security to absorb the sale of a large block without
impacting the security’s price.
2. New Rule:
SFAS 157 does not allow this. The fair value of quoted
securities will be equal to the price multiplied by the
quantity, without any adjustment to reflect a blockage
factor.
36
Fair Value Assets
1) Restricted Securities
1. Old Rule: SFAS 115
a. Applies to equity securities for which sale is restricted for a
period less than one year.
b. It did not permit companies to reduce the quoted price of an
identical but unrestricted security to reflect the impact of the
restriction.
c. More than one year are outside the scope of SFAS 115
2. New Rule: SFAS 157
Requires companies to reduce the quoted price of an
identical unrestricted security to reflect the impact of the
restriction regardless of whether the restriction is for less
than one year or more than one year.
37
Fair Value Assets
1. EITF Issue 02-3 (Day One Gain/Loss Accounting) will be
superseded
1. Old Rule:
a. A dealer cannot recognize Day 1 Profit if a derivative
contract’s fair value is not based on observable market data.
b. Day 1 dealer profit is the unrealized gain or loss resulting
from the difference between the transaction price of a
derivative instrument and the fair value of the instrument at
initial recognition.
2. New Rule:
SFAS 157 specifies that in certain cases, the transaction
price may not be representative of fair value. In those cases,
the company might measure fair value using a valuation
technique and recognize initial profit (or loss) even if the
measure of the derivative’s fair value is based on the
dealer’s valuation model and that model uses significant
entity-specific inputs.
38
Fair Value Assets
(i) Bid & Ask Prices (SEC Accounting Series Release No.
118 / ASR 118)
1. General Rule:
a. Use a price within the bid ask spread that is most
representative of fair value (consistently applied)
2. Default Rule:
Mid-market pricing or other pricing conventions may be
used as a practical expedient for fair value measurements
within a bid-ask spread.
KEYPOINT
 The following would be permitted:
• Assets: Bid price for long positions
• Liabilities: Asking price for short positions
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Fair Value Assets
EXAMPLE
• Foxy Co. (securities dealer) enters into interest rate swap with Gearty Co. (retail
counterparty) in retail market for no initial consideration.
• Foxy Co. would transfer its rights and obligations under the swap to a securities dealer
counterparty in the inter-dealer market, not a retail counterparty in the retail market
• At initial recognition, the transaction price (entry price) might NOT represent fair value
of the swap (exit price)
KEYPOINT
 SFAS 157 nullifies EITF Issue 02-3 (Footnote 3)
40
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
41
Fair Value Liabilities
I. General Rule
A. A fair value measure presumes that the liability is transferred to a
market participant at the measurement date and that the
nonperformance risk relating to the liability is the same before and
after its transfer.
B. Nonperformance risk is risk that the obligation will not be fulfilled
(affects the value at which the liability is transferred/company’s
own credit risk)
C. The measure should reflect the market participants’ measure of
discounted future cash outflows (for the liability)
D. In assessing the effect of non-performance risk, management
should consider the terms of any collateral and other credit
enhancements that are specified in the contract for the liability that
is being measured.
KEYPOINT
 Impact will differ depending on the terms of any credit enhancements (for example, cash
collateral)
42
1) Special Rule
A. The Effect of Changes in Credit Risk on a Fair Value
Measure:
In measuring the fair value of a liability, a company
should take into account the effect of its own credit
standing.
B. Counterintuitive result:
As an entity’s credit standing is remeasured, the fair value
of its liabilities will result in earnings reported on the
income statement:
1. Gains = for credit downgrades
2. Losses = for credit upgrades
KEYPOINT
 These results may indicate that fair value may not be the appropriate measure for a liability in
certain circumstances.
43
1. Liabilities: Fair Value Illustration
ILLUSTRATION
1) Foxy Bank (investment bank with AA credit rating) issues 5-year fixed rate note to
Gearty Inc.
2) Fair value measurement considers:
• Nonperformance risk, including credit risk
• Changes in credit spreads (generally even if no changes in specific credit risk)
• Changes in specific credit risk (even if within the AA spread)
44
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
45
I. SFAS 157 describes three available techniques to measuring
fair value
A. Market Approach:
Identify observable prices and other relevant information that is
generated by market transactions involving identical or
comparable assets or liabilities.
B. Income Approach:
Use valuation techniques to convert future amounts (cash flows or
earnings) to a single, discounted amount. The fair value measure
is based on the value that is indicated by market expectations
about the future amounts. The income approach includes present-
value techniques/option-pricing models:
1. Black-Scholes
2. Binomial models – lattice models
3. Multi-period excess-earnings method (CON 7 specifies that
adjustments reflecting systematic risk can be made to either (1) the
expected cash flows or (2) the discounted rate. The risk-free rate
would be an appropriate discount rate only if the adjustment that
reflects the systematic risk (non-diversifiable risk) is reflected in the
expected cash flows)
46
• Measure fair value by a valuation technique that is appropriate and for which sufficient
data is available.
• Multiple valuation techniques: Management should evaluate and weigh the results to
determine a single best fair value measure.
• The weighting process should not be mechanical and requires a significant amount of
professional judgment.
• Techniques used to measure fair value should be applied consistently. It is
appropriate to change when the change will result in a measure that better represents
fair value.
47
ILLUSTRATION
1) Foxy Co. is testing land and a retail store to be held and used for the purposes of
impairment under SFAS 144. A two-step test is required:
1) Step 1:
Foxy Co. projects cash flows it expects to realize from operating the asset group and
determines that the carrying value of the asset group is not recoverable.
2) Step 2:
Foxy Co. discounts the same cash flows used in Step 1 and arrives at a value.
KEYPOINT
 Determining fair value by simply discounting cash flows based on Foxy Co.’s intended use of
the facility may not comply with SFAS 157.
 Foxy Co. should consider whether recent sales of comparable retail stores in the area have
closed at higher or lower amounts.
48
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
49
Fair Value Hierarchy – Overview
I. SFAS 157, “Fair Value Measurements” establishes a
three-level hierarchy. The purpose of the hierarchy:
A. To increase consistency and comparability in fair value
measures.
B. To maximize the use of observable market data and
minimize the use of unobservable inputs.
C. To establish classification of fair value measurements for
disclosure purposes.
50
1) Input Valuation Techniques:
A. Market participant assumptions are incorporated in the
fair value measurement through the inputs to valuation
techniques
1. Observable inputs:
Developed based on market data obtained from sources
independent of the reporting entity/company
2. Unobservable inputs:
Developed based on the best information available in the
circumstances, subject to cost-benefit constraint
KEYPOINT
 A fair value measurement should maximize the use of observable inputs
51
1) Types of Markets (within Observable Inputs)
Markets in which inputs might be observable include:
1. Exchange Market
In an “active” exchange market, closing prices are both readily
available and representative of fair value
a. Example: New York Stock Exchange
2. Dealer Market:
Dealers stand ready to trade for their own account; the dealers
provide liquidity by using their capital to hold an inventory of the
items for which these dealers make a market. Usually bid prices and
asked prices are more readily available than closing prices.
a. Examples: Financial instruments, commodities, physical assets
3. Brokered Market:
Brokers attempt to match buyers with sellers. Brokers do not stand
ready to trade for their own account and they will not use their own
capital to hold an inventory of the items for a market.
4. Principal-to-Principal Market:
These transactions (both originations and resales) are negotiated
independently, with no intermediary. Typically, there is very little
information about these transactions is publicly available.
52
1. Fair Value Hierarchy:
Observable inputs that reflect quoted prices in active markets for identical Foxy Inc.’s common stock traded and
Level 1
assets/liabilities (unadjusted) quoted on the New York Stock Exchange
• A privately placed bond of Foxy Inc.,
the value is derived from a similar
Directly or indirectly observable (market-based) inputs – including quoted bond that is publicly traded
Level 2 prices for similar assets/liabilities (adjusted) through corroboration and • An over-the-counter interest rate swap,
observable market data inputs valued based on a model whose
inputs are observable LIBOR forward
interest rate curves.
• Shares of Gearty Co., a privately held
company whose value is based on
Unobservable inputs (no market data, not correlated with market data) – projected cash flows.
company’s own data assumptions about market participant assumptions,
Level 3 including assumptions about risk, developed based on the best • A long-dated commodity swap whose
information available in the circumstances (can include the entity’s own forward price curve, used in a
data inputs) valuation model, is not directly
observable or correlated with
observable market data.
KEYPOINT
 Subject to cost-benefit constraints
• Level 3 is most “subjective” and therefore of greatest
risk of manipulation
53
KEYPOINT
 The selection of appropriate valuation techniques may be affected by the availability of inputs
that are relevant to the asset or the liability, as well as be affected by the relative reliability of
the inputs.
• By distinguishing between inputs that are observable in the marketplace and therefore more
objective and those that are unobservable and therefore more subjective, the hierarchy is
designed to indicate the relative reliability of the fair value measures.
54
KEYPOINT
 In some cases, inputs might fall within different levels of the fair value hierarchy. The lowest
level of significant input determines the placement of a fair value measure in the hierarchy.
Assessing the significance of a particular input requires judgment, important for disclosures
• Certain disclosure required by SFAS 157 are applicable only to those fair value measures that
use Level 3 inputs
55
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
56
Fair Value Hierarchy – Level 1
I. Level 1 Inputs
A. Level 1 inputs are quoted prices (unadjusted) for identical
assets or liabilities in active markets.
B. Provides the most reliable fair value measure
C. Level 1 should be used provided that
1. The market is the principal (or the most advantageous)
market, and
2. The company has the ability to access the principal (or the
most advantageous) market.
a. Example: If a retail customer that does not have access to
wholesale market, then the quoted prices in the wholesale
market will not qualify as Level 1 inputs for that company.
57
KEYPOINT
 Matrix Pricing:
i. A company may measure fair value by using matrix pricing, provided
that the company demonstrates that the method replicates actual
prices.
ii. Used to value debt securities by relying on the securities’ relationship
to other benchmark quoted prices.
iii. The resulting measure will be a Level 2 input.
iv. Matrix pricing is a very common approach for such things as valuing
bond portfolios.
58
1) Modification of Transaction Price Presumption
A. Fair value may not equal the transaction price when:
1. Related parties make the transaction
2. Bankruptcy: the transaction is done under duress (or some
other urgency)
3. Unit of account differences (transaction price includes
transaction costs)
4. The transaction is not in Principal (or most advantageous)
market (retail market vs. wholesale market)
59
KEYPOINT
 SFAS 153: Non-monetary Exchanges (Fair Value)
i. An asset is acquired or a liability is assumed in an
exchange transaction – the transaction price represents
the price that was paid for the asset or that was received
to assume the liability (i.e., the entry price).
ii. The fair value of the asset or the liability represents the
price that would be received for the asset or paid to
transfer the liability (i.e., the exit price)
iii. The above two prices can be different.
60
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
61
I. Level 2 Inputs
When an asset or liability has a specified (contractual) term, a Level 2
input should be observable for substantially the full term of the asset or
liability. They include the following:
A. Quoted prices for “similar” assets or liabilities in active markets
B. Quoted prices for “identical” or “similar” assets or liabilities in markets that
are not active.
C. Not Active Markets:
1. Few transactions for the asset or liability
2. Prices are not current
3. Price quotations vary substantially either over time or among market
4. Little information is publicly available
D. Inputs other than quoted price that are observable for the asset or liability
(interest rates and yield curves observable at commonly quoted intervals,
volatilities , prepayment speeds, and default rates)
E. Inputs that are derived principally from or corroborated by other observable
market data through correlation or by other means.
F. Adjustments of Level 2 inputs should reflect factors such as the condition
and/or location and the volume and level of activity in the markets within
which the inputs are observed.
G. An adjustment that is significant might place the measure at Level 3 in the
fair value hierarchy.
62
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
63
I. Level 3 Inputs
A. Level 3 inputs are unobservable inputs that consider the
assumptions that market participants would use in pricing
the asset or liability, including assumptions about risk.
B. Unobservable inputs should be developed based on the
best information available in the circumstances, which
might include the company’s own data.
C. A company need not undertake all possible efforts to
obtain information about market participant assumptions
D. The company should not ignore market participant
assumptions that are reasonably available without undue
cost and effort.
64
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
65
Unit of Valuation
I. Definitions
A. Unit of accounting
Establishes the asset or liability that is being measured at
fair value for purposes of financial reporting.
B. Unit of valuation
Establishes whether the asset or liability is measured at fair
value within a larger group
KEYPOINT
 Attribute the indicated fair value of the group to the asset or liability.
66
Unit of Valuation
1) 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.
A. Highest and Best Use
Use by market participants that maximizes value of asset
(or asset group).
B. Valuation Premise
1. In-Use: Market Participant Synergies
Highest and best use is “in-use” if:
a. Asset would provide maximum value to market participants
through its use with other assets as a group, as installed or
otherwise configured for use.
2. In Exchange: No Market Participant Synergies
Highest and best use is “in-exchange” if:
a. Asset would provide maximum value to market participants
through its use on a stand-alone basis
67
Unit of Valuation
1. Highest Use: Real property Illustration 1
ILLUSTRATION 1
• Foxy Co. acquires land and storage building.
• Observable market data indicates that nearby sites have recently been developed for residential use.
• The highest and best use of the land would be determined by comparing:
1) The fair value of the storage building (in-use)
2) The fair value of the land as a vacant site for condominiums (in-exchange)
• Regardless of the intended use, the highest and best use of the land would be determined based on
the higher of those values
KEYPOINT
 Highest and best use assumptions should be consistently applied to other assets in the asset
group.
 Note: The land’s highest and best use would determine the storage building’s highest and
best use.
68
Unit of Valuation
(i) Asset Group: Illustration 2
ILLUSTRATION 2
• Foxy Co. acquires assets that are used together as a group (Assets X,Y, and Z).
• Unit of account = each individual asset
• Unit of valuation = the group of assets within which the assets would be best used by market
participants
• Highest and best use is in-use
• Exit market = the acquisition market
• Market participants are other bidders for the assets
• Strategic and financial buyers
• Strategic buyers have related assets that would enhance the value of the assets as a group,
including a replacement asset for Asset Z (billing software)
• Financial buyers do not have related assets that would enhance the value of the assets as a
group.
69
Unit of Valuation
I. Asset Group: Illustration 2 (continued)
ILLUSTRATION 2 (continued)
Observable Fair Value

Assets Strategic Buyer Group Financial Buyer Group
X $820 $700
Y $620 $500
Z $160 $300
Total $1,600 $1,500
• Fair values of Assets X, Y, and Z determined based on use within strategic buyer group
because that use would maximize the fair value of Assets X, Y, and Z as a group.
• Do not maximize the fair value of each asset individually
70
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
71
I. New Disclosures
A. Improve transparency regarding how fair value is determined.
B. Applies to both recurring (example: SFAS 115) and non-recurring (example:
SFAS 144) fair value measurements of assets and liabilities
C. Tabular disclosure by major category of which level in the hierarchy a fair
value measurement falls
D. Annually (and in the period of adoption), describe the valuation techniques
and any changes to the valuation techniques.
E. Provide disclosures about:
1. The extent to which companies measure assets and liabilities at fair value
2. The methods and assumptions used to measure fair value
3. The effect of fair value measures on earnings
4. Expanded disclosures about Level 3 (non-market data) measures:
a. Each major category of assets and liabilities measured using a Level 3 fair value
measure, a reconciliation of beginning and ending balances including total gains
and losses
b. The amount of total gains and losses attributable to the changes in unrealized
gains and losses related to Level 3 input-based assets and liabilities held at the
reporting date and a description of where those gains and losses are reported in
the income statement.
72
ILLUSTRATION: Disclosure – Recurring 1
Fair Value at Reporting Date
Level 1: Level 31:
Level 2:
Quoted prices in active
Description 12/31/XX Significant other Significant
markets for identical
observable inputs unobservable inputs
assets
Trading Securities $115 $105 $10 -0-
Available-for-Sale securities 75 75 -0- -0-
Derivatives 60 25 152 $203
Venture capital investments 10 -0- -0- $10
Total $260 $205 $25 $30
1
Additional disclosures are required for recurring Level 3 measurements
2
Standard interest rate swaps
3
20 year energy contract
73
ILLUSTRATION: Level 3 Recurring
Level 3:
Assets Measured on a Recurring Basis Using Significant
Unobservable Inputs
Investments by
Derivatives* Total
Venture Capitalist
Beginning Balance 01/01/XX $14 $11 $25
Total gains or losses (realized / unrealized):
Income Statement 11 (3) 8
Included in Other Comprehensive Income 4 -0- 4
Purchases, issuances and settlements (7) 2 (5)
Transfers in and/or out of Level 3 (2) -0- (2)
Ending Balance 12/31/XX $20 $10 $30
Unrealized gain (loss) in earnings from $ 7 $ 2 $ 9
assets still held at period end
KEYPOINT
 *Derivatives assets and liabilities can be presented net for purposes of this roll-forward.
74
ILLUSTRATION: Nonrecurring*
Level 3:
Assets Measured on a Recurring Basis Using
Significant Unobservable Inputs
Level 1 Level 2 Level 3
Quoted prices in Significant other Significant
End of Year active markets for observable unobservable Total Gains
Description 12/31/XX identical assets inputs inputs (Losses)
Long-lived $225 -0- $225 -0- ($75)
assets held
and used
Goodwill $90 -0- -0- $90 ($40)
Total ($115)
KEYPOINT
 Describe the reason for the nonrecurring fair value measurement
 Describe the inputs and information used to develop the inputs for nonrecurring Level 3 based fair value
measurements.
75
Overview
Exceptions
Unit of Accounting
Considerations
Exit Price
Market Participants
Orderly Transaction

Market Income Cost

Unit of Valuation
Transition
76
Transition
I. Prospective
II. Two Exceptions:
Cumulative effect adjustments to beginning retained
earnings in year of initial application:
A. Block discounts
B. Issue 02-3 and Statement 155 hybrid instrument day-one
gain and loss deferrals
III. Effective for fiscal years beginning after November 15,
2007. (Calendar year business will be required to apply
SFAS starting on January 1, 2008).
77

FAS 157 - Fair Value

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Fair Value

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Exchange Quoted Stock Price Transaction Costs Net

• What is the fair value of Foxy Stock?

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Observable Fair Value

Fair Value Assets Fair Value Liabilities

Fair Value Approaches

Fair Value Hierarchy

Available-for-Sale securities 75 75 -0- -0-

Derivatives 60 25 152 $203