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FAS 157 Provides Much Needed Guidance to Fair Market
Measurement
By James B. Hankins, Alpern Rosenthal
The long-awaited Financial Accounting Standards (FAS), No. 157, Fair
Value Measurements, has redefined “fair value,” establishing
a framework for measuring fair value. FAS 157 may have a significant
impact upon how both public and private companies account for the assets
it owns or acquires in a business combination, such as trademarks, patents,
software, customer relationships and a variety of financial instruments.
Fair value is defined as “the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction
between market participants.” Market participants are buyers and
sellers in the principal (or most advantageous) market where the asset
or liability is transacted. FAS 157 places greater emphasis on fair
value as a market-based measurement, as opposed to an entity specific
measurement. In other words, fair value is intended to be an exit price
rather than an entry price.
FAS 157, effective for fiscal years beginning after November 15, 2007,
was issued in response to a need for consistency and comparability in,
and for expanded disclosures about, fair value measurements. To increase
consistency, FAS 157 has established a fair value hierarchy to rank
the reliability of inputs used as a basis for considering market participant
assumptions. The first, and highest, level refers to quoted prices for
identical assets or liabilities in an active market. When quoted prices
are not available, the second, or middle, level will base fair value
estimates on observable inputs that a market participant would use.
The third, and lowest, level will require the use of unobservable inputs
if observable inputs are not available.
When measuring fair value, FAS 157 provides that the valuation techniques
(or methods) available under the market approach, income approach and/or
cost approach should be used. Valuation specialists are required by
professional standards to consider all three approaches. The nature
of the item being valued, as well as the availability of reliable data,
will determine the valuation approaches and methods to be used. A valuation
expert exercises judgment in weighing the various valuation results
to draw a conclusion regarding the best estimate of value.
The highest and best use of an asset by market participants must be
considered when measuring the fair value of an asset. This refers to
how an asset, or group of assets, would be used by marketplace participants,
often strategic and/or financial buyers, to maximize the value of the
asset or the group of assets with which the asset would be used. The
value is based on the market participant’s use of the asset, regardless
of the intended use by the reporting entity.
This new standard emphasizes consistency and comparability in all applications
of fair value measurements, including FAS 123R, 133, 141, 142, 144 and
157. Because of its far reaching impact, fair value measurements and
disclosures will come under close auditor scrutiny as FAS 157 becomes
effective.
For more information, contact James B. Hankins, Jr., CPA/ABV, CVA,
BVAL, Business Valuation and Litigation Support Shareholder, at 412.281.4323
or at jhankins@alpern.com.
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