Deloitte | Current Exit Price - Is it Fair Value?, FASB Statement No. 15...

http://www.deloitte.com/print/en_IE/ie/services/audit/ff808445881fb...

11 June 2009

Current Exit Price Is it Fair Value?

One of the great debates of financial reporting in recent times is the application of fair value to accounting measurement. There is growing concern that the current mixed measurement model, which combines fair value and cost within financial statements, is not the most preferred or perhaps reliable basis of accounting. Finding an appropriate solution is proving difficult. Current Exit Price The debate has gathered some momentum over the past year, initiated to a large degree by the issuance of FASB Statement No. 157 Fair Value Measurements. Highlights of Statement 157 include the following: A new definition of fair value; A fair value hierarchy used to classify the source of information used in fair value measurements (i.e. market based or non-market based); New disclosures of assets and liabilities measured at fair value; and A modification of the long-standing accounting presumption that the transaction price of an asset or liability equals its fair value. Statement 157 defines fair value as: 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. While Statement 157 does not introduce any new requirements mandating the use of fair value, the definition as outlined does introduce key differences. Firstly, it is based on exit price (for an asset, the price at which it would be sold) rather than an entry price (for an asset, the price at which it would be bought), regardless of whether the entity plans to hold or sell the asset. Secondly, Statement 157 emphasises that fair value is market based rather than entity specific. Thus, the optimism that often characterises an asset owner must be replaced with the scepticism that typically characterises a risk averse buyer. Statement 157s fair value hierarchy underpins the standard. The hierarchy ranks the quality and reliability of information used to determine fair values quoted prices are the most reliable valuation inputs, whereas model values that include inputs based on unobservable data are the least reliable. A typical example of the latter is shares of a privately held company whose value is based on projected cash flows. Deloitte Survey A survey carried out in the US of 1,500 participants across a range of industries showed that only six percent of companies have assessed how Statement 157 will impact the valuation of their assets and liabilities, even though it takes effect in a few months. Approximately half of the participants indicated that the requirement to apply exit price vs. entry price when assessing an assets fair value would have some effect on their company but, as yet, many had done little to quantify the impact. Approximately half also believed that the provisions of Statement 157 will result in the increased use of valuation specialists at their companies. Deloitte US comments that while Statement 157 provides clearer guidelines for the valuation process, early consideration of its provisions is key. Corporate executives signing off on company financial statements need to ensure that the new rules are adhered to, so that both they and their companies are protected. Further Developments in US Since issuing Statement 157, the FASB has also issued SFAS 159 The Fair Value Option for Financial Assets and Financial Liabilities. Statement 159 provides entities with an option of carrying most financial assets and liabilities at fair value, with changes to fair value recorded in earnings, providing the opportunity to eliminate that artificial volatility in earnings that may occur when financial assets and liabilities are measured and reported differently in the financial

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Deloitte | Current Exit Price - Is it Fair Value?, FASB Statement No. 15...
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Under the IASB/FASB Memorandum of Understanding, both parties have committed to the convergence of standards with the shared objective of developing high quality, common accounting standards for use in the worlds capital markets. In pursuance of this objective, the IASB recognises the need for guidance on measuring fair value in IFRSs and for increased convergence with US GAAP. Using SFAS 157 as a starting point, the IASB issued a Discussion Paper seeking preliminary views on the principal issues. Key differences identified between the definition of fair value in SFAS 157 and the current IASB position are that: The definition in SFAS 157 is explicitly an exit (selling) price. The definition in IFRSs is neither explicitly an exit price nor an entry (buying) price with some slight variations in different IFRS standards; The definition in SFAS 157 explicitly refers to market participants. The definition in IFRSs refers to knowledgeable, willing parties in an arms length transaction; and For liabilities, the definition of fair value in SFAS 157 rests on the notion that the liability is transferred (the liability to the counterparty continues it is not settled). The definition in IFRSs refers to the amount at which a liability could be settled between knowledgeable, willing parties in an arms length transaction. Many are concerned that the IASB Discussion Paper is leaning towards an acceptance of the SFAS 157 position which could significantly change some of the key principles underlying many IFRS standards. The ASB Position The Accounting Standards Board submitted its comments to the IASB on the Discussion Paper which are representative of the views of many parties in the UK and Ireland. Some of the main concerns expressed are: The use of fair values is more widespread under IFRS then under US GAAP and the ASB does not consider that SFAS 157 is suitable for consideration in many of those cases where fair value is used under IFRS; The ASB does not support the proposition that market based exit values are the most appropriate measure of fair value for all assets and liabilities to be reported in financial statements; The ASB believes that SFAS 157 is useful only as guidance on the methodology to be used in arriving at a market-based exit price and therefore the IASB Discussion Paper should be re-titled to reflect on its narrow focus; The ASB is of the view that SFAS 157 is based on the presumption that efficient markets are available for most transactions and the approach needs a market participant to be identified. The ASB believes that markets are not always efficient and hence measurement from a market participants view may be flawed, with most transactions occurring in an imperfect market as a result of individual negotiations between two contracting parties; The ASB would welcome further debate on the market participant versus entity specific issue. While possibly open to different measurement, it should be acknowledged that the value of an asset or liability should be viewed from the perspective of the entity and thus reflect the entitys economic opportunities and constraints; and The general use of exit prices seems to move away from the assumption that initial measurement is transaction based, potentially leading to day one gains and losses being recognised which may not faithfully represent the entitys position in its financial statements. There are clearly divergent views on fair value measurement and, in particular, the use of current exit prices. The debate seems set to continue for some time with the hope that a reasonable and globally acceptable conclusion is reached before much longer but without undue haste to a solution overly influenced by the convergence objective.

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