Fair Value

GAAP vs. IFRS

Presented by
Alfred M. King, CMA,CFM
October 6, 2008

Convergence or Conversion of
GAAP-IFRS
World is going towards one set of accounting
standards but is IFRS truly uniform?
United States conceded that IFRS is more widely
used, so U.S. will change but when?
Securities and Exchange Commission:
Currently allows foreign filers to use IFRS
Starting in 2010-11 voluntary adoption of IFRS by
U.S. Companies
Starting in 2014-15 mandatory adoption of IFRS by all
public companies private companies will follow!

Problems with Convergence

Principles vs. Rules Is this distinction a myth?
Business complexity = complex rules
Will IFRS have to adopt Rules over time?

Funding and Membership in IASB

What happens if our SEC disagrees with IFRS?
Transition
Training of preparers option for early adoption by
large companies
Training of auditors

Fair Value vs. Fair Market Value

There are real differences among:
Fair Market Value (not used for financial
reporting)
Fair Value GAAP
Fair Value IFRS

Difference in concept of Fair Value

between GAAP and IFRS has not been
resolved

Exit Value GAAP Concept

5. 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.
This concept works for financial
instruments and does not work for tangible
and intangible assets

Fair Value IFRS Concept

Fair Value is the amount for which an
asset could be exchanged, a liability
settled, or an equity instrument granted
could be exchanged between
knowledgeable, willing parties in an arms
length transaction [IFRS 2, Appendix A]

Exit Value
GAAP concept of valuing something at
what it could be sold for today, to a
market participant works only if there is a
market with market participants
U.S. and EU experience recently with subprime securities indicates that often there
is no market, and no market participants
willing to make a market

How to Value When

There Are No Participants
FASB set up levels 1 through 3
Level 1 quoted prices
Level 2 no direct quotes but similar assets
Level 3 all other
Valuation specialists are always working in Level 3
Level 3 allows for Income Approach and Cost
Approach but these are considered entity specific
values and are 2nd class!

Entity Specific Values

Highest and Best Use is the premise of value
in all cases, e.g. parking lot in downtown
Manchester has to be valued for development
Highest and Best Use will depend on who is
going to use the asset and what they will do with
it Could you develop the site?
If not, you would offer less than would a
developer who would buy the land based on his
assessment of the real estate market

Fair Value - IFRS

Considers both buyer and seller
IASB would like to converge their
definition with U.S. SFAS 157
About half the IASB members, however,
are uncomfortable with how the U.S.
definition is working in practice
Theoretically, at least, IASB believes the
U.S. concept may be correct but not how it
is applied

New FV Definition from IASB?

No decision until 2009

May not converge with U.S. SFAS 157
May stick to its definition
If that happens, quite likely that U.S. will
converge to the IASB (!)
FASB is very aware of the problems they
have created with Market Participants and
Exit value

Defensive Value
Common problem in Business Combination
Seller and Buyer each have competing brand
names
Buyer wants to move Sellers product line to use
the Buyer brand name
Buyer wont use the Sellers brand
Buyer, however, would not sell Sellers brand
name to anyone else

What Is The Value of a Brand

Name That Will Not Be Used?
A Financial Buyer would use the Sellers brand
name
Under U.S. definition of Fair Value whoever the
buyer is we value the brand name on what
someone else would pay for it, or a value in use
to them
Now if the Strategic Buyer will not use it we still
have to place a high value on it

Day 2 Problem
So for the Strategic Buyer we have to
value the brand name as though someone
would use it, even if it is never going to be
used.
It is obvious that the real Fair Value, once
there is no more advertising and
marketing, is going to go down rapidly
The buyer will have an early impairment!

Solution to the Day 2 Problem

Have to change the definition of Fair Value to get
away from rigid application of Exit concept
IASB looks as though their ultimate definition of
Fair Value will likely be such that this problem
may not be there
Value in Use still makes a lot of sense and may
provide better information to users
IASB may permit, or even require in some
cases, Value in Use

Fair Value and Impairment:

Key Differences FASB vs. GAAP
Real Estate
Investment property
Agricultural/biological
IFRS permits/requires periodic revaluation up or down
U.S. GAAP absolutely prohibits write up
In U.S. this is a one-way street. Can take impairment loss but never
an impairment gain or even write back up to previous amount

IFRS Permits Revaluations

A literal reading of IFRS suggests that if they want
to, companies can revalue other assets for
example intangibles
Brand Names
Patents
Will U.S. companies take advantage of this?
Look at Fair Value Option (SFAS 159)

Fair Value Option

Companies are permitted to revalue
LIABILITIES if they wish
Banks and financial institutions have had to write
down investments because of credit problems in
the economy
SFAS 159 permits them to designate liabilities
for same Fair Value treatment
So if a companys credit rating drops, they can
record a GAIN which may offset the Fair Value
loss on the investments Bear Stearns example

Fair Value Option (2)

U. S. Investment Banks did take advantage of
this rule, and literally wrote down the value of
their own bonds
If those debts will be ultimately repaid at Par
(100 %) companies will have to reflect a LOSS
to write up the liability
This accounting is hard to explain!!
The worse you do the better you look
The better you do the worse you look

My Conclusion
If U.S. companies adopt IFRS they will be at
least tempted to write up all sorts of intangible
assets to reflect their true Fair Value
What will this do for valuation specialists?
Lots more work!
What will this do for the integrity of financial
statements?

Asset Impairment
Impairment indicators are essentially the same
between GAAP and IFRS
IFRS writes down to Fair Value when FV is less
than carrying value
No intermediate cash flow test
IFRS looks to the higher of:
Net selling price (exit value)
Value in Use (entity specific)

Asset Impairment (2)

United States has three different methods
SFAS 144 for fixed assets and intangibles
SFAS 142 for indefinite life intangibles
SFAS 142 for testing goodwill
SFAS 144 calls for a determination as to whether
the SUM of all future cash flows, NOT
DISCOUNTED is equal to or larger than carrying
value
Can never write back up once loss recognized

Research & Development

Research expensed in both systems
Development is capitalized in IFRS and
expensed in GAAP
Under SFAS 141R, purchased In-Process R&D
will be capitalized, but further expenditures will
be expensed
Basic question:
Is the true Fair Value of R&D properly
measured based on costs incurred?

Valuing Liabilities and

Contingencies
Rules calling for what you could pay someone to
take on your liabilities makes no sense
Should allow companies to determine the
Present Value or Expected Value of what they
anticipate paying to settle liabilities and
contingencies
GAAP values contingencies only in a Business
Combination

Can We Value Contingencies?

Contingent payment in a Business
Combination
Settle Environmental Liabilities
Fair Value of lawsuits
New SFAS 141R requires this

Revenue Recognition
GAAP has over 200 items in the literature
IFRS is very general
Revenue Recognition is a big item at least
in the U.S.
FASB looks to Fair Value as one way of
measuring Revenue Recognition.
Suzies sweater example

Is There Such a Thing as

The Fair Value?
The value of an asset depends on who is going
to use it, and for what purpose
How can anyone write a set of rules that
provides consistency among preparers and yet
reflects economic reality?
FASB and IASB would like a one size fits all
solution in terms of defining Fair Value
This can not be done!

Where Are We Going?

Personal views:
Recent problems in valuing subprime assets
will slow down move to increased Fair Value
Convergence of IFRS and GAAP will be much
harder (and slower) than anticipated
LIFO problem
Different versions of IFRS

Demand for Fair Value by Security Analysts

will continue and even increase

The Future of the

Valuation Business

Questions?
Presentation by:
Alfred M. King, CMA, CFM
Vice Chairman,
Marshall & Stevens, Inc.
Please feel free to contact me
for information at any time:

E-Mail: aking@marshall-stevens.com