Statement of Financial Accounting Standards No. 157 (FAS 157) first impacted financial statements issued for years beginning after November 15, 2007. Its effect on the most recent round of year-end financials issued by companies, underscores the critical role of independent appraisers with market knowledge when navigating these new financial reporting guidelines.
According to the FAS 157 Summary, “This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands the disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this statement does not require any new fair value measurements. However, for some entities, the application of this statement will change current practices.” And change some current practices, it did. This article, and a series of related articles to follow, will discuss the sweeping changes FAS 157 has had on financial reporting under the fair value standard of value.
Fair Value Redefined
For example, it redefined the standard of value known as “fair value.” Fair value has different meanings, depending upon the context in which it is applied. For financial reporting purposes, it was defined in previous FAS pronouncements as “the amount at which an asset (liability) could be bought (incurred) or sold (settled) in a current transaction between willing parties, that is, other than a forced or liquidation sale.” The definition of fair value under FAS 157 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.”
The “old” definition connotes that fair value is an “entry” price into the asset or liability, whereas the FAS 157 definition focuses on the sales price of an asset or the amount paid to transfer a liability, in essence, an “exit price.” Furthermore, FAS 157 emphasizes that fair value is a market-based measure, as opposed to an entity specific measurement. That is, fair value measurement is to be determined based upon assumptions that market participants would use in pricing the asset or liability.
Broad Reaching Effect
The very definition of fair value under FAS 157 is perhaps the most sweeping change ever made to the valuation of assets and liabilities for financial reporting purposes. FAS 157 lists specific Financial Accounting Standards Board (FASB) pronouncements to which it makes modifications by amending the definition of fair value. The effect on each specific pronouncement is unique to the respective pronouncement. In general, some assets not previously subject to this standard must now be valued using fair value, as determined by an appraiser. Most certainly, the inclusion of the market-based measure language has added complexity to the determination of fair value. To be sure these issues are properly and thoroughly addressed, it is important that appraisers have not only valuation credentials and experience, but also real-world market experience.
Future newsletters will address the effect of FAS 157 on some of the more commonly encountered pronouncements and financial statement issues.