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Thank you. Fair Value. Professor Wayne H. Shaw May 26, 2011. Definition of fair value under ASC 820 Previously known as FAS 157. Fair Value. SFAS 157 defines fair value as :

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  1. Thank you Fair Value Professor Wayne H. ShawMay 26, 2011

  2. Definition of fair value under ASC 820 Previously known as FAS 157 Fair Value

  3. SFAS 157 defines fair value as : “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” Fair Value

  4. Orderly transaction Hypothetical price Sell an asset/transfer a liability Market participants No adjustment for transaction costs Principal/most advantageous market Fair Value

  5. Fair Value Process • Determine the unit of account • Determine the highest and best use • Determine the appropriate market • Principal market • Most advantageous market • Hypothetical market • Valuation technique • Market approach • Income approach • Cost approach

  6. Level 1 – Quoted prices in identical markets Level 2 – Inputs other than quoted prices that are observable Level 3 – Inputs that are not based on observable market data The Fair Value Hierarchy

  7. Market approach Market prices or market multiples Income Approach Present value Option pricing models Discounted cash flows Cost Approach Replacement cost Valuation Models

  8. How do you determine the hypothetical market? • Determine the characteristics of a market participant to which it would hypothetically sell the asset if it were seeking to do so. • Then identify the assumptions that those market participants would consider when pricing the asset

  9. What if there are multiple uses for the assets? Do I need to seek out all of them? • The reporting entity need not undertake all possible efforts to obtain information • A reporting entity should use information reasonably available to it. • A reporting entity should examine realistic scenarios as to how the assets would be used • Judgment should be based on • the nature of the assets, • prior history, knowledge about the market, • or other relevant information.

  10. Can I rely on a single price? • A single market maker would generally not result in a level 1 valuation. • If the quote is supported by comparables and if the market maker stands ready to trade, it could be level 2 • Otherwise it is a level 3 measure

  11. What if I find a higher price on a different exchange? • Is the first exchange your primary market? • If not, which is the most advantageous market?

  12. Bargain purchase • Can I immediately recognize a gain or loss on an asset that I purchase at a bargain price? • Example – You have to settle a loan so I buy an investment from you for $82,000 that has • Book value to you - $78,000 • Face Value - $100,000 • Market value - $ 95,000

  13. Does the valuation model determine the level of the disclosure? • The level of the disclosure is determined by whether the observations are observable not necessarily the model used. • Models that use observable observations are generally preferred over those models that use unobservable inputs.

  14. Other questions • Does a pricing service affect the classification of the level of an input? • When can I use blockage factors? • What if I am restricted from selling the asset?

  15. Measurement issues on Nonrecurring Items • Who are the participants in measuring a nonfinancial asset? • Do I use strategic buyers or financial buyers as market participants? • How do I value debt in a business combination? • What about contingent liabilities? • Can I combine reporting units for goodwill impairment testing?

  16. ASU No. 2011-04 (to achieve Fair Value Measurement • Changes made to achieve convergence with IFRS.

  17. ASU No. 2011-04Fair Value Measurement • Highest and best use is only for non-financial assets • However, called stand-alone basis or in combination with other assets and liabilities • May not group financial assets for valuation purposes • Principal market • Presumption, without evidence to the contrary, the market in which an entity would normally enter into a transaction • Use portfolio FV measurement approach in some circumstances

  18. ASU No. 2011-04Fair Value Measurement • Blockage discounts are not permitted. • Premiums and discounts are permitted only when • The premium and discount are created by a unit of account specified by another standard • Market participants would include the premium or discount when pricing the unit of account • Liability guidance may be applied to measuring its own equity.

  19. ASU No. 2011-04Fair Value Measurement • Disclosures • Transfers between levels 1 and 2 • Hierarchy level for assets and liabilities initially, but not subsequently, listed at FV • Why an asset is not being used for its higher and best use • Addition level 3 disclosures • Measurement required but disclosure exemptions for nonpublic entities

  20. ASU No. 2011-04Fair Value Measurement (IFRS Differences) • Day one gain and losses • Measurement of alternative investments • Quantitative measurement uncertainty analysis required by IFRS for level 3 financial assets measured at FV • IFRS – no non-pubic disclosure exemptions

  21. Thank you Thank You

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