Georgia Society of CPAs Southeast Accounting Show August 19, 2011 Fair Value Accounting: What Is the Latest? Mark Zyla, CPA/ABV, CFA, ASA Acuitas Inc. Atlanta, GA Overview What is Fair Value? Which standards require Fair Value? What is the latest on Fair Value Measurements? History of Fair Value Measurement FVM has been part of financial reporting for many years, primarily for financial assets and liabilities APB 18 – The Equity Method of Accounting for Investments in Common Stock (1971) Losses recognized when fair value is less than carrying value APB 29 – Accounting for Nonmonetary Transactions (1973) SFAS 15 – Accounting by Debtors and Creditors for Troubled Debt Restructurings (1977) Defines fair value and establishes DCF for measuring value SFAS 107 – Disclosures about Fair Value in Financial Statements (1991) SFAS 115 ‐ Accounting for Certain Investments in Debt and Equity Securities (1999) FAS 133‐Accounting for Derivative Instruments and Hedging Activities (2000) SFAS 159 ‐ The Fair Value Option for Financial Assets and Financial Liabilities (2007) History of Fair Value Measurement Significant pronouncements for non‐financial transactions SFAS 141(R), Business Combinations (2007) Revised SFAS 141 (2001) for convergence with IFRS3 Requires recognition of acquired assets and liabilities at fair value, including intangible assets and goodwill SFAS 142, Goodwill and Other Intangible Assets (2001) Requires testing goodwill for impairment Compare fair value of reporting unit to carrying value History of Fair Value Measurement SFAS 157, Fair Value Measurements & Disclosures (2006) Source of controversy during credit crisis FASB Credit Crisis Projects FSP FAS 157‐3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (October 2008) FSP FAS 157‐4 Determining Fair Value When the Volume and Level of Activity for t he Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (April 2009) FSP FAS 115‐2 and FAS 124‐2 Recognition and Presentation of Other‐Than‐Temporary Impairments (April 2009) FSP FAS 107‐1 and APB 28‐1 Interim Disclosures about Fair Value of Financial Instruments (April 2009) ASU 2009‐05 Measuring Liabilities at Fair Value (August 2009) What is Fair Value? Definition ‐ 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. FASB Topic 820, Fair Value Measurement Fair Value Measurements represents a fundamental change in the measurement of assets and liabilities. Financial statements are no longer prepared primarily on historical cost‐based information. Fair value measurement requires judgment. Fair value measurement provides more relevant information for investment decision making. Fair Value Measurement Concepts Price – exit Principal market or most advantageous market Market participants Highest and best use Fair value hierarchy Which standards require Fair Value? Topic 805 – Business Combination Topic 350 ‐ Goodwill & Other Intangible Assets Topic 360 – Impairment of Long‐Lived Assets Topic 825 ‐ Fair Value Option for Financial Assets and Liabilities Topic 860 – Servicing Financial Assets Topic 715 – Defined Benefit and Other Postretirement Plans Topic 718 – Share‐Based Payments Topic 810 – Non‐controlling Interests in Consolidated Financials Topic 410 – Retirement Obligations Topic 420 – Costs Associated with Exit or Disposal Activities Topic 480 – Financial Instruments with Characteristics of Liabilities and Equity What Are the Latest Trends in FVM? Continued Convergence of U.S. GAAP and IFRS Changes in Goodwill Impairment Testing Trend toward More Disclosure Resolution of FVM for Liabilities Evolution of Best Practices FASB and IASB Convergence FASB and IASB Convergence Project has had many phases Conceptual Framework Project Norwalk Agreement in 2002 established goals for convergence Memorandum of Understanding in 2006 addressed achieving convergence through the development of high quality, common standards over time 2008 SEC Roadmap for the Potential Use of IFRS SEC Plan to Incorporate IFRS Condorsement – Staff paper outlining a possible method of incorporation; SEC is reviewing comments SEC is expected to decide whether to proceed with full convergence by the end of the year Convergence of FVM FASB and IASB have recently completed their joint project to converge FVM guidance IFRS 13 adopted several US GAAP concepts Defining fair value as an “exit” price Adopted the “principal market” focus Measuring liabilities at fair value from ASU 2009‐05 Prohibits blockage discounts FVM in inactive markets FASB issued ASU 2011‐04, Amendments to Achieve Common FVM and Disclosure Requirements in U.S. GAAP and IFRSs Highest and best use applies only to non‐financial assets Eliminates some disclosures for private companies New guidance for both US GAAP and IFRS Application of premiums and discounts to Level 2 & 3 Additional disclosures Convergence and Financial Reporting for Non‐Public Companies International Financial Reporting Standards for Small to Medium‐sized Entities (IFRS for SMEs) Modification and simplification of full IFRS, issued 2009 Created to meet the needs of private companies’ financial statement users Intended to ease the financial reporting burden for companies with fewer resources – 203 pages US Blue Ribbon Panel on Standard Setting for Private Companies Report to the Financial Accounting Foundation (2011) Recommended US GAAP modifications for private sector Current standards do not provide “decision useful” information Cost / benefit not considered Highly critical of fair value measurement and goodwill impairment testing ASU 2011‐04 eliminates some disclosures for private entities Other Convergence Projects Leases – the Boards are expected to reissue new exposure drafts 3Q11 “Right of use” asset and liability both reflected on balance sheet Financial Instruments Boards are working on the first phase ‐ Initial Measurement of Financial Instruments Both Boards are likely to permit debt instruments to be measured at amortized cost Business Model Test – objective is to hold asset to collect cash flows Nature of the Asset Test – instrument gives rise to cash flows, at specific dates that are solely payments of principal and interest FASB favors two categories of instruments measured at fair value FV‐NI ‐ changes in fair value recognized in income FV‐OCI – changes in fair value recognized in other comprehensive income IASB favors only one category, FV‐NI Goodwill Impairment Testing Business community is upset about the cost of FVM for goodwill impairment testing FASB has responded with Proposed ASU on Goodwill Impairment Introduces a qualitative, “more likely than not” test Introduces new qualitative factors If events and circumstances indicate fair value exceeds carrying value, no further testing is required Eliminates pervious carry forward of Step 1 ASU 2010‐28, Goodwill Impairment – When to Perform Step Two…for Reporting Units with Zero or Negative Carrying Value Also relies on a qualitative “more likely than not” test Proposed Qualitative Factors for Goodwill Impairment Testing General macroeconomic conditions Industry and market considerations Deterioration in the operating environment Cost factors that have a negative effect on earnings Decline in overall financial performance Entity‐specific events Events affecting a reporting unit A sustained decrease in share price, both absolutely and relative to peers Constituent Reactions to Qualitative Impairment Test Split between financial statement preparers and auditors Larger, national accounting firms tend to oppose qualitative test Difficult to audit a subjective assessment Management may not have the expertise to make assessment Recognition of losses would be delayed because of “more than likely” threshold If qualitative tests are challenged by auditors, preparers will perform a quantitative analysis Auditors will prepare a “shadow” calculation A qualitative test is inadequate when an entity has multiple reporting units Preparers and smaller firms favor qualitative test More guidance would be needed Deterioration is measured against a baseline, which would be quantitative Permitting non‐public companies to amortize goodwill would be more practical Trend Toward More FVM Disclosure FSP FAS157‐4 Interim and annual disclosure of inputs, valuation techniques, and any changes in inputs or valuation techniques Clarifies that “major categories” for required FVM disclosures would be at the security type level ASU 2010‐06, Improving FVM Disclosures Disclose the amounts of significant transfers in and out of Level 1 and Level 2 and describe the reasons for the transfers. The FVM reconciliation for Level 3 should present purchases, sales, issuances, and settlements on a gross basis rather than as one net number Trend Toward More FVM Disclosure ASU 2010‐29, Disclosure of Supplementary Proforma Business Combination Information The entity should disclose revenue and earnings of the combined entity in comparative financial statements as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. Expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro‐ forma revenue and earnings EITF 09‐4 recommends additional disclosures for the seller’s right to receive contingent consideration Description, amount recognized, changes in amount recognized and changes in the range of outcomes Trend Toward More FVM Disclosure ASU 2011‐ Amendments to Achieve Common FVM and Disclosure Requirements in US GAAP and IFRS New Level 3 fair value measurements disclosures explaining: The valuation process used by the reporting entity The sensitivity of fair value measurements to changes in unobservable inputs The interrelationships between observable inputs, if any Disclose the fair value hierarchy level applicable to balance sheet items disclosed, but not measured in the financial statements at fair value Disclose whether the use of a non‐financial asset differs from the highest and best use assumed in the fair value measurement or disclosure of that asset FVM of Liabilities Finally Resolved FVM of liabilities was one of the more contentious issues of the credit crisis Most believe that liabilities are settled, not transferred Changes in an entity’s own credit risk can impact the FVM of its liabilities ASU 2009‐05, Measuring Liabilities at Fair Value Originally proposed as FSP 157‐c, then as FSP 157‐f FVM includes assessment of non‐ performance risk FVM excludes adjustment for restriction on transfer IFRS 13 is consistent with ASU 2009‐05 ASU 2009‐05, Measuring Liabilities at Fair Value When there is no quoted price in an active market for an identical liability, fair value of the liability is determined by The quoted price of an identical liability when traded as an asset For example, bonds are liabilities traded as assets The quoted price of similar liabilities, or similar liabilities traded as assets Another income or market approach used to measure The amount paid to transfer an identical liability, or The amount received when entering into an identical liability Observable inputs should be maximized, unobservable inputs minimized ASU 2009‐05, Measuring Liabilities at Fair Value Level 1 Quoted price in an active market for an identical liability Quoted price in an active market for an identical liability traded as an asset Level 2 When adjustments to the quoted price for a liability traded as an asset are needed Quoted price is for a similar, not identical asset Unit of account is not identical (credit enhancements) Condition / location of the asset / liability are different Volume and level of activity in the markets differ FVM Best Practice Resources AICPA’s IPR&D Practice Aid Assets Acquired in a Business Combination to Be Used in Research and Development Activities: A Focus on Software, Electronic Devices, and Pharmaceutical Industries AICPA’s Practice Aid: Valuation of Privately‐Held‐Company Equity Securities Issued as Compensation (Cheap Stock Practice Aid) AICPA Impairment Task Force Guide – Testing Goodwill for Impairment FVM Best Practice Resources AcSEC Alternative Investments – Practice aid for auditors giving guidance in the application of Fair Value Measurements to Alternative investments issued in April 2010 Appraisal Foundation – Appraisal Issues Taskforce Best Practices for Valuations in Financial Reporting: Intangible Asset Working Group ‐ Contributory Assets Identification of Contributory Assets and Calculation of Economic Rents: Toolkit FVM Best Practices – Anticipated Resources AICPA Revised IPR&D Practice Aid AICPA Revised Practice Aid: Valuation of Privately Held Equity – draft issued Appraisal Foundation – Appraisal Issues Task Force: Best Practices Publications Customer Relationships Control Premiums Mark Zyla, CPA/ABV, CFA, ASA Mark L. Zyla is a Managing Director of Acuitas, Inc. an Atlanta Georgia based valuation and litigation consultancy firm. Mark received a BBA degree in Finance from the University of Texas at Austin and an MBA degree with a concentration in Finance from Georgia State University. Mark also completed the Mergers and Acquisitions Program at the Aresty Institute of The Wharton School of the University of Pennsylvania and the Valuation Program at the Graduate School of Business at Harvard University. He was a member of The Appraisal Foundation’s Business Valuation Best Practices Working Group on Contributory Asset Charges and the AICPA’s Fair Value Resource Panel. He is currently working on the AICPA’s Impairment Practice Aid Task Force. He is also the Chairman of the AICPA’s Fair Value Measurement Conference Committee. Mark is a former member of the Business Valuations Committee of the AICPA, and a former Chairman of the ABV Examination Committee of the AICPA. He is also a member of the Business Valuation Standards Subcommittee of the ASA. Mark is a frequent presenter and author on valuation issues. Mark is the co‐author of the course, “Fair Value Accounting: A Critical New Skill for All CPAs” published by the AICPA. He is the author of Fair Value Measurements: Practical Guidance and Implementation recently published by John Wiley & Sons. Mark Zyla, CPA/ABV, CFA, ASA Managing Director Acuitas Inc. One Midtown Plaza 1360 Peachtree Street NE, Suite 950 Atlanta, GA 30309 404‐898‐1137 www.acuitasinc.com Fair Value Measurements Blog: www.acuitasinc.com/blog