FAIR VALUE ACCOUNTING TOPICS
Randy Gregg, CPA, BDO Assurance Partner
Darren Cordier, CFA, President FV Specialists, Inc.
OVERVIEW – FAIR VALUE ACCOUNTING TOPICS
• Fair Value Accounting Refresher
• Selected Topics
• Goodwill
• Intangible Assets
• Interest Rate Swaps
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FAIR VALUE ACCOUNTING REFRESHER
OVERVIEW OF FAIR VALUE ACCOUNTING
ASC 820 Fair Value Measurement:
• Defines fair value under GAAP
• Provides a framework for measuring fair value
• Requires certain disclosures about fair value measurements
ASC 820 Fair Value Measurement:
• DOES NOT require measurement at fair value
• Note : FASB ASC 825, The Fair Value Option for Financial Assets and
Financial Liabilities—Including an amendment of FASB Statement No.
115 (SFAS No. 159), provides additional flexibility on assets and
liabilities that are not required to be fair valued on a recurring basis.
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MANY STANDARDS REQUIRING FAIR VALUE
MEASUREMENTS
FASB ASC 958 and 805, Not-for-Profit Entities: Mergers and
Acquisitions (SFAS No.164)
FASB ASC 944, Financial Services–Insurance (SFAS No. 163)
FASB ASC 815, Derivatives and Hedging (SFAS No. 161)
FASB ASC 810, Consolidations (SFAS No. 160)
FASB ASC 805, Business Combinations (SFAS No.141R)
FASB ASC 825, Financial Instruments (SFAS No. 159)
FASB ASC 715, Compensation–Retirement Benefits (SFAS No. 158)
FASB ASC 820, Fair Value Measurements and Disclosures (SFAS No. 157)
FASB ASC 860, Transfers and Servicing (SFAS No. 156)
FASB ASC 815, Derivatives and Hedging (SFAS No. 155)
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MANY STANDARDS REQUIRING FAIR VALUE
MEASUREMENTS
FASB ASC 958, Accounting for Contributions Received and
Contributions Made (SFAS No. 116)
FASB ASC 958, Financial Statements of Not-for-Profit Organizations
(SFAS No. 117)
FASB ASC 958, Accounting for Certain Investments Held by Not-forProfit Organizations (SFAS No. 124)
FASB ASC 845, Non-monetary Transactions (SFAS No. 153)
FASB ASC 480, Distinguishing Liabilities from Equity (SFAS No. 150)
FASB ASC 420, Exit or Disposal Cost Obligations (SFAS No. 146)
FASB ASC 360, Property, Plant, and Equipment (SFAS No. 144)
FASB ASC 410, Asset Retirement and Environmental Obligations (SFAS
No. 143)
FASB ASC 350, Intangibles–Goodwill and Other (SFAS No. 142)
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EXCLUSIONS FROM SCOPE OF ASC 820
The following are excluded from the scope of ASC 820:
• Share based payment transactions
• Stock compensation (Topic 718)
• Equity based payments to non-employees (Subtopic 505-50)
• Measurements similar to fair value but not intended to
measure fair value
• VSOE for software revenue recognition (Subtopic 985-605) and
• VSOE for multiple element revenue recognition (Subtopic 605-25)
• Inventory pricing (Topic 330)
• Fair value measurements for purposes of lease
classification (Topic 840)
• Practicability exceptions (listed in ASC 820-15-3)
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DEFINITION OF FAIR VALUE
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
Elements of Fair Value:
•Exit price notion, from market participant perspective
•Hypothetical transaction with a market participant
•“Market participants are unrelated parties, knowledgeable of the asset or
liability given due diligence, willing and able to transact for the asset/liability,
and may be hypothetical”
•For a particular asset and liability
•Highest and best use for assets, credit standing for liabilities (physical, legally
and financially feasible)
•The most advantageous market is the market in which the price obtained
maximizes the amount received.
A Roadmap to Applying FASB ASC 350
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WHEN TRANSACTION PRICE ≠ FAIR VALUE
A transaction price might not represent the fair value of an
asset or liability under the following conditions:
• Transaction is between related parties
• Transaction occurs under duress
• Seller forced to accept price, experiencing financial difficulty
• Different units of account
• Asset/liability is only one element in the transaction
• Different markets
• Market in which the transaction occurs is not the principal or most
advantageous market
• Market differs from the one in which the reporting entity would
transact
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HOW IS FAIR VALUE DETERMINED?
By answering the following questions:
• What is the unit of account?
• What is the exit market (i.e., principal or most advantageous
market from the perspective of the reporting entity)
• Who are the market participants?
• What is the highest and best use (assets) or nonperformance risk
(liabilities)?
• What is the appropriate valuation premise (assets)?
• What is the unit of valuation?
• What are the valuation techniques?
• What are the valuation inputs?
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DETERMINING MOST ADVANTAGEOUS MARKET:
REMINDERS
Transaction costs
• Are the incremental direct costs to sell the asset or transfer the
liability in the exit market
• Are used to determine most advantageous market
• Are not an adjustment to the price used to measure fair value in the
exit market
• Do not include transportation costs
Transportation costs
• Fair value is adjusted for transportation costs if location is an
attribute of the asset or liability, which is frequently the case—for
example, commodities
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LIABILITIES TRANSFERRED
Assumes nonperformance risk is the same before and after
its transfer.
Nonperformance risk is the risk that the obligation will not
be fulfilled.
May include the reporting entity’s own credit risk.
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FAIR VALUE HIERARCHY
The fair value hierarchy ranks the inputs to fair value
measurements from most reliable (Level 1) to least reliable
(Level 3)
• ASC 820 describes three levels of inputs:
•
•
•
Level 1: Unadjusted quoted prices in active markets for identical
assets or liabilities that the reporting entity has the ability to
access at the measurement date
Level 2: Inputs other than quoted prices that are observable for
the asset or liability, either directly or indirectly
Level 3: Unobservable inputs for the asset or liability
Valuation techniques must maximize use of relevant observable
inputs and minimize use of unobservable inputs
A Roadmap to Applying FASB ASC 350
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FAIR VALUE HIERARCHY
In practice, an entity may use the following inputs to
measure fair value:
• Quoted market prices (level 1 or 2)
• Market prices for similar assets (level 2 or 3)
• Multiples, such as earnings, revenue or performance
measures (level 3)
• Present value techniques (level 3)
A Roadmap to Applying FASB ASC 350
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VALUATION TECHNIQUES
Three techniques acceptable under ASC 820:
• Market approach
• Income approach
• Cost approach
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MARKET APPROACH
Uses prices and other relevant information generated by
market transactions involving identical or comparable assets
or liabilities (including a business)
• Use of market multiples derived from a set of comparables
• Includes the use of matrix pricing
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INCOME APPROACH
Uses valuation techniques to convert future amounts (i.e.,
cash flows, earnings) to a single present amount
(discounted).
• The measurement is based on the value indicated by
current market expectations about those future amounts.
• Techniques include the following:
-
Present value techniques
Option pricing models
Multiperiod excess earnings method
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COST APPROACH
The amount that currently would be required to replace the
service capacity of an asset (often referred to as current
replacement cost).
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FAIR VALUE DISCLOSURES
FAIR VALUE HIERARCHY
Level 1 – Quoted prices in active markets for identical
assets or liabilities.
Level 2 – Inputs other than quoted prices that are
observable, either directly or indirectly.
Level 3 – Unobservable inputs based on best information
available in the circumstances.
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BASIC DISCLOSURE REQUIREMENTS
Information that enables users of the financial statements
to assess both:
• The inputs and valuation techniques used to develop
those measurements.
• Their impact on earnings for the period.
Applicable to each major class of assets and liabilities
measured at fair value.
Required for annual and interim reporting periods.
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RECURRING BASIS REQUIREMENTS
The fair value measurements at the reporting date.
The level within the fair value hierarchy used (levels 1, 2,
or 3).
For transfers between levels 1 and 2, identification of
transfers and the reasons for each.
For Level 3, a reconciliation between beginning and ending
balances and separately presented changes during the
period for five items.
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NONRECURRING BASIS REQUIREMENTS
The fair value measurements recorded during the period
and the reasons for the measurements.
The level within the fair value hierarchy for the fair value
(Levels 1, 2, or 3).
If Level 3, a description of the inputs and valuation
technique(s) used and the inputs used for each class of
assets or liabilities.
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TABULAR FORMAT
Required for any quantitative disclosures.
Provide a reconciliation between beginning and ending
balances.
Provide information about Level 3 inputs and changes
among levels of inputs.
Additional Requirements Encouraged
Combine the fair value information required .
Disclose information about other similar measurements.
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GOODWILL
Impairment Testing
GOODWILL IMPAIRMENT
• Impairment is the condition that exists when the carrying
amount exceeds the implied fair value:
- If the carrying amount of the reporting unit = zero or negative,
step two of the impairment test is performed, when it is more
likely than not that a goodwill impairment exists.
Carrying Amount > Fair Value
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GOODWILL IMPAIRMENT TESTING - STEPS
• A two-step impairment test performed on reporting units
(“RUs”)
- Where Step 1 identifies potential impairment and Step 2 measures
the amount of impairment (if any)
- RUs determined by Management [ASC 350/ASC 280], and
assets/liabilities allocated to RUs
- Perform annually or if triggered
• Impairment is the condition that exists when the carrying
amount exceeds the implied fair value:
Carrying Amount > Fair Value
- If the carrying amount of the reporting unit = zero or negative,
step two of the impairment test is performed, when it is more
likely than not that a goodwill impairment exists.
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GOODWILL IMPAIRMENT TESTING –
TRIGGERING EVENTS
• Triggering Event – An event or change in
circumstances occurs that would more likely than
not reduce the fair value below the carrying amount
• Examples of such events or circumstances include:
- A significant adverse change in legal factors or in the
business climate
- A loss of key personnel
- Unanticipated competition
- A more-likely-than-not expectation that a reporting unit
will be sold or otherwise disposed of
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STEP 1 QUANTITATIVE TESTING
• Step 1 test –
• Quantitative may use various approaches to derive the
fair value of a reporting unit:
• Income approach
• Projected Free Cash Flows +
• Terminal/Residual Value
• Market approach
• Asset-based approach (rare for majority of BDO companies)
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STEP 1 – QUALITATIVE TESTING
• Step 1 – Qualitative
i.
Whether more likely than not (more than 50% likelihood)
ii.
Fair value of reporting unit is less than carrying amount
iii.
If likely that is impaired then determine FV of RU
iv.
If so, proceed to 2 step test
v.
Factors to consider include macroeconomic conditions, cost factors,
overall financial performance, specific events, others
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MARKET CAP (“MC”) AND GOODWILL IMPAIRMENT
• Recommended: Reconcile aggregate FV of RUs to MC
-
MC based on average stock price determined over a reasonable period
of time
• SEC Guidance highlights: (1) Appropriate if facts and
circumstances evidence that the decline in the stock price is
not related to the entity or industry-specific factors or is due
to certain extraordinary events;
(2) May not be appropriate if the decline in the stock price is
due to entity or industry specific factors (i.e. change in growth
expectations, cost structure) or if stock price shows a
systematic decline
• Trends in stock prices subsequent to the valuation date may be
considered to evaluate whether the decline in the stock price
is other than temporary
• Length of the averaging period will depend upon specific facts
and circumstances, however, an averaging period exceeding 30
days is expected to be rare
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CONTROL PREMIUM AND GOODWILL IMPAIRMENT
• Determining FV of RU – Need to consider additional
factors!
• ASC 350-20-35-23
-
Substantial value may arise from ability to take advantage of synergies
and other benefits that flow from control over another entity
• Thus, an acquiring entity is often willing to pay more (“control
premium”) for equity securities that give it a controlling
interest
• This control premium may cause the FV of RU to then > its
market cap - i.e., Market cap of an entity may not fully capture
the FV of RU as a whole
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CONTROL PREMIUM AND GOODWILL IMPAIRMENT
(CONT.)
• Determining significance of control premiums? SEC
says no bright lines/rules of thumb – need well
reasoned valuation!
-
-
Consider recent trends in market cap – e.g., over a reasonable
period of time, particularly in light of volatile markets
Consider changes in underlying stock prices – e.g., declines may
be indicative of factors that should be considered in
determination of FV
Refer to SEC speech
http://www.sec.gov/news/speech/2008/spch120808rgf.htm
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STEP 1 CONCLUSION
Determine if fair value of the RU is greater than the
carrying value of goodwill.
If Fair Value of RU > Carrying Amount  NO IMPAIRMENT
If Fair Value of RU < Carrying Amount  Step 2
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GOODWILL IMPAIRMENT TESTING –
STEP TWO PROCESS
• Step 2 – determine the implied fair value of reporting
unit goodwill and compare to the carrying amount
- Implied fair value of goodwill determined by allocating the fair value
of the reporting unit to the assets (including unrecognized intangible
assets) and liabilities of that reporting unit as if the reporting unit had
been acquired in a business combination and the fair value of the
reporting unit is the “purchase price”
- Excess of fair value over sum of amounts assigned to assets and
liabilities is the implied fair value of reporting unit goodwill
- If carrying amount of goodwill > implied fair value of goodwill 
recognize an impairment loss equal to the difference
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GOODWILL IMPAIRMENT TESTING –
FV OF GOODWILL
If Fair Value of GW > Carrying Amount  NO IMPAIRMENT
If Implied Fair Value of GW < Carrying Amount  IMPAIRED
• Determined in same manner as goodwill is determined in a business
combination
- Must consider the concept of “defensive value” when assigning fair value
to the assets included in the reporting unit
- Defensive value may be created when the highest and best use of an
asset by a market participant is different from the intended use of the
reporting entity
- Defensive value may apply to an intangible asset, such as a trademark,
which is the enterprise either:
• Does not use or
• Uses in a manner other than its highest and best use
• Excess = Implied fair value of goodwill
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INTANGIBLE ASSETS- WHAT ARE THESE?
• ASC definition — “assets (not including financial assets)
that lack physical substance”
− Identifiable:
− “…separable, i.e., capable of being separated or divided from
the entity and sold, transferred, licensed, rented or
exchanged…”
− “arises from contractual or other legal rights…”
• Intangible assets do not include goodwill (ASC 350-20)
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INTANGIBLE ASSETS
Intangible asset examples
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INDEFINITE LIVED INTANGIBLES
• If there is not a useful life for an intangible asset,
the asset is considered to have an indefinite life and
thus, is not amortized
• Examples of potential indefinite lived assets
include:
- Taxi cab medallions
- Certain trade names
- Bridge/tunnel rights
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VALUING INTEREST RATE SWAPS
BASIC SWAP VALUATION
• An interest rate swap is an agreement between two parties
(known as counterparties) where one stream of future
interest payments is exchanged for another based on a
specified principal (“notional”) amount
• Inputs – Fixed for Floating Swap
-
Notional Amount
Effective Date
Maturity Date
Fixed Rate
Floating Rate
Frequency
Non-Performance Risk (Unique to ASC 820)
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BASIC SWAP VALUATION
Most inputs are provided in the swap agreement (notional
amount, effective date, maturity date, fixed rate, underlying
floating rate, frequency, and counter-party).
• Non Performance Risk – Became an
• Floating rate – underlying
issue with the implementation of
benchmark rate is defined but
ASC 820
forward curve must be derived.
• Understanding the client and the
• Calculation of forward curve
counterparty
can be time consuming and
challenging
• Credit risk / analysis
• Many sources for forward
- Market participant
curves. Curve must reflect
- Credit default swaps
reset rates (bootstrapped
- Spreads associated with similar
rates).
terms and credit ratings
- Bloomberg is a common
- Synthetic credit ratings –
source
www.creditmodel.com
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BASIC SWAP VALUATION
METHODOLOGY
• Once inputs are defined, the rest is math
• Calculate payments over the life of the agreement
using fixed curve and floating rates
• Net the payments
• Discount the payments using the floating rates plus
non-performance risk
• Sum the values = Fair Value
- Said differently, the Fair Value of the interest rate swap is X
and broken out of X is the credit or non performance risk.
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BASIC SWAP VALUATION
NON PERFORMANCE RISK
The risk to each party of a contract that the counterparty will not live up to its
contractual obligations.
• Determine risk for both parties
• Is there non-performance risk when subject company is in asset / liability
position?
-
Most agree that NPR should be considered when a swap is an asset.
FASB - “Nonperformance risk refers to the risk that the obligation will not be fulfilled
and affects the value at which the liability is transferred. Therefore, the fair value of
the liability shall reflect the nonperformance risk relating to that liability.
Nonperformance risk includes but may not be limited to the reporting entity's own
credit risk. The reporting entity shall consider the effect of its credit risk (credit
standing) on the fair value of the liability in all periods in which the liability is
measured at fair value. That effect may differ depending on the liability, for
example, whether the liability is an obligation to deliver cash (a financial liability) or
an obligation to deliver goods or services (a nonfinancial liability), and the terms of
credit enhancements related to the liability, if any.”
• Papers written on the subject
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CONCLUSION
QUESTIONS?