Making fair value fairly simple
Insights for technology companies September 2010
Michael Schamberger, Audit partner
Fair value accounting, which requires
many accounts and transactions to be
measured at fair value — part of U.S.
GAAP since the early 1990s — has
increased steadily over the past decade,
primarily in response to investor demand
for relevant financial information. In
simple terms, fair value represents the
price an owner would receive to sell an
asset or the price that a company would
have to pay to transfer a liability in an
orderly transaction between market
participants. But in practice determining
fair value can be complicated — especially
when valuing assets and liabilities acquired
as part of a business combination or
securities issued in financing transactions.
What follows is a primer on what
technology companies need to understand
about fair value.
Equally relevant to both public and
private companies, fair value accounting
requires many assets, liabilities and
transactions to be measured at fair
value under U.S. GAAP. This complex
accounting requirement affects most
technology companies. Given the
dynamic growth of many technology
companies, these companies need to
understand the fair value principles
associated with acquisitions and equity
raises where preferred shares are issued
with warrants and conversion features.
These fair value measurements can be
particularly troublesome as there may be
no active markets with quote prices, which
consequently requires alternative fair value
measurement principles to be applied.
Recurring measurements
A number of common situations require
fair value measurements. Among the
recurring measurements that require fair
value accounting are derivatives, such as
interest rate swaps, forward contracts,
options and warrants that can be netcash settled by the holder. Any of these
must be recorded at fair value each time
financial statements are prepared.
Like derivatives, investments in debt
and equity securities that are classified as
available-for-sale or trading are measured
at fair value at each reporting period.
In testing goodwill for impairment,
the fair value of a reporting unit must be
calculated at least annually and compared
with its carrying value. Depending on
the outcome of this analysis, additional
fair value measurements may be required
to determine if the goodwill has been
impaired.
Equally relevant to both public and private
companies, fair value accounting requires
many assets, liabilities and transactions
to be measured at fair value under
U.S. GAAP.
Making fair value fairly simple
Nonrecurring measurements
In addition to recurring measurements,
many nonrecurring measurements call for
fair value accounting, such as acquisitions
and financing transactions. These types of
transactions typically require many fair
value measurements, some of which can
be quite challenging.
For instance, assets and liabilities
acquired in a business combination are
recorded initially at fair value.
Also, securities issued in a capital-raising
transaction— such as equity-classified
warrants, notes and preferred shares
— are measured at fair value, if only to
allocate the total offering proceeds on a
relative fair-value basis. Long-lived assets
and investments that are determined to be
impaired must be written down to
fair value.
Determining fair value for certain
assets and liabilities, such as acquired
intangible assets, assumed deferred
revenue obligations, interest rate swaps,
detachable warrants, conversion features
and debt instruments can be challenging
because these rarely trade in active
markets. For this reason, companies
typically are unable to use quoted market
prices for identical assets or liabilities
when making a fair value measurement.
Instead, valuation techniques, such as
discounted cash flows, must be developed
using inputs and assumptions that the
reporting entity believes would be
employed by market participants.
Regardless of the technique used
and the nature of the asset or liability
being valued, the valuation approach
must reflect the perspective of a market
participant. Wherever possible, observable
data points should be used as inputs to the
model, and all risks must be considered in
the valuation.
To help with these challenging issues,
Grant Thornton’s publication Insights on
fair value measurements: considerations
associated with business combinations or
capital-raising transactions discusses a
number of considerations and potential
traps in making fair value measurements
in acquisitions and capital-raising
activities. The publication provides
examples of commonly used valuation
approaches and shares insights on some of
the important assumptions that underlie
those techniques.
Topics covered in the publication
include:
• Fair value measurement principles
under U.S. GAAP
• Market participant view
• Exit price notion
• Highest and best use
• Principal versus most advantageous
market
• Valuation techniques
• Fair value hierarchy
• Fair value measurements in business
combinations
• Intangible assets
• Multiperiod excess earnings method
• With or without model
• Relief from royalty method
• Replacement cost approach
• Deferred revenue
• Fair value measurements in financing
transactions
• Interest rate swaps
• Warrants and embedded conversion
features
• Debt
Click here to receive a copy of Insights on fair value
measurements.
For more information, contact:
Michael Schamberger
Audit Partner
T 312.602.8760
E Michael.Schamberger@gt.com
Content in this publication is not intended to answer specific
questions or suggest suitability of action in a particular case.
For additional information on the issues discussed, consult a
Grant Thornton client service partner.
www.GrantThornton.com
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