Changes to Fair Value Concepts
for Financial Reporting
David K. Goesling – dgoesling@srr.com
Introduction n n n
No. 157, Fair Value Measurements which provided a Fair
Value definition, set up a structure for measuring Fair Value,
In May 2011, the Financial Accounting Standards Board (“FASB”)
and established standards for disclosures about Fair Value
amended its source document describing the generally accepted
measurements. (These measurement and reporting standards are
accounting principles (“GAAP”) used by nongovernmental
now incorporated in ASC Topic 820.) In late 2006, shortly after the
entities in the United States, the FASB Accounting Standards
issuance of SFAS 157, the IASB began developing its own Fair
Codification®. The title of Accounting Standards Update No. 2011-
Value measurement standards, using SFAS 157 as their starting
4, Fair Value Measurement (Topic 820) Amendments to Achieve
point. The IASB 2009 exposure draft, Fair Value Measurement,
Common Fair Value Measurement and Disclosure Requirements
contained proposed standards that were similar to those in SFAS
in U.S. GAAP and IFRSs, explicitly describes the overall intent
157, although there were differences in wording. The exposure
of the changes contained in the amendment. Fair Value is still
draft evoked numerous comments requesting the IASB and
defined as prior to the amendment, “as the price that would be
FASB jointly work to develop common Fair Value standards for
received to sell an asset or paid to transfer a liability in an orderly
measurement and reporting.
transaction between market participants at the measurement
date.” However, changes have been made to the manner in
In October 2009, the FASB and the IASB met and agreed that
which some of the underlying concepts of valuation are applied
they would cooperate and develop common requirements.
to particular types of assets.
Together, they concluded that the comparability of U.S. GAAP
A Little History n n n
Accounting Standards Update 2011-4 came about after years of
effort by the FASB and the International Accounting Standards
Board (“IASB”) to develop nearly identical Fair Value accounting
standards. Originally, the FASB and IASB were each separately
developing Fair Value measurement and reporting standards.
In 2003, the FASB began developing its Fair Value measurement
and reporting standards, eventually issuing FASB Statement
and IFRSs financial statements could be improved if: 1) the term
“Fair Value” had the same meaning in U.S. GAAP and IFRSs and
2) U.S. GAAP and IFRSs had essentially the same measurement
and disclosure requirements. Such changes would also simplify
financial reporting because there would be fewer differences in
the application of Fair Value measurement requirements.
In the spirit of developing common standards, the FASB agreed
to consider the comments received by the IASB on their Fair Value
Measurement Exposure Draft and to propose amendments to
U.S. GAAP if necessary. Discussions between the FASB and IASB
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were held in early 2010 that resulted in a FASB exposure draft of
Before being amended, Topic 820 specified that the concept
amendments to Topic 820, while the IASB issued an exposure draft
of highest and best use was relevant when measuring the Fair
on disclosure of a measurement uncertainty analysis. Comments
Value of assets, but it did not distinguish between financial and
from both exposure drafts were jointly considered and discussed
nonfinancial assets. Based on the comments in response to the
until spring of 2011. The IASB then issued its new standard, IFRS
exposures drafts, the FASB concluded that a change was needed
13 Fair Value Measurement, in May 2011.
to improve consistency in the application of the highest and best
At the same time, the FASB issued Accounting Standards Update
use concept.
2011-4 with changes to the wording of many of its requirements
As amended, the highest and best use concept is no longer relevant
for measuring Fair Value and for disclosing information about
when measuring the Fair Value of financial assets or of liabilities
Fair Value measurements. According to the FASB, they did
because such items do not have alternative uses. The FASB
not intend for the amendments to change the meaning of Fair
reasoned that because a financial asset has specific contractual
Value, the requirements for measuring Fair Value, or how those
terms, it can have a different use only if those contractual terms
requirements are applied, but to either clarify their intent regarding
are changed. Such a change in characteristics would cause that
the application of existing Fair Value measurement requirements
particular asset to become a completely different asset.
or change a particular principle or requirement for measuring Fair
Value or disclosing information about Fair Value measurements.
For liabilities, the FASB concluded that although an entity might
Among the amendments that clarify the FASB’s intent regarding
cash flows, doing so would not constitute an alternative use.
the application of existing Fair Value measurement requirements
Even if an entity has specific advantages or disadvantages that
are changes in the application of two closely related valuation
allow it to fulfill a liability more or less efficiently than other market
concepts: highest and best use and the valuation premise. The
participants, those specific factors don’t affect Fair Value.
amendments specify that these two Fair Value measurement
concepts are still relevant when determining the Fair Value of
nonfinancial assets, but not when valuing financial assets or
somehow relieve itself of an obligation and change the associated
The highest and best use concept still applies to nonfinancial
assets such as real and personal property. The following new
liabilities.
paragraphs from Topic 820 contain the now-current language:
Changes to Highest
and Best Use Concept n n n
820-10-35-10A A Fair Value measurement of a nonfinancial
The highest and best use concept originated with the valuation of
by selling it to another market participant that would use the asset
real property, although it is a concept that is also used in personal
in its highest and best use.
property appraisal. Basically, the highest and best use concept
recognizes that real estate and personal property can have multiple
uses, and that the value of an asset may change with a change in
its use. Determining the highest and best use of an asset relies
asset takes into account a market participant’s ability to generate
economic benefits by using the asset in its highest and best use or
820-10-35-10B The highest and best use of a nonfinancial asset
takes into account the use of the asset that is physically possible,
legally permissible, and financially feasible, as follows:
on an analysis of the current use and potential alternative uses
a. A use that is physically possible takes into account
the physical characteristics of the asset that market
participants would take into account when pricing the
asset (for example, the location or size of a property).
of the property, considering what is legally permissible, physically
possible, financially feasible, and maximally productive.
For example, consider a piece of highly specialized equipment
used in the manufacture and assembly of the finned core of an
b. A use that is legally permissible takes into account any
legal restrictions on the use of the asset that market
participants would take into account when pricing the
asset (for example, the zoning regulations applicable to
a property).
automotive radiator. This very expensive, highly complex, custom
designed and constructed piece of equipment is a valuable asset,
allowing for the fabrication of hundreds of thousands of cores
each year as part of an operating business. Yet, if taken out of that
specific production setting, the unique characteristics of the core
c. A use that is financially feasible takes into account
whether a use of the asset that is physically possible and
legally permissible generates adequate income or cash
flows (taking into account the costs of converting the
asset to that use) to produce an investment return that
market participants would require from an investment in
that asset put to that use.
assembly machine – specific core size, complexity of operation,
physical capacity, etc. – change its worth to the amount realized
from the sale of its common components (controls, transformers
and power supplies) and the scrap value of its metallic components.
The change from its current use in radiator manufacturing to an
alternate use has drastically affected the value.
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820-10-35-10C Highest and best use is determined from the
However, the valuation premise concept still applies for
perspective of market participants, even if the reporting entity
nonfinancial assets. Under the Amendment, the terms “in
intends a different use. However, a reporting entity’s current use
use” and “in exchange” are gone. Although suggestions of
of a nonfinancial asset is presumed to be its highest and best
alternative terms were provided by respondents, the FASB instead
use unless market or other factors suggest that a different use by
chose to simply describe the objective of the valuation premise in
market participants would maximize the value of the asset.
a narrative format.
820-10-35-10D To protect its competitive position, or for other
820-10-35-10E The highest and best use of a nonfinancial asset
reasons, a reporting entity may intend not to use an acquired
establishes the valuation premise used to measure the Fair Value
nonfinancial asset actively, or it may intend not to use the
of the asset, as follows:
asset according to its highest and best use. For example,
a. The highest and best use of a nonfinancial asset might
provide maximum value to market participants through
its use in combination with other assets as a group
(as installed or otherwise configured for use) or in
combination with other assets and liabilities (for example,
a business).
that might be the case for an acquired intangible asset that the
reporting entity plans to use defensively by preventing others
from using it. Nevertheless, the reporting entity shall measure
the Fair Value of a nonfinancial asset assuming its highest and
best use by market participants.
Changes to Valuation Premise Concept n n n
1. If the highest and best use of the asset is to use the
asset in combination with other assets or with other
assets and liabilities, the Fair Value of the asset is the
price that would be received in a current transaction
to sell the asset assuming that the asset would be
used with other assets or with other assets and
liabilities and that those assets and liabilities (that
is, its complementary assets and the associated
liabilities) would be available to market participants.
Previously, Topic 820 used the terms “in use” and “in exchange”
to describe the premise of valuation for a Fair Value measurement.
Those terms were also used by the IASB when they issued their
Fair Value Measurement Exposure Draft and were as follows:
a. In-use. The highest and best use of the asset is in-use
if the asset would provide maximum value to market
participants principally through its use in combination
with other assets as a group (as installed or otherwise
configured for use). For example, that might be the
case for certain nonfinancial assets.
2. Liabilities associated with the asset and with the
complementary assets include liabilities that fund
working capital, but do not include liabilities used
to fund assets other than those within the group
of assets.
b. In-exchange. The highest and best use of the asset is inexchange if the asset would provide maximum
value to market participants principally on a standalone
basis. For example, that might be the case for a financial
asset.
3. Assumptions about the highest and best use of a
nonfinancial asset shall be consistent for all of the
assets (for which highest and best use is relevant)
of the group of assets or the group of assets and
liabilities within which the asset would be used.
Apparently, many respondents to the IASB Exposure Draft thought
the terms “in use” and “in exchange” were confusing, particularly to
b. The highest and best use of a nonfinancial asset might
provide maximum value to market participants on a
standalone basis. If the highest and best use of the asset
is to use it on a standalone basis, the Fair Value of the
asset is the price that would be received in a current
transaction to sell the asset to market participants that
would use the asset on a standalone basis.
a layman. Comments were made that the terms did not accurately
describe different valuation premises because an asset is being
exchanged (sold) in both cases. In addition, some respondents
thought that the “in use” valuation premise could be confused
with the term value in use, which was already used in IAS 36,
Impairment of Assets. As used in IAS 36, value in use specifically
refers to the present value of the future cash flows derived from an
entity’s intended use of the asset/asset group without adjustment
to reflect the different cash flows that might arise from a third party
market participant’s use of the asset/asset group.
820-10-35-11A The Fair Value measurement of a nonfinancial asset
assumes that the asset is sold consistent with the unit of account
specified in other Topics (which may be an individual asset). That
Like the highest and best use concept, the FASB has deemed the
is the case even when that Fair Value measurement assumes that
valuation premise as no longer relevant when measuring the Fair
the highest and best use of the asset is to use it in combination
Value of financial assets or of liabilities because their Fair Values do
with other assets or with other assets and liabilities because a Fair
not depend on their use within a group of other assets or liabilities.
Value measurement assumes that the market participant already
holds the complementary assets and associated liabilities.
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Timing for the Amendments n n n
be revised accordingly. The regulatory bodies may have clarified
the valuation premise concept to the layperson and also helped to
For
public
entities,
2011-4
more clearly align multiple promulgations and the spirit associated
become effective during interim and annual periods beginning
with each, but the actual definitions have been significantly
after
the
expanded without the benefit of concisely defined terms. As such,
amendments become effective for annual periods beginning after
the “in use” valuation premise is now described as “the premise
December 15, 2011.
that assumes that an asset would be used in combination with
December
the
15,
changes
2011.
For
in
Amendment
nonpublic
entities,
Conclusion n n n
The FASB and IASB have made significant strides with respect to
converging standards and in particular Fair Value standards and
measurement requirements. As a result, the comparability of U.S.
GAAP and IFRS financial statements will be improved and overall
financial reporting simplified for multinational companies.
For valuation experts, the previously mentioned changes will be
more a matter of form than function. While a highest and best use
analysis is now irrelevant to valuation professionals focusing on
financial assets and liabilities, it will continue to be applicable to
tangible asset professionals.
While dropping the valuation premise terms “in use” and “in
exchange” will not change the appraisal process for tangible asset
other assets or with other assets and liabilities.” And the “in
exchange” premise has now become “the premise that assumes
that an asset would be used on a standalone basis.”
“The premise that assumes that an asset would be used in
combination with other assets or with other assets and liabilities”?
It brings to mind the musician Prince, who changed his name in
1993 to an unpronounceable symbol. Maybe we should just use
“The Premise Formerly Known as In Use.”
David K. Goesling is a Managing Director in the Valuation &
Financial Opinions Group at Stout Risius Ross (SRR). He specializes
in the valuation of industrial and commercial personal property for
financial accounting, tax accounting, property tax appeals, and
other corporate and litigation related purposes. Mr. Goesling can be
reached at +1.312.752.3308 or dgoesling@srr.com.
professionals, the report language and descriptions will need to
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