Fair Value Measurements
Revisited
Herschel Mann
Texas Tech University
1
FASB Statement 157
Fair Value Measurements
2
FASB Statement 157
• Guidance on determining fair value evolved
piecemeal and is inconsistent
• SFAS 157
 Defines fair value
 Establishes a framework for measuring fair value
 Expands disclosure requirements about fair value
• SFAS 157 applies under other accounting
pronouncements that require or permit fair value
measurements; it does not require any new fair
value measurements.
3
FASB Statement 157
• Selected scope exceptions
 SFAS 123R share-based payment transactions
 ARB 43, Chapter 4, “Inventory Pricing”
 Does not eliminate the practicability exceptions to
fair value measurements in accounting
pronouncements within the scope of SFAS 157
 APB 29
 SFAS 87, 106, 107, 140, 141, 143, 146, 153
 FIN 45, 47
4
FASB Statement 157
• 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
• A fair value measurement is for a particular asset or
liability
• A fair value measurement assumes that the
transaction to sell the asset or transfer the liability
occurs in the principal market or, in the absence of a
principal market, the most advantageous market
• A fair value measurement assumes the highest and
best use of the asset by market participants
5
FASB Statement 157
• Valuation techniques used to measure fair
value should maximize the use of
observable inputs and minimize the use of
unobservable inputs
• Fair value hierarchy
 Level 1 inputs – quoted prices in active markets
for identical assets or liabilities
 Level 2 inputs – those other than quoted prices
that are observable for the asset or liability
 Level 3 inputs – unobservable inputs
6
FASB Statement 157
• SFAS 157 is effective for financial
statements issued fiscal years beginning
after November 15, 2007.
• SFAS 157 must be applied prospectively.
• FSP 157-2 delays the effective date of
SFAS 157 to fiscal years beginning after
November 15, 2008 for nonfinancial
assets and nonfinancial liabilities, except
for items that are recognized or disclosed at
fair value in the financial statements on a
recurring basis (at least annually).
7
FASB Statement 159
The Fair Value Option for Financial
Assets and Financial Liabilities
8
FASB Statement 159
• SFAS 159 allows entities to choose to
measure eligible items at fair value (the “fair
value option”)
• The entity must report unrealized gains and
losses on these “opted” items in earnings
• The decision to elect the fair value option is
 Applied instrument by instrument
 Irrevocable (unless a new election date occurs)
 Applied only to an entire instrument and not to
only specified risks, cash flows, or portions of
that instrument
9
FASB Statement 159
• Entities may elect the fair value option for
the following items
 A recognized financial asset and financial liability
 A firm commitment that would otherwise not be
recognized at inception and that involves only
financial instruments
 A written loan commitment
 The rights and obligations under an insurance
contract that is not a financial instrument but
whose terms permit the insurer to settle by
paying a third party to provide those goods or
services
10
FASB Statement 159
 The rights and obligations under a warranty that is
not a financial instrument but whose terms permit
the warrantor to settle by paying a third party to
provide those goods or services
 A host financial instrument resulting from the
separation of an embedded nonfinancial derivative
instrument from a nonfinancial hybrid instrument
under paragraph 12 of SFAS 133 (example is an
instrument in which the value of the bifurcated
embedded derivative is payable in cash, services,
or merchandise but the debt host is payable only in
cash)
11
FASB Statement 159
The following recognized financial assets and financial liabilities
are not eligible items:
 An investment in a subsidiary that the entity is required to consolidate
 An interest in a variable interest entity that an entity is required to
consolidate
 Employers’ and plans’ obligations for pension benefits, other
postretirement benefits, postemployment benefits, employee stock option
and stock purchase plans and other forms of deferred compensation
arrangements
 Financial assets and financial liabilities recognized under leases
 Deposit liabilities, withdrawable on demand, of banks, savings and loan
associations, credit unions, and other similar depository institutions
 Financial instruments that are, in whole or in part, classified by the issuer
as a component of shareholders’ equity
12
FASB Statement 159
• The following recognized financial assets and financial
liabilities are not eligible items:
 An investment in a subsidiary that the entity is required to consolidate
 An interest in a variable interest entity that an entity is required to
consolidate
 Employers’ and plans’ obligations for pension benefits, other
postretirement benefits, postemployment benefits, employee stock
option and stock purchase plans and other forms of deferred
compensation arrangements
 Financial assets and financial liabilities recognized under leases
 Deposit liabilities, withdrawable on demand, of banks, savings and loan
associations, credit unions, and other similar depository institutions
 Financial instruments that are, in whole or in part, classified by the
issuer as a component of shareholders’ equity
13
FASB Statement 159
An entity may decide whether to elect the fair value
option for each eligible item on its election date, which
is the date that one of the following occurs:
 The entity first recognizes the eligible item
 The entity enters into an eligible firm commitment
 Financial assets that have been reported at fair value with
unrealized gains and losses included in earnings because of
specialized principles cease to qualify for that specialized
accounting
 The accounting treatment for an investment in another entity
changes because the investment becomes subject to the
equity method or the investor ceases to consolidate a
subsidiary or a variable interest entity but retains an interest
14
FASB Statement 159
 An event that requires an eligible item to be measured at
fair value at the time of the event but does not require fair
value measurement at each reporting date after that
(excluding the recognition of impairment)
15
FASB Statement 159
Examples of events that require remeasurement of
eligible items at fair value, initial recognition of eligible
items, or both, and thereby create an election date for
the fair value option are:
 Business combinations
 Consolidation or deconsolidation of a subsidiary or variable
interest entity
 Significant modifications of debt
16
FASB Statement 159
The fair value option may be elected for a single
eligible item without electing it for other identical
items, with the following four exceptions
 If multiple advances are made to one borrower pursuant to
a single contract and the individual advances lose their
identify and become part of a larger loan balance, the fair
value option should be applied only to the larger balance
and not to each advance individually
 If the fair value option is applied to an investment that
would otherwise be accounted for under the equity method,
it must be applied to all of the investor’s financial interests
in that entity
17
FASB Statement 159
 If the fair value option is applied to an eligible insurance or
reinsurance contract, it should be applied to all claims and
obligations under that contract
 If the fair value option is elected for an insurance contract
for which integrated or nonintegrated contract features or
coverages are issued, the fair value option must be
applied to those other features or coverages
18
FASB Statement 159
Assets and liabilities reported at fair value under SFAS 159
must be reported separately from the carrying amounts of
similar assets and liabilities measured using another
measurement attribute
 Present the aggregate of fair value and non-fair-value
amounts in the same line item in the balance sheet and
parenthetically disclose the amount measured at fair
value included in the aggregate amount
 Present two separate line items to display the fair value
and non-fair-value carrying amounts
Cash receipts and payments related to items measured at
fair value should be classified according to their nature in
statements of cash flows
19
FASB Statement 159
SFAS 159 became effective as of the beginning of
each reporting entity’s first fiscal year that begins
after November 15, 2007.
20
Emergency Economic Stabilization Act of 2008
• Emergency Economic Stabilization Act of 2008 (EESA)
signed into law on October 3, 2008
• Section 133 mandated that the SEC conduct a study on
mark-to-market accounting standards as provided by SFAS
157 (in consultation with the Federal Reserve and the
Secretary of the Treasury)
• EESA mandated that six key issues be addressed
21
Six Key Issues Addressed in Response to EESA
• Effects of fair value accounting standards on financial
institutions’ balance sheets
• Impact of fair value accounting on bank failures in 2008
• Impact of fair value accounting on the quality of financial
information to investors
• Process used by the FASB in developing accounting
standards
• Alternatives to fair value accounting standards
• Advisability and feasibility of modifications to fair value
accounting standards
22
Recommendations in SEC Response
1. SFAS 157 should be improved, but not suspended
2. Existing fair value and mark-to-market requirements
should not be suspended
3. Additional measures should be taken to improve the
application and practice related to existing fair value
requirements (particularly as they relate to both Level
2 and Level 3 estimates
4. The accounting for financial asset impairments
should be addressed
23
Recommendations in SEC Response
5. Implement further guidance to foster the use of sound
judgment
6. Accounting standards should continue to be
established to meet the needs of investors
7. Additional formal measures to address the operation
of existing accounting standards in practice should be
established
8. Address the need to simplify the accounting for
investments in financial assets
24
FASB Staff Position (FSP) FAS 157-1
(Issued Before SEC Response)
• SFAS 157 does not apply under SFAS 13, Accounting
for Leases, and other accounting pronouncements that
address fair value measurements for purposes of lease
classification or measurement under SFAS 13
• This scope exception does not apply to assets acquired
and liabilities assumed in a business combination that
are required to be measured at fair value under SFAS
141 or SFAS 141R, regardless of whether those assets
and liabilities are related to leases
25
FASB Staff Position (FSP) FAS 157-2
(Issued Before SEC Response)
• Defers the effective date of SFAS 157 to fiscal years
beginning after November 15, 2008 for nonfinancial assets
and nonfinancial liabilities
 except for items that are recognized or disclosed at fair value in an
entity’s financial statements on a recurring basis (at least annually)
• Nonfinancial assets and nonfinancial liabilities include all
assets and liabilities other than financial assets and
financial liabilities (per SFAS 159, The Fair Value Option for
Financial Assets and Financial Liabilities)
26
FASB Staff Position (FSP) FAS 157-3
(Issued Before SEC Response)
• Clarifies the application of SFAS 157 in a market that
is not active
• Added an illustrative example to SFAS 157
 Example relates to an entity that invested in a AA-rated
tranche of a collateralized debt obligation security, with the
underlying collateral for the collateralized debt obligation
security being unguaranteed nonconforming residential
mortgage loans
• This FSP became effective upon its issuance
27
FASB Staff Position (FSP) FAS 157-4
(Issued After SEC Response)
• Provides guidance for estimating fair value in
accordance with SFAS 157 when the volume and
level of activity for the asset or liability have been
significantly decreased
• Provides guidance on identifying circumstances that
indicate a transaction is not orderly
• Applies to all assets and liabilities within the scope of
accounting pronouncements that require or permit fair
value measurements, except for the exemptions
identified in SFAS 157 (e.g., share-based payments)
28
FASB Staff Position (FSP) FAS 157-4
(Selected Items)
• This FSP does not change the requirements in
paragraphs 24-27 of SFAS 157, which provides
guidance on the use of Level 1 inputs
 Thus, it does not apply to quoted prices for an identical asset
or liability in an active market (Level 1 input)
 For example, although the volume and level of activity for an
asset or liability may significantly decrease, transactions for
the asset or liability may still occur with sufficient frequency
and volume to provide pricing information on an ongoing basis
29
FASB Staff Position (FSP) FAS 157-4 (Par. 12)
• An entity must evaluate the following factors to
determine whether there has been a significant
decrease in the volume and level of activity for the
asset or liability when compared with normal market
activity for the asset or liability (or similar assets or
liabilities):
 There are few recent transactions
 Price quotations are not based on current information
 Price quotations vary substantially, either over time or among
market makers
 Indexes that previously were highly correlated with the fair
values of the asset or liability are demonstrably uncorrelated
with recent indications of fair value for that asset or liability
30
FASB Staff Position (FSP) FAS 157-4 (Par 12)
 There is a significant increase in implied liquidity risk
premiums, yields, or performance indicators for observed
transactions or quoted prices when compared with the entity’s
estimate of expected future cash flows, considering all
available market data about credit and other nonperformance
risk for the asset or liability
 There is a wide bid-ask spread or significant increase in the
bid-ask spread
 There is a significant decline or absence of a market for new
issuances (that is, a primary market) for the asset or liability or
similar assets or liabilities
 Little information is released publicly (e.g., a principal to
principal market)
31
FASB Staff Position (FSP) FAS 157-4 (Par. 13)
• If the entity concludes there has been a significant
decrease in the volume and level of activity for the
asset or liability in relation to normal market activity for
the asset or liability (or similar assets or liabilities),
transactions or quoted prices may not be
determinative of fair value (for example, there may be
increased instances of transactions that are not
orderly).
• In that case, further analysis of the transactions or
quoted prices is needed, and a significant adjustment
to the transactions or quoted prices is needed, and a
significant adjustment to the transactions or quoted
prices may be necessary.
32
FASB Staff Position (FSP) FAS 157-4 (Par. 14)
• SFAS 157 does not prescribe a methodology for making
significant adjustments to transactions or quoted prices when
estimating fair value.
• If there has been a significant decrease in the volume and
level of activity for the asset or liability, a change in valuation
technique or the use of multiple valuation techniques may be
appropriate.
• When weighting indications of fair value resulting from the
use of multiple valuation techniques, a reporting entity shall
consider the reasonableness of the range of fair value
estimates.
• The objective is to determine the point within that range that
is most representative of fair value under current market
conditions.
• A wide range of fair value estimates may be an indication
that further analysis is needed.
33
FASB Staff Position (FSP) FAS 157-4 (Par. 15)
• Even in circumstances where there has been a significant
decrease in the volume and level of activity for the asset or
liability and regardless of the valuation technique(s) used,
the objective of a fair value measurement remains the same.
 Fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction (that is, not a forced
liquidation or distressed sale) between market participants at the
measurement date under current market conditions.
34
FASB Staff Position (FSP) FAS 157-4 (Par. 15-16)
• Determining the price at which willing market participants
would transact at the measurement date under current
market conditions if there has been a significant decrease in
the volume and level of activity for the asset or liability
depends on the facts and circumstances and requires the
use of significant judgment.
 However, a reporting entity’s intention to hold the asset or liability is
not relevant in estimating fair value.
 Fair value is a market-based measurement, not an entity-specific
measurement.
• A reporting entity shall evaluate the circumstances to
determine whether the transaction is orderly based on the
weight of evidence.
35
FASB Staff Position (FSP) FAS 157-4 (Par. 17)
• The determination of whether a transaction is orderly (or not
orderly) is more difficult if there has been a significant
decrease in the volume and level of activity for the asset or
liability.
• Accordingly, a reporting entity shall consider the following
guidance:
a. If the weight of the evidence indicates the transaction is not orderly, a
reporting entity shall place little, if any, weight (compared with other
indications of fair value) on that transaction price when estimating fair
value or market risk premiums.
b. If the weight of the evidence indicates the transaction is orderly, a
reporting entity shall consider that transaction price when estimating
fair value or market risk premiums. The amount of weight placed on
that transaction price when compared with other indications of fair
value will depend on the facts and circumstances such as the volume
of the transaction, the comparability of the transaction to the asset or
liability being measured at fair value, and the proximity of the
transaction to the measurement date.
36
FASB Staff Position (FSP) FAS 157-4 (Par. 17)
c. If a reporting entity does not have sufficient information to
conclude that the transaction is orderly or that the
transaction is not orderly, it shall consider that transaction
price when estimating fair value or market risk premiums.
However, that transaction price may not be determinative
of fair value (that is, that transaction price may not be the
sole or primary basis for estimating fair value or market
risk premiums.) A reporting entity shall place less weight
on transactions on which a reporting entity does not have
sufficient information to conclude whether the transaction
is orderly when compared with other transactions that are
known to be orderly.
 In its determinations, a reporting entity need not undertake all
possible efforts, but shall not ignore information that is available
without undue cost and effort.
 A reporting entity would be expected to have sufficient
information to conclude whether a transaction is orderly when it is
party to the transaction.
37
FASB Staff Position (FSP) FAS 157-4
Effective Date and Transition
• FSP FAS157-4 is effective for interim and
annual reporting periods ending after June
15, 2009, and must be applied
prospectively.
• Early adoption is permitted for periods
ending after March 15, 2009.
 If an entity elects to adopt early either FSP FAS
115-2 and FAS 124-2 or FSP FAS 107-1 and
APB 28-1, it also is required to adopt early this
FSP.
38
FSP FAS 115-1and FAS 124-1
• This FSP
 addresses the determination as to when an investment
is considered impaired
 whether that impairment is other than temporary
 the measurement of an impairment loss
• Issued November 3, 2005
39
FSP FAS 115-1and FAS 124-1
Step 1 – Determine Whether an Investment is Impaired
• Impairment must be assessed at the individual security
level
 Individual security level means the level and method of
aggregation used by the reporting entity to measure
realized and unrealized gains and losses on its debt and
equity securities.
• An investment is impaired if its fair value is less than its cost
 Cost includes adjustments made to the cost basis of an investment
for accretion, amortization, previous other-than-temporary
impairments, and hedging.
• Except as otherwise provided in this FSP, an investor must
assess whether an investment is impaired in each reporting
period.
40
FSP FAS 115-1and FAS 124-1
Step 1 – Determine Whether an Investment is Impaired
• An investor may not combine separate contracts (a debt
security and a guarantee or other credit enhancement) for
purposes of determining whether a debt security is impaired
or can contractually be prepaid or otherwise settled in such
a way that the investor would not recover substantially all of
its cost.
• For investments other than cost-method investments, if the
fair value of the investment is less than its cost, proceed to
Step 2 (i.e., evaluate whether an impairment is other than
temporary)
41
FSP FAS 115-1and FAS 124-1
Step 1 – Determine Whether an Investment is Impaired
• Since the fair value of cost-method investments is not
readily determinable, the evaluation of whether an
investment is impaired should be determined as follows:
 If an investor has estimated the fair value of a cost-method
investment, that estimate should be used to determine if the
investment is impaired for the reporting periods in which the investor
estimates fair value.
 If the investor has not estimated the fair value of a cost-method
investment, the investor must evaluate whether an event or change
in circumstances has occurred in that period that may have a
significant adverse effect on the fair value of the investment (an
“impairment indicator”).
 If an impairment indicator is present, the investor must estimate the
fair value of the investment.
42
FSP FAS 115-1and FAS 124-1
Step 1 – Determine Whether an Investment is Impaired
• Examples of “impairment indicators”
 A significant deterioration in the earnings performance, credit rating,
asset quality, or business prospects of the investee
 A significant adverse change in the regulatory, econo9mic, or
technological environment of the investee
 A significant adverse change in the general market condition of
either the geographic area or the industry in which the investee
operates
 A bona fide offer to purchase (whether solicited or unsolicited), an
offer by the investee to sell, or a completed auction process for the
same or similar security for an amount less than the cost of the
investment
 Factors that raise significant concerns about the investee’s ability to
continue as a going concern, such as negative cash flows from
operations, working capital deficiencies, or noncompliance with
statutory capital requirements of debt covenants.
43
FSP FAS 115-1and FAS 124-1
Step 2 – Evaluate Whether an Impairment Loss
is Other Than Temporary
• If in Step 1, when the fair value of the investment is less
than its cost at the balance sheet date for which impairment
is assessed, the impairment is either temporary or other
than temporary.
• An investor should apply other guidance that is pertinent to
the determination of whether an impairment is other than
temporary (such as paragraph 16 of SFAS 115).
44
FSP FAS 115-1and FAS 124-1
Step 3 – If the Impairment is Other Than Temporary, Recognize an
Impairment Loss Equal to the Difference between the Investment’s
Cost and Its Fair Value
• If the impairment loss is other than temporary, an
impairment loss should be recognized in earnings equal to
the entire difference between the investor’s cost and
its fair value at the balance sheet date of the reporting
period in which the assessment is made.
• The fair value of the investment would then become the
new cost basis of the investment and should not be
adjusted for subsequent recoveries in fair value.
• In periods subsequent to the recognition of an other-thantemporary loss for debt securities, an investor should
account for the other-than-temporarily impaired debt
security as if the debt security had been purchased at the
measurement date of the other-than-temporary impairment.
45
FSP FAS 115-1and FAS 124-1
• Effective Date and Transition
 The guidance in this FSP must be applied to
reporting periods beginning after December
15, 2005.
46
FSP FAS 115-2 and FAS 124-2
• Issued April 9, 2009
• The recognition guidance in this FSP applies to
debt securities classified as available-for-sale and
held-to-maturity that are subject to other –thantemporary impairment guidance within:




47
SFAS 115
FSP FAS 115-1 and FAS 124-1
EITF Issue 99-20, as amended by FSP EITF 99-20-1
AICPA Statement of Position 03-3
FSP FAS 115-2 and FAS 124-2
Evaluating Whether an Impairment of a Debt Security Is
Other Than Temporary
• If the fair value of a debt security is less than its amortized cost basis
at the balance sheet date, an entity shall assess whether the
impairment is other than temporary.
• If an entity has decided to sell the debt security, an other-thantemporary impairment shall be considered to have occurred.
• If an entity does not intend to sell the debt security, the entity should
consider available evidence to assess whether it more likely than not
will be required to sell the security before the recovery of the
amortized cost basis. If so, an other-than-temporary impairment shall
be considered to have occurred.
48
FSP FAS 115-2 and FAS 124-2
Evaluating Whether an Impairment of a Debt Security Is
Other Than Temporary
• If the entity does not expect to recover the entire amortized cost
basis, the entity would be unable to assert that it will recover its
amortized cost basis even if it does not intend to sell the security.
Therefore, an other-than-temporary impairment shall be considered to
have occurred.
 In assessing whether the entire cost basis of the security will be
recovered, an entity must compare the present value of cash flows
expected to be collected from the security with the amortized cost basis
of the security.
 If present value of cash flows expected to be collected is less than the
amortized cost basis of the security, the entire amortized cost basis of the
security will not be recovered (that is, a credit loss exists), and an otherthan-temporary impairment shall be considered to have occurred.
49
FSP FAS 115-2 and FAS 124-2
Determination of the Amount of an Other-Than Temporary
Impairment Recognized in Earnings and OCI
• When an other-than-temporary impairment loss has occurred, the
amount that should be recognized in earnings depends on whether an
entity intends to sell the security or more likely than not will be required to
sell the security before recovery of its amortized cost basis less any
current-period credit loss.
 If it intends to sell the security or more likely than not will be required to sell it
before recovery of its amortized cost basis less any current-period credit loss,
the other-than-temporary impairment must be recognized in earnings equal to
the entire difference between the investment’s amortized cost basis and its
fair value at the balance sheet date.
 If an entity does not intend to sell the security and it is not more likely than
not that the entity to be required to sell the security before recovery of its
amortized cost basis less any current-period credit loss, the other-thantemporary shall be separated into (a) the amount representing the credit loss
and (b) the amount related to all other factors.
50
FSP FAS 115-2 and FAS 124-2
Determination of the Amount of an Other-Than Temporary
Impairment Recognized in Earnings and OCI
 The amount of the total other-than-temporary impairment related to the credit
loss must be recognized in earnings. The amount of the total other-thantemporary impairment related to other factors must be recognized in OCI, net
of applicable taxes.
 The previous amortized cost less the other-than-temporary impairment
recognized in earnings shall become the new amortized cost basis of the
investment.
 The new amortized cost basis shall not be adjusted for subsequent
recoveries in fair value.
• However, the amortized cost basis should be adjusted for accretion and
amortization as prescribed in this FSP.
51
FSP FAS 115-2 and FAS 124-2
Accounting for Debt Securities after an
Other-Than Temporary Impairment
 An entity shall account for the other-than-temporarily-impaired debt security
as if the debt security had been purchased on the measurement date of the
other-than-temporary impairment at an amortized cost basis equal to the
previous amortized cost basis less the other-than-temporary impairment
recognized in earnings.
 Debt securities classified as available-for-sale
• Subsequent increases and decreases (if not an additional other-than-temporary
impairment) in the fair value of the available-for-sale securities shall be included in
OCI.
 Debt securities classified as held-to-maturity
• The other-than-temporary impairment recognized in OCI shall be accreted from
OCI to the amortized cost of the debt security over the remaining life of the debt
security in a prospective manner on the basis of the amount and timing of future
estimated cash flows.
• That accretion shall increase the carrying value of the security and shall continue
until the security is sold, the security matures, or there is an additional other-thantemporary impairment that is recognized in earnings.
52
FSP FAS 115-2 and FAS 124-2
Presentation
• In periods in which an entity has an other-than-temporary impairment, the
entity must present the total other-than-temporary impairment in the
statement of earnings with an offset for the amount that is recognized in
OCI.
• An entity also must separately present, in the financial statement where
the components of accumulated OCI are reported, amounts recognized
therein related to held-to-maturity and available-for-sale debt securities
for which a portion of an other-than-temporary impairment has been
recognized in earnings.
53
FSP FAS 115-2 and FAS 124-2
Effective Date and Transition
• This FSP is effective for interim and annual reporting periods ending
after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. Earlier adoption is prohibited.
54
55