Fair Value
GAAP vs. IFRS
Presented by
Alfred M. King, CMA,CFM
October 6, 2008
Convergence or Conversion of
GAAP-IFRS
• World is going towards one set of accounting
standards but is IFRS truly uniform?
• United States conceded that IFRS is more widely
used, so U.S. will change – but when?
• Securities and Exchange Commission:
– Currently allows foreign filers to use IFRS
– Starting in 2010-11 voluntary adoption of IFRS by
U.S. Companies
– Starting in 2014-15 mandatory adoption of IFRS by all
public companies – private companies will follow!
Problems with Convergence
• Principles vs. Rules – Is this distinction a myth?
• Business complexity = complex rules
– Will IFRS have to adopt ‘Rules’ over time?
• Funding and Membership in IASB
• What happens if our SEC disagrees with IFRS?
• Transition
– Training of preparers – option for early adoption by
large companies
– Training of auditors
Fair Value vs. Fair Market Value
• There are real differences among:
– Fair Market Value (not used for financial
reporting)
– Fair Value – GAAP
– Fair Value – IFRS
• Difference in concept of Fair Value
between GAAP and IFRS has not been
resolved
Exit Value – GAAP Concept
• “¶5. 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.”
• This concept works for financial
instruments and does not work for tangible
and intangible assets
Fair Value – IFRS Concept
• “Fair Value is the amount for which an
asset could be exchanged, a liability
settled, or an equity instrument granted
could be exchanged between
knowledgeable, willing parties in an arm’s
length transaction” [IFRS 2, Appendix A]
Exit Value
• GAAP concept of valuing something at
what it could be sold for today, to a ‘market
participant’ works only if there is a market
with market participants
• U.S. and EU experience recently with subprime securities indicates that often there
is no market, and no market participants
willing to make a market
How to Value When
There Are No Participants
• FASB set up levels 1 through 3
– Level 1 – quoted prices
– Level 2 – no direct quotes but similar assets
– Level 3 – all other
• Valuation specialists are always working in Level 3
• Level 3 allows for Income Approach and Cost
Approach but these are considered “entity specific
values” and are 2nd class!
Entity Specific Values
• “Highest and Best Use” is the premise of value
in all cases, e.g. parking lot in downtown
Manchester has to be valued for development
• Highest and Best Use will depend on who is
going to use the asset and what they will do with
it – Could you develop the site?
• If not, you would offer less than would a
developer who would buy the land based on his
assessment of the real estate market
Fair Value - IFRS
• Considers both buyer and seller
• IASB would like to ‘converge’ their
definition with U.S. SFAS 157
• About half the IASB members, however,
are uncomfortable with how the U.S.
definition is working in practice
• Theoretically, at least, IASB believes the
U.S. concept may be correct but not how it
is applied
New FV Definition from IASB?
•
•
•
•
No decision until 2009
May not converge with U.S. SFAS 157
May stick to its definition
If that happens, quite likely that U.S. will
converge to the IASB (!)
• FASB is very aware of the problems they
have created with Market Participants and
Exit value
“Defensive Value”
• Common problem in Business Combination
• Seller and Buyer each have competing brand
names
• Buyer wants to move Seller’s product line to use
the Buyer brand name
• Buyer won’t use the Seller’s brand
• Buyer, however, would not sell Seller’s brand
name to anyone else
What Is The Value of a Brand
Name That Will Not Be Used?
• A Financial Buyer would use the Seller’s brand
name
• Under U.S. definition of Fair Value whoever the
buyer is we value the brand name on what
someone else would pay for it, or a value in use
to them
• Now if the Strategic Buyer will not use it we still
have to place a high value on it
“Day 2 Problem”
• So for the Strategic Buyer we have to
value the brand name as though someone
would use it, even if it is never going to be
used.
• It is obvious that the real Fair Value, once
there is no more advertising and
marketing, is going to go down rapidly
• The buyer will have an early impairment!
Solution to the Day 2 Problem
• Have to change the definition of Fair Value to get
away from rigid application of Exit concept
• IASB looks as though their ultimate definition of
Fair Value will likely be such that this problem
may not be there
• “Value in Use” still makes a lot of sense and may
provide better information to users
• IASB may permit, or even require in some
cases, Value in Use
Fair Value and Impairment:
Key Differences FASB vs. GAAP
• Real Estate
• Investment property
• Agricultural/biological
• IFRS permits/requires periodic revaluation up or down
• U.S. GAAP absolutely prohibits write up
• In U.S. this is a one-way street. Can take impairment loss but never
an impairment gain – or even write back up to previous amount
IFRS Permits Revaluations
• A literal reading of IFRS suggests that if they want
to, companies can revalue other assets – for
example intangibles
– Brand Names
– Patents
• Will U.S. companies take advantage of this?
• Look at Fair Value Option (SFAS 159)
Fair Value Option
• Companies are permitted to revalue
LIABILITIES if they wish
• Banks and financial institutions have had to write
down investments because of credit problems in
the economy
• SFAS 159 permits them to designate liabilities
for same Fair Value treatment
• So if a company’s credit rating drops, they can
record a ‘GAIN’ which may offset the Fair Value
loss on the investments – Bear Stearns example
Fair Value Option (2)
• U. S. Investment Banks did take advantage of
this rule, and literally wrote down the ‘value’ of
their own bonds
• If those debts will be ultimately repaid at Par
(100 %) companies will have to reflect a LOSS
to write up the liability
• This accounting is hard to explain!!
• The worse you do the better you look
• The better you do the worse you look
My Conclusion
• If U.S. companies adopt IFRS they will be at
least tempted to write up all sorts of intangible
assets to reflect their ‘true’ Fair Value
• What will this do for valuation specialists?
• Lots more work!
• What will this do for the integrity of financial
statements?
Asset Impairment
• Impairment indicators are essentially the same
between GAAP and IFRS
• IFRS writes down to Fair Value when FV is less
than carrying value
• No intermediate cash flow test
• IFRS looks to the higher of:
– Net selling price (exit value)
– Value in Use (entity specific)
Asset Impairment (2)
• United States has three different methods
– SFAS 144 for fixed assets and intangibles
– SFAS 142 for indefinite life intangibles
– SFAS 142 for testing goodwill
• SFAS 144 calls for a determination as to whether
the SUM of all future cash flows, NOT
DISCOUNTED is equal to or larger than carrying
value
• Can never write back up once loss recognized
Research & Development
• ‘Research’ expensed in both systems
• ‘Development’ is capitalized in IFRS and
expensed in GAAP
• Under SFAS 141R, purchased In-Process R&D
will be capitalized, but further expenditures will
be expensed
• Basic question:
– Is the true Fair Value of R&D properly
measured based on costs incurred?
Valuing Liabilities and
Contingencies
• Rules calling for what you could pay someone to
take on your liabilities makes no sense
• Should allow companies to determine the
Present Value or Expected Value of what they
anticipate paying to settle liabilities and
contingencies
• GAAP values contingencies only in a Business
Combination
Can We Value Contingencies?
• Contingent payment in a Business
Combination
• Settle Environmental Liabilities
• ‘Fair Value’ of lawsuits
• New SFAS 141R requires this
Revenue Recognition
• GAAP has over 200 items in the literature
• IFRS is very general
• Revenue Recognition is a big item at least
in the U.S.
• FASB looks to ‘Fair Value’ as one way of
measuring Revenue Recognition.
• Suzie’s sweater example
Is There Such a Thing as
The Fair Value?
• The value of an asset depends on who is going
to use it, and for what purpose
• How can anyone write a set of rules that
provides ‘consistency’ among preparers and yet
reflects economic reality?
• FASB and IASB would like a “one size fits all”
solution in terms of defining Fair Value
• This can not be done!
Where Are We Going?
• Personal views:
– Recent problems in valuing subprime assets
will slow down move to increased Fair Value
– Convergence of IFRS and GAAP will be much
harder (and slower) than anticipated
• LIFO problem
• Different versions of IFRS
– Demand for Fair Value by Security Analysts
will continue and even increase
The Future of the
Valuation Business
Questions?
Presentation by:
Alfred M. King, CMA, CFM
Vice Chairman,
Marshall & Stevens, Inc.
Please feel free to contact me
for information at any time:
E-Mail: aking@marshall-stevens.com