ST Convergence
with IASB
1
SFAS No. 151 – Inventory Costs


Part of the “international convergence” project.
Clarifies that abnormal costs of idle facilities
should not be capitalized as product costs.
 Companies
should use “normal capacity” for the
allocation of overhead.
 Any unallocated overhead is expensed during the
period in which they are incurred.
 Other abnormal handling costs or abnormal levels of
spoilage might also need to be expensed.
2
Coming soon

Short-term convergence with IASB
EPS (ED expected 1st half 2007)
 Income taxes (ED expected 1st half 2007)


Research and Development - ?
3
Fair Value
Measurements
SFAS No. 157
Signs of the Future!
4
FAS157 Issued Sept. 2006
With a few exceptions, it does not change
WHAT is currently measured using fair
value
 Sets out a framework for measuring fair
value
 Requires additional disclosures about fair
value measurements

5
FAS157 – Definition of Fair Value

Paragraph 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
is an exit-price definition of fair value
(see paragraph 7)
6
FAS157 – Related definitions

Market Participants (4 criteria)
 Independent
of reporting entity
 Have knowledge needed for reasonable
understanding about transaction
 Financial and legal ability to enter into the
transaction
 Be willing to enter into transaction without
compulsion
7
FAS157 – Related definitions

Principal Market
 Has


the greatest volume and level of activity.
If there is no principal market, use the most advantageous
market
Most Advantageous Market
 Most
advantageous market has price that maximizes
the net amount that would be received or minimizes
the net amount paid

Transactions costs are included in determining which market
to use but do NOT become part of the fair value
measurement
8
Example of which market…
Market A
Selling price
Transaction cost
Net proceeds
Fair value to use
Market B
$50
$48
$5
$2
$45
$46
$48
9
FAS157 – Related definitions

Assumptions about the market
 The
asset or liability is exchanged in an orderly
transaction between market participants


An orderly transaction is a transaction that assumes
exposure to the market for a period prior to the measurement
date to allow for marketing activities that are usual and
customary for transactions involving such assets or liabilities;
it is not a forced transaction (for example, a forced liquidation
or distress sale).
 The
price is for a hypothetical transaction at the
measurement date, considered from the perspective
of a market participant that holds the item
10
FAS157 – Related definitions

Valuation premise – the assumption about
how market participants would use an
asset
 Choose
the premise based on “highest and
best use”

In-use premise


Provides maximum value through use in combination
with other assets
In-exchange premise

Provides maximum value principally on a stand-alone
basis
11
Valuation Techniques

Market approach
 Uses
observable prices from market transactions for
comparable assets or liabilities

Income approach
 Analysis

of future cash flows using present values
Cost approach
 Estimates
cost to replace an asset’s service capacity
A change in valuation technique is a change in accounting
estimate, not a change in accounting principle
12
The “Fair Value Hierarchy”
Level Inputs to achieve reliability level
1
Quoted prices in active markets for identical assets or liabilities
2
Observable prices in active markets for similar assets or
liabilities, or prices from markets that are not active. Market
inputs for substantially full term of item (interest rates). Market
inputs that are not directly observable but can be derived or
corroborated by market data
3
Unobservable inputs based on the reporting entity’s own
assumptions about assumptions that market participants would
use. Cannot be corroborated by observable market data
13
Valuing Liabilities

The valuation technique must consider the
reporting entity’s credit standing
 A reporting
entity could record a GAIN for
derivatives at a measurement date because
the fair value of the liability decreases in
response to a credit downgrade if all other
inputs remain unchanged
14
Restrictions on Assets

Restrictions are evaluated to determine whether
they are an attribute of the asset or an attribute
of the reporting entity
 If
sold, would the restriction transfer to another
holder?
 If yes, the impact of the restriction would be taken into
consideration (adjust asset fair value downward)
 If no, the restriction would not reduce the fair value
15
Other provisions of FAS157
It is now possible to recognize a gain on
the day recognized (previously prohibited
under EITF 02-3)
 Blockage adjustments are not permitted in
pricing
 Bid-ask spreads

 Use
the price within the bid-ask spread that is
most representative of fair value in the
circumstances
16
FAS 157 Disclosures

Will be extensive and reported in three sections
(see paragraph A33-A36 for examples)
 Assets
and liabilities measured at fair value on a
recurring basis

Tabular display reconciles beginning and ending amounts
when significant Level 3 inputs are used
 Assets
and liabilities measured at fair value on a
nonrecurring basis (impairment of assets, etc.)
 For all fair value measurements, a table showing the
reliance on Level 1, 2 or 3 inputs plus discussion of
the valuation techniques used for the measurements
17
FAS 157 – effective date
Implementation is prospective
 Required for financial statements issued
for fiscal years beginning AFTER Nov. 15,
2007

18
FAS 159 – The Fair
Value Option
Optional use of fair value for
certain assets and liabilities
19
Essentially a one-time election
On a contract by contract basis, company
can designate specified financial
instrument to be accounted for using fair
value instead of the usual measurement
technique
 Companies may be able to reduce
volatility in reported earnings caused by
measuring assets and liabilities differently

20
Other “benefits”
Movement toward accounting for all
financial instruments at fair value
 Brings US GAAP into closer agreement
with IASB 39 which already contains a fair
value election

21
Eligible assets & liabilities

Most recognized investments including those
currently accounted for using the equity method
 But
cannot be used to recognized investments that
must be consolidated (VIEs, subsidiaries)

Many recognized liabilities
 Excluding
leases, demand deposits of banks,
postretirement plans, etc.
22
Eligible assets & liabilities



Firm purchase commitments that would
otherwise not be recognized at inception (but
only for ones involving financial instruments)
Rights and obligations under warranties that
meet certain requirements
Certain host financial instruments that result
from separation of embedded nonfinancial
hybrid instruments under FAS133
23
Irrevocable election
Must be applied to contracts as a whole
and not to parts of contracts
 Changes in fair value will be recognized in
earnings during each reporting period

24
Election date
Transition – any eligible item as of the date
that FAS159 is initially adopted
 Thereafter:

 The
eligible item is first recognized (including
entering into an eligible firm commitment)
 Occurrence of a short list of other events
25
Disclosures

If fair value option is elected, company
must disclose separately assets and
liabilities measured at fair value from those
not measured at fair value
 Intended
to help readers compare companies
that choose the option to those that choose
not to elect fair value accounting
26
Disclosures – specific (1)




Why fair value option was selected for each
eligible item
Difference between fair value and aggregate
unpaid principal amounts
Relation to other fair value measurements under
FAS157
Description of partial applications to groups of
similar items and why company chose not to be
consistent
27
Disclosures – specific (2)




Loans carried at assets at fair value that are past due by
90 days or more
APB18 disclosures about investments that would
otherwise have been reported using equity method
Description of how interest and dividends are measured
and reported for items with fair value election
Quantitative information (line by line) as to where gains
and losses related to fair value option have been
reported in the income statement
28
FIN 46R and 48
Lecture notes are in doc file (not ppt) and
this was covered as part of the deferred
tax lectures
 Note to self – need to verify
 FIN46R notes were only in doc file, I think

29
FSP of interest

Note that FSP158-1 (Feb 21, 2007)
contains Update of Illustrations,
Application Guidance
hit ‘print’ – 257 pages!
 Fixes examples in FAS87, FAS88 & FAS106
as related to issuance of FAS158. FAS132R
was “fixed” in FAS158 so is not included in
this FSP
 Don’t
30
What’s Next?
31
Forthcoming – first half 2007
Conceptual Framework – Reporting Entity
– preliminary views
 Business Combinations – for-profit:

 Applying
the Acquisition Method (final)
 Noncontrolling Interests (final)

Derivatives disclosures (final)
32
Forthcoming – first half 2007

Implementation Projects
 Statement
140—Transfers of Financial
Assets (ED)
 Insurance Risk Transfer (ED)
 Financial Guarantee Insurance (ED and
maybe final by mid year)

Definition of liability vs. equity (Prelim
views expected first half of 2007)
33
Forthcoming – second half 2007
Financial Statement Presentation (prelim
views maybe by 3rd quarter)
 Revenue recognition (PV by 3rd or 4th
Quarters)

34
Longer term projects

Not-for-profit business combinations and
intangible assets
 In
process of reviewing comments (nothing on
calendar about when a final version is
expected)
35