FASB’s MOVE TOWARDS FAIR VALUE AND ACADEMIC RESEARCH
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Transcript of FASB’s MOVE TOWARDS FAIR VALUE AND ACADEMIC RESEARCH
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FASB’s MOVE TOWARDS FAIR VALUE AND
ACADEMIC RESEARCH
Derivatives
Contingencies
Financial instruments Stock Options – 123R
Guarantees – Int. 45
Fair value hierarchy –
FAS 157
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Today’s Discussion on Fair Value
• The new fair value standard – FAS 157
• The fair value option proposal
• Business combination procedures – more and more fair value
• FAS 5 on contingencies – are its days numbered?
HOW CAN ACADEMIC RESEARCH HELP?
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Fair Value
FAS 157, 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.
IOU $100 million
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FAIR VALUE-how not when!
FASB STATEMENT 157
Codify all the accounting literature on fair value
Developed a common definition, increased disclosures
Establish a 3 category hierarchy for measuring fair value – market quotes are always the best! A “market participant” view!
Effective year ends – beginning after 11/15/07
What will the impact be and what warrants further research????
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FAS 157 - New terms to learn!
Market – principal or most advantageous market
Fair value hierarchy (3 levels – use the highest)
Observable inputs -Wall Street Journal
- Derived from markets
Unobservable inputs – discounted cash flows
Types of valuations (market, income, cost approaches)
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MARKET PLACE PARTICIPANTS
• Buy software & customer list - $10 million: Company plans Market participant - Have customers use -Would sell software
buyer’s software and use customer list - Scrap seller’s software
(Buyer’s allocation) FV (FASB allocation) FV Customer list $ 10 Customer list $ 2 Software 0 Software 8
Day two accounting?
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The Fair Value Option Proposal
• Applicable to almost all financial instruments
• If elect to use fair value – changes thru income!
• Elect at inception – irrevocable and document it
• Choose contract by contract
• Debt - consider credit rating in calculation
• Prospective, cum catch up through retained earnings at the same time FAS 157 is adopted.
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Discussion Points
• Why is the FASB adopting a fair value option?
• More alternatives vs. eliminating alternatives
• Credit rating goes down – big gain??? (hmm)
• How will companies react?
• How will users react?
• Research ideas?
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BUSINESS COMBINATIONS- the procedures proposal!
Many proposed “fixes” to how we do purchase accounting
When there is a choice – the winner is use FAIR VALUE!
PROPOSALS ARE VERY CONTROVERSIAL!Could research help?
Historical cost
Fair value
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Contingent LiabilitiesCompany A buys Co. B for $50,000,000
Company B is being sued for $10,000,000
Chance of B losing - 40% (i.e., losing is not probable)
How much should A record as part of purchase
price allocation as a liability for lawsuit??
Zero? $4,000,000? More? (Answer fair value!)
What if B eventually wins the lawsuit?
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Contingent Consideration
Company C buys Company D from Mr. Jones for cash of $10 million.
Further, if earnings of D in next two years exceed $4 million, Company C must pay another $2 million to Mr. Jones
How should Company C account for this contingency at the date of acquisition? Can an amount be objectively estimated?
(Answer-fair value!)
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In-Process R&D
FAS 141 -Continue to require immediate write-off
New Thinking: - Capitalize at fair value - Subsequent R&D – expense - Amortize – eventually
But what about FAS 2?
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ACQUIRE LESS THAN 100%
Fair Value of Company X - $100 million
Fair value of identifiable net assets - $30 million
If buy 100% of X – goodwill is $70 million ($100-30)
Assume company only buys 60% for $60 million:
TEST – How much is goodwill?
$42 million ($70 x 60%)? WRONG!
“Correct” answer - $70 million
A FAIR VALUE MODEL!
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WHAT ABOUT FASB No. 5 - CONTINGENCIES
Remote Reasonably Possible
Probable
Accrue – Probable & Estimable
Disclose – Reasonable PossibleDo Nothing – Remote
IS THIS STILL OK??
(e.g., $100 Million lawsuit)
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FAIR VALUE VS. FAS 5
FASB’s Invitation to Comment --Assets & Liabilities With Uncertainties
The role of probability and uncertainty and the conceptual framework – big potential impact!
The FASB is considering whether the FAS 5 model for contingencies (i.e., recognize when “probable”) is becoming obsolete!
Research???
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Recognition vs. Measurement
Company A is being sued for $100 million—Record anything?
More likely than not ______20%__________ 51%________80%_______
Remote Reasonably possible Probable
Today we ask when should liability be “recognized” (probable threshold)
IASB thinking – there is a liability! – Measure at fair value using expected cash flows (e.g., a 10% chance of losing – book $10 million!). Skip recognition threshold!
What about plaintiff – book an asset? (why not!)
Should we converge with IASB on uncertainties?
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IS FAIR VALUE THE WAY TO GO?
More useful to users? Costly for preparers? Auditable? Increase or decrease complexity? Will fair value be used for everything some day ?
ACADEMIC RESEARCH– COULD IT HELP STANDARD SETTERS AS THEY KEEP MOVING TOWARDS FAIR VALUE?