FASB Fair Value Standard Being Finalized; FSP to Address Business Combinations, Other
June 28, 2006
On June 28, 2006, the Financial Accounting Standards Board (FASB or “the board”) voted to add back an undue cost and effort practicability constraint in its proposed Fair Value Measurement (FVM) standard, to allow use of entity developed data when there is a lack of observable market inputs.
FASB also voted to work on FASB Staff Positions (FSP) to address diversity in practice issues arising from FVM of Business Combinations and certain other nonfinancial assets and liabilities.
The board is proceeding to vote on a ballot draft of the FVM standard, although issuance of any final FVM standard may be delayed pending further work on drafting and discussing the proposed FSPs. Following is a summary of decisions reached.
FV Definition: FASB emphasized it is not changing the basic definition of fair value and entity specific values will not be deemed to be fair value per se; it is staying with the market participants approach.
- Specifically, the definition of fair value will be: “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.”
- FASB staff noted insertion of “orderly transaction” into the definition to distinguish from, e.g. “fire sale” transaction.
Undue cost and effort practicability constraint for unobservable data will be added back into the proposed standard.
- Use of the reporting entity’s own data to develop unobservable inputs should exclude factors specific to the reporting entity if information available without undue cost and effort indicates that market participants (MP) would exclude those factors.
- However, the undue cost and effort practicability constraint would not remove the reporting entity’s obligation to consider risk adjustments that a market participant would make. (This point was particularly stressed for derivatives but applies generally.)
Bid-ask: FASB will remove overly prescriptive guidance on use of bid vs. ask prices, which some viewed as inconsistent with IAS 39, Financial Instruments-Recognition and Measurement, and will retain just the general principles.
Disclosure of nonrecurring Level 3 FV measurements: FASB will require qualitative disclosures about unobservable inputs used for nonrecurring Level 3 FV measurements.
§ According to the board handout, it will require “a description of the inputs and the information used to develop the inputs.”
Disclosure of recurring Level 3 FV measurements: FASB agreed to allow net presentation of derivatives, and noted that this may be reconsidered as part of the separate project on derivatives disclosures.
Transition: The board agreed to remove the requirement to disclose information about the effect of the change in accounting for financial instruments that would be applied restrospectively. The board also agreed to clarify that the related transition adjustment should be determined in a single step as the difference between the carrying amounts and the fair values of those instruments at the date the final FVM standard is initially applied, and the adjustment would be recognized as a cumulative effect adjustment to the opening balance of retained earnings for that fiscal year.
Timing: Linda MacDonald, of FASB staff, asked board members if any indication of timing of issuance of the final standard could be given to constituents, since some were wondering if they should expect a final standard in early July. FASB Chairman Robert Herz said FASB is currently going through the ballot process of voting on the final FVM standard, and would proceed with the ballot vote “as expeditiously as possible.” He added, “I think Linda’s question is, should we delay actual issuance of it [the final FVM standard] until we finalize the FSP.” He said, he hoped FASB would not have to delay issuance of the final FVM standard, but without knowing the approach that will be taken in the related FSPs, he wasn’t sure if a delay of issuing the FVM standard would be warranted.
Larry Smith, of FASB staff, suggested going forward and issuing the FVM standard (once balloting is completed), saying, “you’ve made your decision, [issuing the FVM standard would] force the board to look very carefully at the measurement attribute going forward, and had you not issued the FVM document now, you would still need the FSP [to address the current diversity in practice].”
However, Herz said, “My only concern might be, there are a number of financial institutions that would like to apply some of this [FVM standard] sooner than later [e.g. early adopt the standard],” and they would have to adopt the standard not only for financial instruments, but nonfinancial instruments as well, including aspects of business combinations to be addressed in the FSPs.
Jim Leisenring, of the International Accounting Standards Board (IASB) observed that if FASB were to wait until comments came in on the proposed FSPs, that could take months.
FASB staff’s Sue Bielstein said FASB would take this one stage at a time and proceed to finishing the FVM document.
Board member Leslie Seidman noted that the handout for the meeting did not include specific language in certain areas (specifically paragraph 25 of the current draft of the FVM standard) and asked that the minutes of the June 28 board meeting include more detail so people can see the exact words, adding “I don’t know if you plan to do any additional external review,” of the proposed standard. Herz said, “there ought to be ways for us to effectively communicate” that information.
FSPs on Fair Valuing Business Combinations, Other
The board supported the FASB staff’s request to begin work on one or more proposed FSPs to address “Measurement of Nonfinancial Assets and Nonfinancial Liabilities that are Required to be measured at Fair Value in a Business Combination or an Impairment Evaluation.“
The purpose of the FSPs was to address the diversity in practice that FASB learned of from feedback from external reviewers of the draft FVM standard, as note in the board handout:
“Many preparers have interpreted the guidance in Statements 142 and 144 to suggest that, whenever quoted market prices are not available for nonfinancial assets and nonfinancial liabilities, there is a presumption that assumptions that market participants would use in their estimates of FV are not available without undue cost and effort. As a result, it appears that some preparers have used their own assumptions about entity-specific cash flows for purposes of determining the fair values assigned to certain nonfinancial assets and liabilities in business combinations and impairment tests without performing procedures to determine what assumptions market participants would use to determine those fair values.”
The staff identified FAS 141 (Business Combinations), 142 (Goodwill and Other Intangible Assets) and 144 (Impairment or Disposal of Long-Lived Assets) as being in the scope of the FSP(s).
At the suggestion of board member Don Young, FASB also agreed that staff should consider other existing standards listed in Appendix F of the proposed FVM standard, particularly as relate to nonfinancial assets and liabilities, to see if they raise similar issues. Among the additional items Smith envisioned potentially including in scope of the FSPs were consolidation of variable interest entities (VIEs) and leveraged buyouts.
In explaining why he believed the scope of the FSPs should potentially be broadened, Young said, ”I’m a little worried we’re shifting complexity from the standard setter to the preparer by saying ‘here’s what we meant 10 years ago.’ “ Young suggested that rather than the staff’s recommended approach of looking at just three issues (relating to FAS 141, 142 and 144), another approach would be to reconfirm historical use of FV.
“We, as standard setters, should address complexity, not dump it on preparers,” said Young, adding, “I don’t think this FV is what we were thinking about ten yrs ago.”
Board member Ed Trott replied: “We are not challenging, and nobody should challenge, a FV estimate made before issuance of the final FVM standard, if it is deemed to have been in compliance at that point in time.”
IASB’s Leisenring cautioned FASB staff not to ignore IFRS 3 and said he hoped the proposed FSPs would not “bring [FASB and IASB] apart on this matter.
Two alternative approaches for proposed FSPs
Although the June 28 board discussion of the proposed FSP focused on just the agenda decision to take the project on – not a decision on what direction the proposed FSP should take – two alternatives were presented to the board, which the staff will consider going forward on the FSPs, and the staff said they welcome any additional alternatives or input the board has.
§ “Alternative A” would grandfather previous measurements reflecting entity specific assumptions for nonfinancial assets and liabilities in business combinations or similar new basis transactions, and require accounting going forward by use of market participants approach, with a similar undue cost and effort clause as in the proposed FVM standard.
§ “Alternative B” would amend the guidance in FAS 141, 142 and 144 to provide a practical exception to permit an entity to use entity specific assumptions for measuring nonfinancial assets and liabilities in business combinations and new basis transactions, and for related impairment evaluations, if certain conditions are met.
Assets acquired that are “put on the shelf” cannot be ascribed zero value
Larry Smith, of FASB staff, noted that in a handout provided to the board, “There is an example of a company, if it applied entity specific notion, would not be able to record that at zero.” He said the example was put in there “to reiterate comments that regulators [presumably, the U.S. Securities and Exchange Commission or SEC] have made to registrants that came in arguing a particular intangible asset acquired, they put on the shelf and therefore putting no value on that.
“The regulator has accepted some entity specific [valuations] but has told [registrants they] can’t put no value on that.” [i.e. the regulator rejects carrying the asset at zero value on day one].
Smith’s comments appeared to reflect the language in the board handout that said:
“If the board elects alternative b [amend the guidance in FAS 141, 142 and 144, as part of the FSP project], the staff recommends that the proposed FSP contain examples illustrating the use of entity-specific measurements. For example, if an entity acquires a brand or trademark that will be taken off the market but has significant defensive value, the entity specific cash flows used to value that brand or trademark would be based on the incremental cash flows that the acquirer’s existing brand or trademark will be expected to generate or maintain) as a consequence of removing the competing brand or trademark from the market. That is, the entity-specific value would not be zero.
“Additionally, if the board elects alternative b, the staff recommends that reporting entities would be required to disclose their use of entity specific measurements. “
One thing to look for when the proposed FSP comes out is if the language prohibiting zero value will apply only redundant assets obtained for “defensive value” as described in the board handout, or more broadly other redundant assets or assets which the entity may intend to abandon.
Links to related information:
The board handout for the June 28, 2006 FASB board meeting is available here.
Prepared June 28, 2006 by Edith Orenstein (eorenstein@FinancialExecutives.org), Director, Technical Policy Analysis, Financial Executives International (FEI), based on listening to the webcast of the FASB board meeting. This summary does not represent FEI opinion, unless specifically noted above.