Valuation for Financial Reporting : Fair Value Measurements and ...

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Statement of Financial Accounting Standards No. 157 7Fair value for financial reporting is different from fair market value. Characteristicsof fair value in business combinations under GAAP and best practices include:Valuation methodologies specified in the accounting literature and/or acceptableto the auditors;Generally established on an asset-by-asset and a situation-by-situation basis;Typically a control value;The fair values of individual assets do not include a specific buyer’s uniquesynergies unless such synergies are also those of ‘‘market participants’’;The additional purchase price paid in a business combination due to a synergisticcomponent is recorded as goodwill and subsequently will be subject to impairmenttesting under SFAS No. 142;The total fair value of all assets acquired is always reconciled (adjusted) to thepurchase price in a business combination or to a market participant’s price;In the absence of quoted market prices, the technique used to estimate fair valuewould be the method producing a fair value best approximating quoted marketprices;Includes tax amortization benefits;Transaction costs are not deducted;Considers the highest and best use of market participants in the principal (or mostadvantageous) market to establish the valuation premise (in-use or in-exchange);Considers a reporting entity’s credit standing;Requires the use of market participant assumptions in accepting management’sprospective financial information (projections); andRelies on but does not define active market.Fair Value HierarchyIn SFAS No. 157, the FASB specified a hierarchy approach to determining fair value.The pronouncement defines a hierarchy 8 in the development of fair value measurementsas follows:Level 1. Inputs are observable market inputs that reflect quoted prices for identicalassets or liabilities in active markets the reporting entity has the ability to access at themeasurement date.Level 2. Inputs are observable market inputs other than quoted prices for identicalassets or liabilities in active markets the reporting entity has the ability to access at themeasurement date. Level 2 inputs include the following: Quoted prices for similar assets or liabilities in active markets Quoted prices for identical or similar assets or liabilities in markets that are not active;that is, a market in which there are few transactions for the asset or liability, the pricesare not current, or price quotations vary substantially either over time or among
8 Valuation for Financial Reportingmarket makers (e.g., some brokered markets) or in which little information is releasedpublicly (e.g., a principal-to-principal market) Market inputs other than quoted prices that are directly observable for the asset orliability; for example, interest rates, yield curves, volatilities, and default rates that areobservable at the commonly quoted intervals Market inputs that are not directly observable for the asset or liability but that arederived principally from or corroborated by other observable market data throughcorrelation or by other means (market-corroborated inputs); for example, inputsderived through extrapolation or interpolation that are corroborated by other observablemarket dataLevel 3. Inputs are unobservable market inputs; for example, inputs derived throughextrapolation or interpolation that are not able to be corroborated by observable marketdata. Unobservable market inputs shall be used to measure fair value if observablemarket inputs are not available, thereby allowing for situations in which there is little, ifany, market activity for the asset or liability. However, the fair value measurementobjective remains the same; that is, an exit price from the perspective of a marketparticipant (seller). Therefore, a fair value measurement using unobservable marketinputs within Level 3 shall consider the assumptions that market participants would usein pricing the asset or liability, including assumptions about the amount a marketparticipant (buyer) would demand to assume the risk related to the unobservable marketinputs used to measure fair value. The reporting entity’s own data used to develop theinputs shall be adjusted to exclude factors specific to the reporting entity if information isavailable that indicates that market participants would use different assumptions.Entry Price Versus Exit PriceSFAS No. 157 describes fair value from the perspective of an exit (sale) price ratherthan an entry (purchase) price. 9 The price is determined based on the amount requiredto exchange the asset or liability in an orderly transaction between market participants.Exchange means to sell the asset or transfer the liability at the measurementdate. An orderly transaction assumes exposure to the market for a period prior to themeasurement date to allow for marketing activities that are usual and customary. Anexit price is based on a hypothetical transaction from the perspective of a marketparticipant who holds the asset or owes the liability. Therefore, the objective is todetermine the price that would be received to sell the asset or paid to transfer theliability at the measurement date, which makes it an exit price.Principal (or Most Advantageous) MarketThe exit price is to be considered from the perspective of market participants in theprincipal (or most advantageous) market for the asset or liability. 10 A fair valuemeasurement is based on a transaction assumed to occur in the principal market for theasset or liability. The principal market is the market with the greatest volume and levelof activity for the asset or liability. The most advantageous market is the market that
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210 IndexBusiness Enterprise Analys
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212 IndexGoodwill (continued )111,
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214 IndexLong-termcapital, 71debt,
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216 IndexSecurities and Exchange Co
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