Measuring Liabilities at Fair Value - ASU 2009-05
Accounting Standard Update 2009-05 – Measuring Liabilities at Fair Value (ASU 2009-05) is an update of FASC 820 – Fair Value Measurements (FASC 820). This ASU was issued in response to the credit crisis and will reduce potential differences in measuring liabilities at fair value and thus promote comparability of companies’ financial statements. This update is effective for fiscal periods (including interim periods) beginning after its issuance. For calendar year companies, it would be effective for the 4th quarter of 2009. Just in time for the annual 10K filing.
FASC 820 assumes that the fair value of a financial instrument is the price that would be paid to transfer a liability in an orderly transaction between market participants. However, most liabilities have restrictions that do not allow them to be transferred and as such there isn’t a market for transferring the liabilities. ASU 2009-05 states that in the absence of a market for the liability a company can use:
1. The quoted price of the identical liability when traded as an asset;
2. A quoted price for similar liabilities or similar liabilities when traded as assets; or
3. Another valuation technique that is consistent with the principles of FASC 820 such as a present value technique.
When using any of these techniques, companies are to apply all of the provisions of FASC 820 including guidelines for assessing whether the market is active and orderly.
A Level 1 input would be considered a quoted price for the identical liability or the identical liability traded as an asset. Bonds are normally traded as assets.
Using a quoted price for similar liabilities or similar liabilities when traded as assets would represent a Level 2 input, unless significant adjustments are made to the quoted price. Significant adjustments would render the quoted price as a Level 3 input.
No adjustments should be made for the non-transferability of the liability because such restrictions relate to the performance of the company under the obligation. The effect of this restriction is already included in the other inputs either implicitly or explicitly. Also, most liabilities have a non-transfer clause and as such this clause is inherent in liabilities and its presence does not require any adjustments.
The quoted price for the liability traded as an asset would need to be adjusted if there are clauses that are different from the liability or if the unit of account of the asset differs from the unit of account of the liability (i.e. if the asset includes a third party credit enhancement).
Other Valuation Techniques
Other valuation techniques such as a present value method or a method that is based on the amount at the measurement date that the company would pay to transfer the liability or would receive to enter into the identical liability would most likely be a Level 3 input. Such valuation techniques would have to be analyzed as to the percentage of unobservable inputs that are used in assessing the fair value to determine the Level of the measure as a whole.
ASU 2009-05 allows for the concept of a re-entry price as the Board discussed that the entry price and the exit price for most liabilities would be the same, therefore a re-entry price would also represent the fair value of the liability.
In the example to the ASU involving an asset retirement obligation, the FASB states that the profit margin that a contractor would add to the costs of removing the asset would represent the rate a market participant would demand as a return for bearing the obligation. This concept should help in estimating the rate of return a market participant would require when assuming a liability.
There are three examples in the ASU to help in understanding the new guidance. I would recommend looking at them if you have fair value different kinds of liabilities. The ASU can be accessed at the FASB website: http://www.fasb.org.
The FASB has been very busy and I will try to get all the updates read and posted in the near future.
Linda is a CPA living in Southwestern Ohio, working as a research accountant for an investor-owned publicly traded utility company. She specializes in implementing new FASB and SEC requirements and FAS 133 derivative issues. In her role at the utility she has encountered many issues and written many memos, so send in your implementation and derivative issues and Linda will help figure out an answer.