FASB enhances guidance for measuring fair value

The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements, providing enhanced guidance for using fair value to measure assets and liabilities. More than 40 current accounting standards within generally accepted accounting principles (GAAP) require or permit entities to measure assets and liabilities at fair value. Prior to last week’s issuing of this standard, the methods for measuring fair value were diverse and inconsistent.

“Today’s Statement establishes a market-based framework for measuring assets and liabilities at fair value if a particular accounting standard calls for it,” Leslie F. Seidman, FASB member, said in a statement announcing the issuing of the Statement. “Moreover, by requiring companies to provide expanded information about the assets and liabilities measured at fair value, investors and other financial statement users will be able to make more informed decisions about the potential effect of those measurements on a entity’s financial performance.”

The standard, which is effective for financial statements issued for fiscal years beginning after November 15, 2007, also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances.

Under the standard, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. The standard clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted price in active markets and lowest priority to unobservable data, for example, the reporting entity’s own data. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy.

“The standard clarifies that for items that are not actively traded, such as certain kinds of derivatives, fair value should reflect the price in a transaction with a market participant, not just the company’s mark-to-model value,” said Linda MacDonald, FASB director and fair value measurements project manager. “The standard also requires expanded disclosure of the effect on earnings for items measured using unobservable data.”

The International Accounting Standards Board (IASB) intends to issue this statement to its constituents in the form of a preliminary views document.

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