How do you Measure Fair Value?
“Fair value” is the standard for valuing assets and liabilities under U.S. Generally Accepted Accounting Principles (GAAP). When it comes to valuing a security or business interest in mergers and acquisitions or litigation, other valuation standards may apply.
What is the FASB Guidance?
According to the Account Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures issued by The Financial Account Standards Board (FASB), 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.”
The statement was able to unify about 60 existing accounting pronouncements that used this term. Asset retirement obligations, intangible assets acquired in a business combination, and derivatives are among the items reported at fair value instead of historic cost.
What is the valuation hierarchy?
The statement brought about a “fair value hierarchy” that focuses on market-based valuation methods. The following factors should be considered when measuring fair value, in order of relevance:
- Quoted prices in active markets for identical assets or liabilities,
- Quoted prices in active markets for similar assets or liabilities, or other “observable” inputs, and
- Unobservable inputs, such as the reporting entity’s data.
When the recession hit in 2008, the FASB directed companies to use internal assumptions to value securities, such as expected cash flows and appropriately risk-adjusted discount rates. Market prices may not always be a determining factor of fair value in times of “market dislocation,” according to FASB guidance. “Significant judgment may be required when deciding whether individual transactions are forced liquidations of distressed sales” for valuations.
Different standards for different purposes
In some cases, the values may not be equivalent when “recycling” valuations used for litigation and M&A purposes for use in financial reporting. Different standards may apply, which is dependent on the meaning of the valuation.
To put this into perspective, in an oppressed shareholder or divorce case, “fair value” could be statutorily defined and based on relevant case law. Similarly, “strategic value,” which is commonly used in M&As, may warrant a higher premium than usual due to its inclusion of buyer-specific synergies.
The FASB avoided using the term “fair market value” in ASC 820, a term applied to valuations prepared for federal tax purposes, in an attempt to separate its guidance from the IRS and the Tax Court. The condition “fair value” gave the FASB the ability to start fresh.
Use our Valuation Experts
When it comes to estimating fair value, similar to any valuation assignment, you may require specialists independent of your existing audit team. Our team can help! Contact us at 949-860-9891 or click here, and we will contact you or for more information regarding fair value measurements.