Monday, May 16, 2011

FASB and IASB Align IFRS-US GAAP Fair Value Measurement Standards

After five years of work and an ensuing financial crisis, the IASB and FASB have issued common fair value measurements and disclosure standards. IFRS and US GAAP will now generally have the same definition and meaning of fair value and the same disclosure requirements about fair value measurements. The requirements do not extend the use of fair value, but provide guidance on how it should be applied where its use is already required or permitted by other IFRS or US GAAP standards.

The IASB issued IFRS 13 on fair value measurement of financial instruments, setting out in a single IFRS a framework for measuring fair value and requiring disclosure about fair value measurements. IFRS 13, which takes effect on January 1, 2013, does not determine when an asset or liability is measured at fair value, but applies measurement and disclosure requirements when another IFRS requires or allows an item to be measured at fair value.

FASB updated Topic 820 in the Accounting Standards Codification (formerly SFAS 157). For US GAAP, the Update will supersede most of the guidance in Topic 820, although many of the changes are clarifications of existing guidance or wording changes to align with IFRS 13. It also reflects the FASB’s consideration of the different characteristics of public and non-public entities and the needs of users of their financial statements. FASB said that the amendments should be applied prospectively. For public entities, the amend¬ments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted.

IASB Chair David Tweedie said that the finalization of the fair value project was a culmination of a major convergence project and is a fundamentally important element of the IASB-FASB joint response to the global financial crisis. FASB Chair Leslie Seidman said the Board’s Update represents another positive step toward the shared goal of globally converged accounting standards. Having a consistent meaning of the term fair value, emphasized the FASB Chair, will globally improve the consistency of financial information, while at the same time responding to the request for enhanced disclosures about the assumptions used in fair value measurements.

While we now have a converged definition of fair value and the mea¬surement and disclosure require¬ments are aligned, some differences remain between U.S. GAAP and IFRSs. For example, there are some different disclosure requirements about fair value measurements, most notably that IFRS requires a quantitative sensitivity analysis for financial instruments that are measured at fair value and categorized within Level 3 of the fair value hierarchy and U.S. GAAP does not require a quantitative sensitivity analysis disclosure. There are different requirements about whether, and in what circumstances, an entity with an investment in an investment company may use the reported net asset value as a measure of fair value

The FASB amendments clarify how to apply the existing fair value measurement and disclosure re¬quirements in Topic 820, including concepts of highest and best use and valuation premise in a fair value measurement applied when measuring the fair value of non-financial assets. Similar to comparable guidance for liabilities, the fair value of an instrument classified within a reporting entity’s shareholders’ equity should be measured from the perspective of a market participant that holds that instrument as an asset. For fair value measurements categorized within Level 3 of the fair value hierarchy, a reporting entity is required to disclose quantitative information about the unobservable inputs used in the measurements. Level 3 is the level for inactive securities in illiquid markets.

SFAS 157 established a fair value hierarchy that prioritizes the inputs that should be used to develop the fair value estimate. The fair value hierarchy prioritizes quoted prices in active markets for identical assets or liabilities (Level 1). In the absence of quoted prices in active markets for identical assets or liabilities, the fair value hierarchy allows for the use of valuation techniques, such as pricing models that incorporate a combination of other inputs. Those other inputs consist of observable inputs that are reasonably available in the circumstances, including quoted prices in markets for comparable assets or liabilities (Level 2), and unobservable inputs in illiquid markets (Level 3).

Under the changes to FASB Topic 820, provided that certain criteria are met, a reporting entity that holds a group of financial assets and financial liabilities that exposes it to market risks and counterparty credit risk may apply an exception to the requirements in Topic 820, which permits the fair value of those financial instruments to be measured on the basis of the reporting entity’s net risk exposure.

In addition, premiums or discounts may be applied in a fair value measurement to the extent that they are consistent with the unit of account and market participants would consider them in a transaction for the asset or liability. However, adjustments commonly referred to as blockage factors are not permitted in fair value measurements.

A reporting entity must disclose the following information about fair value measurements. For fair value measurements categorized within Level 3 of the fair value hierarchy, the company must disclose the valuation processes employed and provide a narrative description of the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, if any.

The company must also disclose the use of a non-financial asset if it differs from the highest and best use assumed in the fair value measurement. For items that are not measured at fair value in the statement of financial position but for which the fair value is required to be disclosed, the company must disclose the level of the fair value hierarchy in which that measurement is categorized.