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news:
I just returned from a trip to San Francisco to attend an accounting conference discussing many of the recent happenings at FASB. No topic was more widely discussed than the pending move to fair-value accounting. There has been a pretty sizeable push toward fair-value over the past 10 years, with FAS 133 (Hedge Accounting) playing a big part. But FAS 157 represents the first attempt to consolidate all things fair-value into one statement. Overall, I was left with the impression that financial professionals are not going to enjoy this push to fair-value. On the surface, it seems much easier to carry assets & liabilities at their historical cost. But, in my opinion, this shift to fair-value represents an even larger movement towards principals-based accounting (which FASB has long avoided) and a more seismic shift to alignment with International Accounting Standards. Seems like the fun has only just begun. . . Auction rate securities ("ARS") are now entering the infamous collection of securities that no one had heard of until companies began incurring losses from writing them down. ARS are debt instruments with long-term maturities (student loans, municipal bonds, CDOs and preferred stock are typically the underlying securities), but with interest rates that are reset regularly (typically every 7, 28 or 35 days) based on a Dutch auction. With a ready market, the ARS were carried at par on company's balance sheets and were viewed as a safe way to achieve a higher return than short-term bonds. Unfortunately, beginning at the end of 2007, the auctions began failing. By February, 100% of the auctions were failing and the ARS essentially became illiquid. This is where FAS 157 enters the scene. Without a ready market to support valuation at par, companies are being required to determine fair value for the securities. Fair value in connection with business combinations will see significant changes after December 31,2008. Quist Valuation's Denise Curd discusses the new 141R and the general process of allocating the purchase price of a transaction in this Accounting Best Practices Podcast with Steve Bragg. The podcast is Episode 61 and can be found at here. As part of its mission to improve and enhance the quality, consistency, and comparability of financial statements, the FASB has formed a resource group to address what additional and more specific valuation guidance is needed for financial reporting. This will go beyond the guidance provided in FASB Statement No. 157, Fair Value Measurements. This formation of this group was formally anounced on June 21, 2007, and the first meeting is expected to be held in October 2007. This past week I attended a valuation conference focused on private equity at the Tuck School of Business at Dartmouth. The main topic of discussion was SFAS 157 and how it might impact the fair value reported by GPs to LPs. The discussion at times became heated, as several GPs were still debating that cost was the best indication of value, while representatives from the Big 4 were saying "that ship has sailed". The Big 4's rationale was that with the passage of 157, they would be relying on the new FASB statement as the guidepost for the carrying value of investments for auditing purposes. Most of the GPs argued that cost was a conservative measure and often the most appropriate indication of fair value. Is there a difference? Fair value vs. Fair Market Value...value is value right? Wrong? Standards are critical to clearly defined valuation parameters.Tackling valuation problems in the world of corporate finance and dissenting shareholders is often a tightrope driven by the valuation standard. Shareholders, managers and board members are all concerned about what is "fair" and how to reduce potential liability. A recent Colorado court case highlights the importance of clearly defining the valuation standard on the front end of an engagement. In the case of Kim v. The Grover C. Coors Trust (March 8, 2007), a minority shareholder alleged a breach of fiduciary duty by directors for approving a $100 million sale of preferred stock to raise badly-needed capital. The court determined that the fair value standard was not appropriate, which would have involved a dissenters' rights action and precluded the application of discounts to minority interests (Model Corporation Business Act). Instead, the court concluded the fair market value standard should be applied, which meant that the case involved "the question of whether a transaction was fair". The fair market value standard in this context allows for the consideration of discounts. What is the difference? Well in the Kim case the discounts were 15% to 20% for marketability and the difference in whether the transaction was "fair". One aspect of the trend towards fair value accounting is a requirement for companies to record the fair value of contingent liabilities, such as lawsuits, on their balance sheets. This used to be a footnote disclosure, unless the contingent liability met two criteria: 1) It is probable that the liability has been incurred (in practice meaning > 50%) and 2) the amount of loss can be reasonably measured. The new approach will require a probability weighted calculation of the expected value of the loss. As an example, if a company has a lawsuit against it, and there is a 75% chance it will prevail (i.e., no liability) and 25% chance it will lose $40 million, the company would have to book a $10 million liability. However, after the lawsuit is over, and assuming that the company prevailed, it would actually recognize income of $10 million (because the liability would go away). This may give companies an incentive to over estimate the value of the liability, especially in the case where the contingency gets on the company's books due to an acquisition, with the expectation that they will be less likely to recognize a loss down the road, and possibly realize a large gain on their income statement for doing nothing! Last month the FASB released its final take on fair value measurements (SFAS |
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