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Ask FERF about ...... fair value.

The year 2006 may go down in history as "The Year of Fair Value." During calendar year 2006, the Financial Accounting Standards Board (FASB) issued three Statements of Financial Accounting Standards (FAS 155, 156 and 157) and one Proposed Statement (The Fair Value Option) that relate to fair value. These documents are available for download on the FASB Web site,

With great foresight, FEI President Colleen Cunningham included "Fair Value Measurement" in her "Top 10 Financial Reporting Challenges of 2006" (see Financial Executive, January/February 2006) and includes it again this year in her "2007 Top 10 Financial Reporting Challenges" (see Financial Reporting column on page 14).

What follows is some brief detail on each of the statements and the proposal.

FAS 155, Accounting for Certain Hybrid Financial Instruments

Issued in February 2006, FAS 155 amends FAS 133, Accounting for Derivative Instruments and Hedging Activities and FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. FAS 155 permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation.

FAS 156, Accounting for Servicing of Financial Assets

Issued in March 2006, FAS 156 amends FAS 140 with respect to the accounting for separately recognized servicing assets and servicing liabilities. FAS 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract.

FAS 156 requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. It then permits the entity to choose either of the following subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities:

* Amortization method -- Amortize servicing assets or servicing liabilities in proportion to and over the period of estimated net servicing income or net servicing loss, and assess servicing assets or servicing liabilities for impairment or increased obligation based on fair value at each reporting date.

* Fair value measurement method -- Measure servicing assets or servicing liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur.

FAS 157, Fair Value Measurements

Issued in September 2006, FAS 157 defines fair value and establishes a framework for measuring fair value in generally accepted accounting principles (GAAP). (See how users and preparers are responding to the new statements in an article on page 33.) While previous pronouncements involving valuation focused on what to measure at fair value, FAS 157 focuses on how to measure fair value.

FAS 157 provides this new definition of fair value: "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."

This definition abandons a long-standing practice of using the transaction price for an asset or liability as its initial fair value. In other words, fair value will no longer be based on what you pay for something; it will now be based on what you can sell it for, also known as its "exit price."

Just as important, this definition emphasizes that fair value is market-based, requiring the consideration of what other market participants might pay for something, and no longer entity-specific. Valuation will now be determined by a skeptical, rather than optimistic, buyer.

The Fair Value Option for Financial Assets and Financial Liabilities

In this project, FASB is considering whether to permit entities a one-time election to report certain financial instruments (and perhaps similar non-financial instruments) at fair value with the changes in fair value included in earnings.

The Fair Value Option (FVO) project has been split into two phases:

* Phase 1 addresses creating an FVO for financial assets and financial liabilities; and

* Phase 2 addresses creating an FVO for selected non-financial items.

On Jan. 25, 2006, FASB issued an FASB Exposure Draft, The Fair Value Option for Financial Assets and Financial Liabilities, for Phase 1. The ED's comment period ended on April 10, 2006.

At its meeting on Oct. 18, FASB made a number of decisions regarding election of the FVO; recognition, measurement and presentation; proposed new disclosures; transition and effective date; and the scope of the final statement. These decisions, as well as the current status of the Fair Value Option project, can be found at

William M. Sinnett ( is Director of Research for Financial Executives Research Foundation (FERF).

contributed by FERF
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Title Annotation:resources
Author:Sinnett, William M.
Publication:Financial Executive
Date:Jan 1, 2007
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