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Heads Up

Converging on Fair ValueFASB Proposes Guidance on FairValue Measurement and Disclosureby Tiffany Prudhomme, Magnus Orrell, and Beth Ann Reese, Deloitte & Touche LLP

Yesterday, the FASB issued a proposed Accounting Standards Update (ASU), Amendments

or Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and

IFRSs. The proposed ASU is the result o a joint project between the FASB and IASB (theboards) to develop a single, converged air value ramework.1

In October 2009, the boards reached an agreement to develop common air value

measurement and disclosure guidance. To meet this objective, the FASB agreed toconsider comments the IASB received on its May 2009 ED and to amend ASC 820, 2 as

necessary, on the basis o decisions reached during the boards joint redeliberations.The proposed ASU revises ASC 820 extensively; however, a number o the amendmentsare changes to the wording used to describe the principles and requirements and are

not expected to change existing practice. (For more inormation about internationalconvergence, see the Convergence With IFRSs section below.) Comments on the

proposed ASU are due by September 7, 2010.

The proposed ASU retains the term air value and continues to dene it as an exit pricenotion, which is consistent with current guidance under ASC 820. The proposal, which

would apply to any reporting entity that must measure or disclose the air value o anasset, liability, or instrument classied in shareholders equity in the nancial statements,does not introduce any new or revised requirements related to which items should

be measured at air value, nor does it aect the scope o ASC 820. However, entitiesaected by the FASBs proposed ASU on accounting or nancial instruments,3 or by its

project on accounting or nancial instruments with characteristics o equity, may need tomeasure more nancial assets and nancial liabilities at air value. That is, the proposed

amendments to other Codication topics may signicantly expand the requirement tomeasure nancial assets and nancial liabilities at air value.

Summary o Notable Provisions

The proposed ASU contains certain amendments that would change how the air valuemeasurement and disclosure guidance in ASC 820 is applied. For example, the proposal

(1) claries the application o the highest-and-best-use and valuation-premise concepts,(2) permits an exception to air value measurement principles when nancial assets andnancial liabilities that have osetting positions in market risks or counterparty credit

risk are managed on the basis o the net exposure to either o those risks, (3) includesguidance on measuring the air value o an instrument classied in shareholders equity,

In This Issue:

Summary o NotableProvisions

Highest-and-Best-Use andValuation-Premise Concepts

Measuring the Fair Valueo Financial Instruments

That Are Managed Within aPortolio

Other Key Proposals

Disclosures

Convergence With IFRSs

Eective Date and Transition

Next Steps

June 30, 2010

Volume 17, Issue 21

The proposed ASU isthe result o a jointproject between theFASB and IASB todevelop a single,

converged air valueramework.

1 Also yesterday, the IASB published ED/2010/7, Measurement Uncertainty Analysis Disclosure or Fair Value Measurements,

which is a limited re-exposure o its May 2009 ED, IASB ED/2009/05, Fair Value Measurement. The new ED is identical to the

proposed measurement uncertainty analysis disclosure in the FASBs proposed ASU.2 For titles o FASB Accounting Standards Codifcation(ASC or Codication) reerences, see Deloittes Titles o Topics and

Subtopics in the FASB Accounting Standards Codifcation.3 FASB Proposed Accounting Standards Update, Accounting or Financial Instruments and Revisions to the Accounting or

Derivative Instruments and Hedging Activities.

http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820873224&blobheader=application%2Fpdfhttp://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820873224&blobheader=application%2Fpdfhttp://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820873224&blobheader=application%2Fpdfhttp://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820873224&blobheader=application%2Fpdfhttp://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Content/Articles/AERS/Accounting-Standards-Communications/us_assur_Titles_of_Cod_Topics_Subtopics.pdfhttp://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Content/Articles/AERS/Accounting-Standards-Communications/us_assur_Titles_of_Cod_Topics_Subtopics.pdfhttp://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Content/Articles/AERS/Accounting-Standards-Communications/us_assur_Titles_of_Cod_Topics_Subtopics.pdfhttp://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Content/Articles/AERS/Accounting-Standards-Communications/us_assur_Titles_of_Cod_Topics_Subtopics.pdfhttp://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Content/Articles/AERS/Accounting-Standards-Communications/us_assur_Titles_of_Cod_Topics_Subtopics.pdfhttp://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Content/Articles/AERS/Accounting-Standards-Communications/us_assur_Titles_of_Cod_Topics_Subtopics.pdfhttp://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820873224&blobheader=application%2Fpdfhttp://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820873224&blobheader=application%2Fpdfhttp://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820873224&blobheader=application%2Fpdf

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The proposed ASUamends theguidance on thehighest-and-best-useand valuation-premise concepts byclariying that theyonly apply to

measuring the airvalue o nonfnancialassets.

and (4) eliminates the use o blockage actors at all levels within the air value hierarchy.The proposal also requires measurement uncertainty disclosure in the orm o a sensitivity

analysis o unobservable inputs to reasonable alternative amounts or all Level 3recurring air value measurements unless a standard other than ASC 820 exempts such

a disclosure. The sensitivity analysis disclosure would take into account the eect o thecorrelation between unobservable inputs when such correlation is relevant.

Highest-and-Best-Use and Valuation-Premise ConceptsThe proposed ASU amends the guidance on the highest-and-best-use and valuation-

premise concepts by clariying that they only apply to measuring the air value ononnancial assets. The boards concluded that nancial assets and liabilities do not havealternative uses. Under the proposal, the highest and best use o a nonnancial asset

is determined rom the perspective o market participants, even i the reporting entityintends a dierent use. However, a reporting entitys current use o an asset is presumed

to be its highest and best use unless market or other actors suggest that a dierent useby market participants would maximize the value o the asset. In determining the highestand best use, an entity must still contemplate whether the use o the asset is physically

possible, legally permissible, and nancially easible. The proposed ASU discusses themeaning o these three terms.

The valuation premise used to determine the air value o an asset is derived rom

the highest and best use o the nonnancial asset. Under the proposal, the terms

in-exchange and in-use are eliminated rom ASC 820. These terms were used todescribe the valuation-premise concept; however, the wording was oten conusing to

constituents. The proposal replaces the terms with descriptions o the concepts (i.e.,valuing an asset on a stand-alone basis or in combination with other assets or with other

assets and liabilities). The proposed ASU claries that when an assets highest and bestuse is on a stand-alone basis, an entitys determination o air value would refect the

assumption that market participants would use the asset on a stand-alone basis. Whenan assets highest and best use is in combination with other assets or with other assetsand liabilities (i.e., with complementary assets and liabilities), an entity can assume that

those complementary assets and liabilities are available to market participants.

Measuring the Fair Value o Financial Instruments ThatAre Managed Within a PortolioThe proposed ASU provides an exception to air value measurement when a reportingentity holds a group o nancial assets and nancial liabilities that have osetting

positions in market risks or counterparty credit risk that are managed on the basiso its net exposure to either o those risks. That is, when an entity has a portolio in

which the market risks (e.g., interest rate risk, currency risk, other price risks) beingoset are substantially the same, the reporting entity shall apply the price within thebid-ask spread that is most representative o air value in the circumstances to the

reporting entitys net exposure to those market risks. In addition, when there is a legallyenorceable right to oset one or more nancial assets and nancial liabilities with a

counterparty (e.g., master netting agreement), the reporting entity shall include theeect o the reporting entitys net exposure to the credit risk o that counterparty in the

air value measurement. The proposed ASU urther indicates:

I the reporting entity has a net short position (that is, the reporting entity owes thecounterparty), the reporting entity shall apply such an adjustment on the basis o its owncredit risk. I the reporting entity has a net long position (that is, the counterparty owesthe reporting entity), the reporting entity shall apply an adjustment on the basis o thecounterpartys credit risk.

The proposal outlines the ollowing criteria an entity must meet to use the exception:

a. Manages the group o nancial assets and nancial liabilities on the basis o thereporting entitys net exposure to a particular market risk (or risks) or to the credit risko a particular counterparty in accordance with the reporting entitys documented riskmanagement or investment strategy

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The amendments inthe proposed ASUwould result in U.S.GAAP and IFRSshaving the samerequirements or

measuring the airvalue o fnancialinstruments.

b. Provides inormation on that basis about the group o nancial assets and nancialliabilities to the reporting entitys management (or example, the reporting entitysboard o directors or chie executive ocer)

c. Manages the net exposure to a particular market risk (or risks) or to the credit risk o aparticular counterparty in a consistent manner rom period to period

d. Is required to or has elected to measure the nancial assets and nancial liabilities at airvalue in the statement o nancial position at each reporting date.

The ASUs proposed amendments are intended to reduce the current diversity in howentities interpret the air value measurement guidance on nancial instruments managed

on a portolio basis. Under U.S. GAAP, some entities apply the in-use valuation premise,while others apply the in-exchange valuation premise but apply a unit o valuation

dierent rom the unit o account. As discussed above, the valuation premise is no longerdeemed relevant or nancial assets and liabilities. Under IFRSs, reporting entities takeinto account the eects o osetting market risks (as permitted under IAS 39) 5 when

measuring the air value o nancial instruments. The amendments in the proposed ASUwould result in U.S. GAAP and IFRSs having the same requirements or measuring the

air value o nancial instruments.

The FASB indicated that the change in guidance is meant to refect current practice andthat it believes the proposed amendments would not change how nancial assets andnancial liabilities that are managed on the basis o a reporting entitys net risk exposure

are measured in practice. However, the board acknowledged that current practice could

be aected or entities that tend to apply the in-use valuation premise more broadly (e.g.,or nancial assets that do not have osetting positions in market risks or counterpartycredit risk). For these entities, a dierent air value measurement conclusion may result

when the proposed amendments are applied.

Other Key ProposalsThe proposal also amends guidance in the ollowing areas:

Reerence market The reerence market or a air value measurement is the

principal (or, in the absence o a principal, most advantageous) market, providedthat the entity has access to that market. The principal market is presumed to

be the market in which the entity normally transacts. The proposal also indicatesthat an entity does not need to perorm an exhaustive search or markets that

might have more activity than the market in which the entity normally transactsbut that the entity should consider inormation that is reasonably available.

Application to liabilities In the air value measurement o a liability (whethernancial or nonnancial), it is assumed that the liability continues and the market

participant transeree assumes responsibility or the obligation. The proposalrequires that when using a present value technique to determine the air value oa liability, a reporting entity take into consideration the uture cash fows that a

market participant would require as compensation or ullling and taking on theobligation. The guidance also provides examples o how that compensation may

be refected in the air value o a liability.

Application to instruments classifed in shareholders equity No guidancecurrently exists on measuring the air value o an instrument classied inshareholders equity. The proposed ASU species that the objective o a

air value measurement o an instrument classied in a reporting entitysshareholders equity . . . is to estimate an exit price rom the perspective o a

market participant who holds the instrument as an asset at the measurementdate.

Blockage actors The proposal claries that the application o a blockage

actor is prohibited at all levels o the air value hierarchy and notes that ablockage actor is not relevant and, thereore, shall not be used when air valueis measured using a valuation technique that does not use a quoted price or

the asset or liability (or similar assets or liabilities). The boards indicated that the

5 IAS 39 Financial Instruments: Recognition and Measurement.

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The boards decidedto require sensitivitydisclosure inresponse tocomments receivedrom IFRS fnancialstatement users androm comments

received in responseto the exposure dratthat led to ASU2010-06.

prohibition on using blockage actors is necessary because blockage is specicto that reporting entity, not to the asset or liability. Entities that currently apply

a blockage actor to assets and liabilities categorized within Level 2 o the airvalue hierarchy (that are measured on the basis o quoted prices) could be

aected by these proposed amendments. The Board does not expect other Level2 and Level 3 air value measurements to be aected.

DisclosuresThe proposed ASU requires entities to disclose inormation about measurement

uncertainty in the orm o a sensitivity analysis or recurring air value measurementscategorized in Level 3 o the air value hierarchy unless another Codication topicspecies that such disclosure is not required (e.g., investments in unquoted equity

instruments are not included in the scope o the disclosure requirement under theaccounting or nancial instruments project). Specically, the amendment to ASC 820-10-

50-2() states that an entity would disclose the ollowing:

A measurement uncertainty analysis or air value measurements categorized within Level3 o the air value hierarchy. I changing one or more o the unobservable inputs used ina air value measurement to a d ierent amount that could have reasonably been used inthe circumstances would have resulted in a signifcantly higher or lower air valuemeasurement, a reporting entity shall disclose the eect o using those dierent amountsand how it calculated that eect. When preparing a measurement uncertainty analysis, areporting entity shall not take into account unobservable inputs that are associated with

remote scenarios. A reporting entity shall take into account the eect o correlationbetween unobservable inputs i such correlation is relevant when estimating the eect onthe air value measurement o using those dierent amounts. For that purpose, signicanceshall be judged with respect to earnings (or changes in net assets) and total assets or totalliabilities, or, when changes in air value are recognized in other comprehensive income,with respect to total equity. [Emphasis added]

The boards decided to require sensitivity disclosure in response to comments receivedrom IFRS nancial statement users and rom comments received in response to the

exposure drat that led to ASU 2010-06.6 IFRS users indicated to the boards that themeasurement uncertainty analysis disclosure required by IFRS 7 [7] provides useul

inormation that helps them assess the subjectivity o a reporting entitys air valuemeasurements categorized within Level 3 o the air value hierarchy. However, users

also thought the IFRS 7 requirements could be enhanced to include the eect o

correlation between unobservable inputs because such inormation would help themto assess the extent to which using a dierent unobservable input can aect a air

value measurement. The boards agreed that an uncertainty analysis would be moremeaningul i, when relevant, the correlation between unobservable inputs is taken into

account.

Editors Note: For entities that do not currently provide the sensitivity analysis orhave it readily available, preparing the proposed disclosures may prove challenging.

Entities may need to consider (1) upgrading their inormation technology systems andexisting valuation models to comply with the proposed disclosure requirements and

(2) the eect o those disclosure requirements on their internal controls over nancialreporting. For nancial instruments that an entity may be required to measure at airvalue as a result o the proposed amendments to other Codication topics, the entity

would need to assess whether its internal personnel are suciently well versed in airvalue measurements to comply with the additional air value requirements.

In addition, the proposal:

Requiresdisclosurewhenthehighestandbestuseofanassetdiffersfromitscurrent use. In this instance, a reporting entity discloses the reason its use o theasset is dierent rom the highest and best use.

Requiresdisclosureoffairvaluebylevelforeachclassofassetsandliabilitiesnot

measured at air value in the statement o nancial position but or which theair value is disclosed.

6 FASB Accounting Standards Update No. 2010-06, Improving Disclosures About Fair Value Measurements.7 IFRS 7, Financial Instruments: Disclosures.

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The air valuemeasurement anddisclosurerequirements to beissued under IFRSsare expected to be

nearly identical tothose in theproposed ASU.

AmendstheLevel3reconciliationrequirements.ASU2010-6recentlyamendedASC 820 to require disclosure o signifcant transers between Level 1 andLevel 2 o the air value hierarchy. The proposed ASU amends the disclosurerequirement to include any transers between Level 1 and Level 2 o the airvalue hierarchy.

Convergence With IFRSsThe FASB and the IASB worked together with the objective o creating a commonstandard under U.S. GAAP and IFRSs. In May 2009, the IASB issued an ED that proposed

replacing all o the existing guidance on air value measurement under IFRSs with a singlestandard that was broadly similar to ASC 820 under U.S. GAAP. Then, in October 2009,the boards agreed to develop converged air value guidance. On the basis o the boards

decisions, the air value measurement and disclosure requirements to be issued underIFRSs are expected to be nearly identical to those in the proposed ASU, with the ollowing

exceptions:

Certainstyledifferences(e.g.differencesinspellinganddifferencesinreferences

to other U.S. GAAP and IFRSs).

Theassets,liabilities,andequityinstrumentsmeasuredatfairvalueunderIFRSsmay dier rom those measured at air value under U.S. GAAP as a result o

the dierent measurement bases prescribed by other literature under IFRSs orU.S. GAAP (e.g., currently the measurement bases or nancial instruments aredierent under IFRSs and U.S. GAAP).

Differencesintherecognitionofday-onegainsorlossesthatarisewhenthe

initial air value o an asset or liability diers rom the transaction price. Forexample, under IAS 39, gains and losses related to unobservable market data

are precluded rom immediate recognition. Under U.S. GAAP, there is no similarrequirement.

DifferencesrelatedtotheU.S.GAAPguidanceonnetassetvaluepershare.8This guidance provides a practical expedient that, under circumstances, permits

an entity to measure the air value o investments in certain entities that applyinvestment-company accounting on the basis o net asset value per share. The

IASB is not including this guidance in IFRSs because there are no equivalent

investment-company accounting requirements under IFRSs. Differencesindisclosurerequirements.Forexample,IFRSsdonotrequirea

reporting entity to distinguish between recurring and nonrecurring air value

measurements. In addition, amounts disclosed in Level 3 o the air valuehierarchy may dier because under IFRSs, net presentation or derivatives

generally is not permitted.

Eective Date and TransitionThe proposed ASU does not yet speciy an eective date. The FASB plans to add one ater

considering the comments it receives on the proposal.

I a change occurs in the air value measurement o an item as a result o applying theamendments in the proposed ASU, the transition would be applied via a cumulative-

eect adjustment in beginning retained earnings in the period o adoption. Theadditional proposed disclosures would be required prospectively. That is, a reporting

entity would provide those disclosures or periods beginning ater the amendments in theproposed ASU are eective.

Next StepsAter the proposed ASUs comment period closes, the boards will jointly redeliberate thecomments received. The FASBs goal is to issue a nal ASU during the rst quarter o

2011.

8 FASB Accounting Standards Update No. 2009-12, Investments in Certain Entities That Calculate Net Asset Value per Share (or

Its Equivalent).

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