SFAS 157 – FAIR VALUE MEASUREMENTS (as amended)

The purpose of SFAS 157 (effective for fiscal years beginning after November 15, 2007) is to provide a revised definition of fair value and to incorporate this new definition into all GAAP where fair values are required in order to improve consistency and comparability.  It does not apply to fair value under SFAS 123[R], the practicability exceptions to fair value measurements in existing standards and statements that involve values that are similar to fair value, but not actual fair value, such as with valuing inventories. 
           
The Statement defines fair value as 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.  Embedded in this definition are certain presumptions that need to be understood when calculating fair value.  First, the price is based on an orderly transaction between market participants at the measurement date from the point of view of the transferor.  Second, fair value is asset or liability specific.  Third, there is an orderly transaction in which the sale has occurred after a reasonable period of marketing activities has occurred.  Fourth, the transfer takes place in the principal or most advantageous market for the asset or liability.  Fifth, the buyers and sellers in the principal market are called market participants.  Sixth, fair value for assets is based on their highest and best use, and fair value for liabilities assume the risk of nonperformance will be the same before and after the transfer.
           
In the context of the presumptions above, the Statement allows three valuation techniques that can be used individually or in combination.  The market approach uses market prices and other information from market transactions involving identical or comparable assets or liabilities.  The income approach is based on the present value of a future stream of cash flows or income.  Lastly, the cost approach is essentially replacement cost based on the cost for a buyer to acquire or construct assets of comparable utility.  The use of any one of these approaches requires the use of “inputs” which are assumptions used in the calculation of fair value.  These inputs could include risk factors, interest rates and timing of cash flows to name a few.  The inputs are categorized into “level 1”, “level 2” or “level 3 inputs depending on the reliability and verifiability of the input.  Valuations using “level 1” inputs are better than “level 2” inputs, which are better than “level 3” inputs.
           
Lastly, SFAS 157 expands the disclosure requirements in include information on the “inputs” used in the three valuation techniques discussed above.  The disclosure requirements distinguish between fair values measured on a recurring basis and those measured on a non-recurring basis.
           
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