Fair Value Measurement

Overview: Currently there are 42 Statements, 26 Interpretations and Staff positions and 150 Emerging Task Force Consensuses which include fair value measurements. Some have tried to blame fair value accounting for the failure of certain banks and raised the question of whether fair value accounting is really fair.

ASC 825, The Fair Value Election (pre-Codification Statement 159) allows all entities to make an irrevocable instrument-by-instrument election to measure eligible items at fair value. ASC 820, Fair Value Measurement (pre-Codification Statement 157, “Fair Value Measurements”), provides a revised definition of fair value, establishes a framework for measuring fair value and expands the disclosure and documentation requirements. ASC 820 redefined 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. Fair value is no longer defined as what a Company pays for assets or receives for liabilities. It is what the Company could get for the asset or would have to pay for the liability if they were going to transfer it to somebody else.

ASC 820 also establishes a hierarchy for valuing assets and liabilities, in which items are categorized into three (3) different tranches:

Level 1. Items for which there are quoted market prices in an active market
Level 2. Items that have inputs other than quoted market inputs
Level 3. Unobservable Inputs

Since the Level 3 items include assumptions and are subjective, they require significantly more disclosure under ASC 820.

With the increased focus on accurate and reliable valuations and enhanced transparency for the users of financial statements, it is important (and difficult) to comply with the increasingly complex reporting requirements related to fair value measurements.

Services: We perform supportable and timely valuations in connection with ASC 820 and 825 and we also have the capability to provide your company with the complex footnotes that correspond to these valuations. We have extensive knowledge of financial accounting as well as valuation experience which allows us to assist our clients in supporting their valuations and related financial reporting with auditors and the SEC. We apply the guidance of Statements on Standards for Valuation Services, published by the AICPA, to provide a formal report with a calculated values as well as providing support for the assumptions used in the calculations.

Case Study: What happened to the Black-Scholes method?

We were engaged to assist a client with responding to SEC comments related to the method of accounting for a convertible financing arrangement. The embedded conversion option in the financing arrangement had been valued using the Black-Scholes technique. The SEC had determined that the Black-Scholes technique that was used was too simplistic to use for this valuation since it did not allow for the use of assumptions such as exercise behavior, credit risk and interest risk. We assisted the client by using a Monte Carlo valuation technique to calculate the fair value of the embedded conversion option. The SEC approved of the method of valuation and the calculated value.

In recent guidance such as ASC 718, the FASB has also stated that they believe closed models, such as the Black-Scholes method, are not complex enough for valuing instruments such as stock options and that a lattice model will provide a better estimate of the fair value of the stock option. We have assisted companies with changing to the more preferable lattice model for valuing their stock options. For one such company, we calculated their stock options using the more preferable lattice model and reduced their compensation expense by 20% compared to what the value would have been using the traditional Black-Scholes valuation method.