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SFAS No. 151 – Inventory Costs SFAS No. 151 – Inventory Costs
Part of the “international convergence” project. Clarifies that abnormal costs of idle facilities
should not be capitalized as product costs. Companies should use “normal capacity” for the
allocation of overhead. Any unallocated overhead is expensed during the
period in which they are incurred. Other abnormal handling costs or abnormal levels of
spoilage might also need to be expensed.
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Coming soonComing soon
Short-term convergence with IASB EPS (ED expected 1st half 2007) Income taxes (ED expected 1st half 2007)
Research and Development - ?
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FAS157 Issued Sept. 2006FAS157 Issued Sept. 2006
With a few exceptions, it does not change WHAT is currently measured using fair value
Sets out a framework for measuring fair value
Requires additional disclosures about fair value measurements
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FAS157 – Definition of Fair ValueFAS157 – Definition of Fair Value
Paragraph 5 - 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 is an exit-price definition of fair value
(see paragraph 7)
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FAS157 – Related definitionsFAS157 – Related definitions
Market Participants (4 criteria) Independent of reporting entityHave knowledge needed for reasonable
understanding about transactionFinancial and legal ability to enter into the
transactionBe willing to enter into transaction without
compulsion
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FAS157 – Related definitionsFAS157 – Related definitions
Principal Market Has the greatest volume and level of activity.
If there is no principal market, use the most advantageous market
Most Advantageous Market Most advantageous market has price that maximizes
the net amount that would be received or minimizes the net amount paid
Transactions costs are included in determining which market to use but do NOT become part of the fair value measurement
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Example of which market…Example of which market…
Market A Market B
Selling price $50 $48
Transaction cost $5 $2
Net proceeds $45 $46
Fair value to use $48
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FAS157 – Related definitionsFAS157 – Related definitions
Assumptions about the market The asset or liability is exchanged in an orderly
transaction between market participants An orderly transaction is a transaction that assumes
exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities;
it is not a forced transaction (for example, a forced liquidation or distress sale).
The price is for a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the item
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FAS157 – Related definitionsFAS157 – Related definitions
Valuation premise – the assumption about how market participants would use an assetChoose the premise based on “highest and
best use” In-use premise
Provides maximum value through use in combination with other assets
In-exchange premise Provides maximum value principally on a stand-alone
basis
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Valuation TechniquesValuation Techniques
Market approach Uses observable prices from market transactions for
comparable assets or liabilities
Income approach Analysis of future cash flows using present values
Cost approach Estimates cost to replace an asset’s service capacity
A change in valuation technique is a change in accounting estimate, not a change in accounting principle
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The “Fair Value Hierarchy”The “Fair Value Hierarchy”
Level Inputs to achieve reliability level
1 Quoted prices in active markets for identical assets or liabilities
2
Observable prices in active markets for similar assets or liabilities, or prices from markets that are not active. Market inputs for substantially full term of item (interest rates). Market inputs that are not directly observable but can be derived or corroborated by market data
3Unobservable inputs based on the reporting entity’s own assumptions about assumptions that market participants would use. Cannot be corroborated by observable market data
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Valuing LiabilitiesValuing Liabilities
The valuation technique must consider the reporting entity’s credit standingA reporting entity could record a GAIN for
derivatives at a measurement date because the fair value of the liability decreases in response to a credit downgrade if all other inputs remain unchanged
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Restrictions on AssetsRestrictions on Assets
Restrictions are evaluated to determine whether they are an attribute of the asset or an attribute of the reporting entity If sold, would the restriction transfer to another
holder? If yes, the impact of the restriction would be taken into
consideration (adjust asset fair value downward) If no, the restriction would not reduce the fair value
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Other provisions of FAS157Other provisions of FAS157
It is now possible to recognize a gain on the day recognized (previously prohibited under EITF 02-3)
Blockage adjustments are not permitted in pricing
Bid-ask spreadsUse the price within the bid-ask spread that is
most representative of fair value in the circumstances
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FAS 157 DisclosuresFAS 157 Disclosures
Will be extensive and reported in three sections (see paragraph A33-A36 for examples) Assets and liabilities measured at fair value on a
recurring basis Tabular display reconciles beginning and ending amounts
when significant Level 3 inputs are used Assets and liabilities measured at fair value on a
nonrecurring basis (impairment of assets, etc.) For all fair value measurements, a table showing the
reliance on Level 1, 2 or 3 inputs plus discussion of the valuation techniques used for the measurements
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FAS 157 – effective dateFAS 157 – effective date
Implementation is prospective Required for financial statements issued
for fiscal years beginning AFTER Nov. 15, 2007
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FAS 159 – The Fair FAS 159 – The Fair Value OptionValue Option
Optional use of fair value for certain assets and liabilities
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Essentially a one-time electionEssentially a one-time election
On a contract by contract basis, company can designate specified financial instrument to be accounted for using fair value instead of the usual measurement technique
Companies may be able to reduce volatility in reported earnings caused by measuring assets and liabilities differently
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Other “benefits”Other “benefits”
Movement toward accounting for all financial instruments at fair value
Brings US GAAP into closer agreement with IASB 39 which already contains a fair value election
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Eligible assets & liabilitiesEligible assets & liabilities
Most recognized investments including those currently accounted for using the equity method But cannot be used to recognized investments that
must be consolidated (VIEs, subsidiaries)
Many recognized liabilities Excluding leases, demand deposits of banks,
postretirement plans, etc.
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Eligible assets & liabilitiesEligible assets & liabilities
Firm purchase commitments that would otherwise not be recognized at inception (but only for ones involving financial instruments)
Rights and obligations under warranties that meet certain requirements
Certain host financial instruments that result from separation of embedded nonfinancial hybrid instruments under FAS133
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Irrevocable electionIrrevocable election
Must be applied to contracts as a whole and not to parts of contracts
Changes in fair value will be recognized in earnings during each reporting period
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Election dateElection date
Transition – any eligible item as of the date that FAS159 is initially adopted
Thereafter:The eligible item is first recognized (including
entering into an eligible firm commitment)Occurrence of a short list of other events
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DisclosuresDisclosures
If fair value option is elected, company must disclose separately assets and liabilities measured at fair value from those not measured at fair value Intended to help readers compare companies
that choose the option to those that choose not to elect fair value accounting
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Disclosures – specific (1)Disclosures – specific (1)
Why fair value option was selected for each eligible item
Difference between fair value and aggregate unpaid principal amounts
Relation to other fair value measurements under FAS157
Description of partial applications to groups of similar items and why company chose not to be consistent
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Disclosures – specific (2)Disclosures – specific (2)
Loans carried at assets at fair value that are past due by 90 days or more
APB18 disclosures about investments that would otherwise have been reported using equity method
Description of how interest and dividends are measured and reported for items with fair value election
Quantitative information (line by line) as to where gains and losses related to fair value option have been reported in the income statement
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FIN 46R and 48FIN 46R and 48
Lecture notes are in doc file (not ppt) and this was covered as part of the deferred tax lectures
Note to self – need to verify FIN46R notes were only in doc file, I think
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FSP of interestFSP of interest
Note that FSP158-1 (Feb 21, 2007) contains Update of Illustrations, Application GuidanceDon’t hit ‘print’ – 257 pages!Fixes examples in FAS87, FAS88 & FAS106
as related to issuance of FAS158. FAS132R was “fixed” in FAS158 so is not included in this FSP
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Forthcoming – first half 2007Forthcoming – first half 2007
Conceptual Framework – Reporting Entity – preliminary views
Business Combinations – for-profit:Applying the Acquisition Method (final)Noncontrolling Interests (final)
Derivatives disclosures (final)
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Forthcoming – first half 2007Forthcoming – first half 2007
Implementation ProjectsStatement 140—Transfers of Financial Assets
(ED) Insurance Risk Transfer (ED)Financial Guarantee Insurance (ED and
maybe final by mid year) Definition of liability vs. equity (Prelim
views expected first half of 2007)
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Forthcoming – second half 2007Forthcoming – second half 2007
Financial Statement Presentation (prelim views maybe by 3rd quarter)
Revenue recognition (PV by 3rd or 4th Quarters)