Fair Value Measurement

Get up to date on the latest FASB, SEC, and AICPA guidelines and best practices

Fair Value Measurement provides hands-on guidance and the latest best practices for measuring fair value in financial reporting. The Financial Accounting Standards Board (FASB), the U.S. Securities and Exchange Commission (SEC), and the American Institute of CPAs (AICPA) have all updated their guidelines for practitioners, and this book details the changes from a practical perspective. This new third edition includes a discussion on Private Company Council accounting alternatives for business combinations and impairment testing, with a detailed example of the Market Participant Acquisition Premium (MPAP), including European and Asian examples and expanded discussion of IFRS.

Fair value measurement guidelines continue to evolve, and this comprehensive reference provides a valuable, up-to-date resource for preparers, auditors, and valuation specialists.

• Adopt the best practices for implementing the FASB's Topic 820
• Learn the latest reporting requirements for fair value measurements
• Understand accounting alternatives for business combinations

• Examine the details of MPAP in Europe and Asia

Applying fair value measurements to financial statements requires a move away from rules-based standards and toward application of professional judgment. This controversial shift has led to a reliance on valuation specialists, who face their own challenges in applying Topic 820 amidst an economic downturn and recovery, leading to an ever evolving set of best practices. Practitioners must stay up to date, and be aware of the changes as they occur. Fair Value Measurement provides the most recent information and a practical approach to this area of financial reporting.

Preface xiii

Acknowledgments xix

Chapter 1: The History and Evolution of Fair Value Accounting 1

Why the Trend Toward Fair Value Accounting? 2

History and Evolution of Fair Value 5

Fair Value Accounting and the Economic Crisis 12

The FASB and IASB Convergence Project 17

The Future of Fair Value Measurement 23

Fair Value Quality Initiative for Valuation Specialists 24

Conclusion 26

Notes 26

Appendix 1A: The Mandatory Performance Framework 31

Performance Requirements 31

Conclusion 33

Notes 46

Chapter 2: Fair Value Measurement Standards and Concepts 47

FASB ASC 820, Fair Value Measurement 48

Disclosures 67

Fair Value Option 70

Standards in the Valuation Profession and Fair Value Measurements 77

Conclusion 79

Notes 80

Appendix 2A: Taxes and Fair Value Measurements 81

Summary of Changes under 2017 TCJA 81

Chapter 3: Business Combinations 85

Mergers and Acquisitions 86

Accounting Standards for Business Combinations—A Brief History 88

ASC 805, Business Combinations 90

Other Business Combination Highlights 95

Subsequent Accounting for Goodwill and Other Intangible Assets 99

Conclusion 100

Notes 101

Chapter 4: The Nature of Goodwill and Intangible Assets 103

History of Intangible Assets 104

Intellectual Property 105

Economic Basis of Intangible Assets 106

Identification of Intangible Assets 106

Useful Life of an Intangible Asset 111

Intangible Assets and Economic Risk 112

Goodwill 112

Economic Balance Sheet 114

Conclusion 116

Notes 117

Chapter 5: Impairment 119

Evolution of Impairment Testing 120

Applicable FASB Guidance for Impairment Testing 122

Accounting for the Impairment of Long-Lived Assets 123

Goodwill Impairment Testing—Public Companies 125

Goodwill Impairment—One-Step Impairment Loss 138

Testing Other Indefinite-Lived Intangible Assets for Impairment 139

Amortization of Goodwill 139

Conclusion 140

Notes 140

Appendix 5A: Example of a Qualitative Impairment Analysis—PlanTrust, Inc. 143

Financial Accounting Standards Board ASC 350, Intangibles—Goodwill and Other 143

PlanTrust, Inc. 144

Notes 159

Chapter 6: The Cost Approach 161

The Cost Approach under FASB ASC 820, Fair Value Measurement 162

Economic Foundation for the Cost Approach 164

Cost versus Price versus Fair Value 164

The Role of Expected Economic Benefits in the Cost Approach 166

Reproduction Cost versus Replacement Cost 167

Components of Cost 168

Obsolescence 169

The Relationships Among Cost, Obsolescence, and Value 170

Physical Deterioration 171

Functional (Technological) Obsolescence 172

Economic (External) Obsolescence 173

Applying the Cost Approach 174

Taxes Under the Cost Approach 178

Limitations of the Cost Approach 179

Conclusion 179

Notes 180

Chapter 7: The Market Approach 183

Applying the Market Approach When Measuring the Fair Value of an Entity or a Reporting Unit of an Entity 184

Conclusion 213

Notes 213

Chapter 8: The Income Approach 215

Introduction 215

Discounted Cash Flow Method 216

Multiperiod Excess Earnings Method 223

FASB Concepts Statement 7 239

Rates of Return Under the Income Approach 244

The Income Increment/Cost Decrement Method 245

Profit Split Method 246

Build-Out, or Greenfield, Method 251

Weighted Average Cost of Capital Calculation 251

Conclusion 258

Notes 259

Chapter 9: Advanced Valuation Methods for Measuring the Fair Value of Intangible Assets 261

Introduction 261

Limitations of Traditional Valuation Methods 261

Real Options 263

Using Option Pricing Methodologies to Value Intangible Assets 266

Black-Scholes Option Pricing Model 269

Binomial or Lattice Models 272

Monte Carlo Simulation 277

Decision Tree Analysis 280

Conclusion 281

Notes 281

Chapter 10: Measuring the Remaining Useful Life of Intangible Assets in Financial Reporting 283

FASB Guidance on Determining the Remaining Useful Life 283

Considerations in Measuring Useful Lives of Intangible Assets 285

Practical Guidance for Estimating and Modeling the Useful Life 289

Conclusion 295

Notes 295

Chapter 11: Fair Value Measurement for Alternative Investments 297

Introduction 297

Investments in Certain Entities That Calculated Net Asset Value per Share 299

AICPA Technical Practice Aid 300

AICPA Guidance for Determining the Fair Value of Investment 301

AICPA Accounting and Valuation Guide, Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies 305

International Private Equity and Venture Capital Valuation Guidelines 306

Common Valuation Methodologies of Measuring the Fair Value of the Fund’s Investment Portfolio 307

Conclusion 308

Notes 308

Chapter 12: Contingent Consideration 311

Contingent Consideration: Earn-outs in Business Combinations 311

Accounting for Contingent Consideration 312

Conclusion 324

Notes 324

Appendix 12A: Measuring the Fair Value of a Nonfinancial Contingent Liability—Example of a Loan Guarantee 327

The Jordan Lee Fund Guarantee of Townsend Farm Development, LLC 328

Notes 334

Chapter 13: Auditing Fair Value Measurement 335

Auditing Standards 336

The Audit Process 338

Evolution of Audit Standards for Fair Value Measurements and Disclosures 342

Auditing Standard 2501, Auditing Accounting Estimates, Including Fair Value Measurements 344

Auditing Standards for Auditor’s Use of the Work of Specialists 349

Proposed International Standard on Quality Management 1 354

Practical Guidance for Auditors 354

PCAOB Staff Audit Practice Alert No. 9, Assessing and Responding to Risk in the Current Economic Environment 356

AICPA Nonauthoritative Guidance 358

The Appraisal Foundation 359

Conclusion 359

Notes 360

Appendix 13A: Auditing Fair Value Measurement in a Business Combination 363

Auditor Questions 363

General 363

Income Approach 364

Cost Approach 366

Market Approach—General 367

Appendix 13B: Auditing Fair Value Measurement in a Goodwill Impairment Test 369

General 369

Income Approach 370

WACC 371

The Market Approach 372

Chapter 14: Fair Value Measurement Case Study 373

Learning Objectives 373

Business Background and Facts—Dynamic Analytic Systems, Inc. 374

Notes 406

Appendix 14A: Suggested Case Study Solutions 407

Note 437

Appendix 14B: Model Fair Value Measurements Curriculum 439

Acknowledgments 439

AICPA Staff 440

About Us 440

Preface 440

Model Fair Value Measurement Curriculum 440

Appendices and Examples 448

Note 451

Glossary of International Business Valuation Terms 453

Bibliography 463

About the Author 475

Index 477

MARK L. ZYLA is a Managing Director of Zyla Valuation Advisors, LLC. an Atlanta, Georgia based valuation and litigation consultancy firm. He is a Certified Public Accountant, Accredited in Business Valuation (CPA/ABV), Certified in Financial Forensics (CFF) by the American Institute of Certified Public Accountants (AICPA), a Chartered Financial Analyst (CFA), and an Accredited Senior Appraiser with the American Society of Appraisers certified in Business Valuation (ASA).

Mark is the Chairman of the Standards Review Board of the International Valuation Standards Council (IVSC) and has served on the AICPA's Forensic and Valuation Services Executive Committee. Mark was inducted into the AICPA Business Valuation Hall of Fame in 2013.

Fair value accounting has changed how financial information is reported. Fair value is now often used as a basis of measurement for reporting for financial and non-financial assets and liabilities. As the amount of financial statement information measured at fair value under U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) continues to increase, so does the need for experienced and knowledgeable valuation specialists and auditors. This new edition of Fair Value Measurement: Practical Guidance and Implementation covers the history and evolution of fair value accounting, newly implemented accounting standards and best practices, fair value measurement standards and concepts, and more.

This fully revised and updated guide includes substantial new content and examples. In-depth chapters examine an inclusive range of important topics, while helping improve understanding of measuring fair value. The book begins by looking at the history and development of fair value accounting, current trends that affect fair value measurement, and how the once proposed convergence of U.S. GAAP with IFRS has influenced fair value concepts. An overview of fair value measurement in U.S. GAAP, including cross-references to FASB ASC 820, introduces important fair value framework concepts, Uniform Standards of Professional Appraisal Practice (USPAP) and International Valuation Standards (IVS). A chapter examining accounting standards for business combinations is followed by chapters on intangible assets, intellectual property, and testing goodwill for impairment under different accounting standards.

Various approaches to fair value measurement are explained in detail over the next several chapters. Hands-on examples demonstrate various methods and techniques for applying the cost approach to measure contributory assets, the market approach for measuring the fair value of certain intangible assets, and income approach methods used in business combinations. Subsequent chapters cover advanced valuation techniques, auditing fair value measurement, contingent consideration, and alternative investments. The closing chapter of the book provides a new case study illustrating the measurement of fair value for intangible assets, including a question and answer section that highlights important concepts.

Despite some challenges, such as the potential for reporting bias, fair value measurement significantly increases public trust in financial reporting. The goal of Fair Value Measurement: Practical Guidance and Implementation is to help overcome such challenges and assist valuation professionals to navigate the move towards fair value as the fundamental basis for accounting in the future.

The most recent developments and best practices for applying fair value measurement in financial reporting

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have brought fair value measurements in financial reporting together through the issuance of parallel statements. This move away from traditional measurements under accounting standards requires a degree of professional judgment, often provided by an outside valuation specialist. Financial executives, valuation specialists, and auditors need to be aware of the latest requirements for applying fair value measurement to financial statements.

The Third Edition of Fair Value Measurement brings together best practice accounting and valuation guidance on relevant FASB Accounting Standards Codification (ASC) standards, such as ASC 820, Fair Value Measurements. This fully updated edition offers new and revised coverage of Private Company Council (PCC) accounting alternatives for business combinations and impairment testing, the latest on testing for impairment of goodwill for public entities, the application of the Market Participant Acquisition Premium (MPAP), fair value measurement of portfolio investments, and expanded discussion of fair value measurements under International Financial Reporting Standards (IFRS).