Breaking News: FASB Issues Clarifying Guidance on Determining Fair Value of Financial Assets in Markets That Are Not Active

The Financial Accounting Standards Board (FASB) issued guidance clarifying how FASB Statement No. 157, Fair Value Measurements (FAS 157), should be applied when valuing securities in markets that are not active. The guidance, released as a FASB Staff Position (FSP), provides an illustrative example that applies the objectives and framework of FAS 157 to determine the fair value of a financial asset in a market that is not active. It also reaffirms the notion of fair value as an exit price as of the measurement date.

Among other things, the guidance clarifies:

• How management's internal cash flow and discount rate assumptions should be considered when measuring fair value when relevant observable data do not exist
• How observable market information in a market that is not active should be considered when measuring fair value
• How the use of market quotes (e.g., broker quotes or pricing services for the same or similar financial assets) should be considered when assessing the relevance of observable and unobservable data available to measure fair value

The guidance states that significant judgment is required in valuing financial assets. For example, prices in disorderly markets cannot be automatically rejected or accepted without sufficient evaluation. In addition, a distressed market does not result in distressed prices for all transactions—judgment is required at the individual transaction level.

From start to finish, the FASB issued this FSP in literally a matter of days to help financial-statement preparers deal with valuations involving financial assets in markets that are not active. The FSP is effective upon issuance, including prior periods for which financial statements have not been issued (i.e., Q3 for calendar-year companies). The FSP is available on the FASB’s website (http://www.fasb.org/pdf/fsp_fas157-3.pdf).