Fair value is unfair.

• Author: King, Alfred M.
• Position: MEMBERS SPEAK OUT

We have passed the 10th anniversary of the issuance of SFAS 141, Business Combinations, which first elucidated the Financial Accounting Standards Board's concepts of "fair value." Now is the time to review its consequences.

In my 43 years as a valuation specialist no client has ever approached me asking, "Al, please tell me what xxxxx is worth. I am not planning to do anything with the information; I am just intellectually curious what the asset is worth."

One hundred percent of our client inquiries in that 43-year period have been because the client is going to use the value information in some specific way in their business--a use that in some manner ultimately involves cash. Other than complying with GAAP, fair market value (FMV) information may be used to prepare for a taxable transaction, to determine a value for a buy/sell agreement or to appeal a property tax assessment.

Irrespective of the specific reason, there is always a purpose why clients pay us to tell them what something is worth.

Courts, the Internal Revenue Service, business contracts, insurance companies and appraisers had for 100 years referred to fair market value. The basic principles of FMV were well established. Then, in one wave of its magic wand, FASB overturned all our valuation experience. The board came up with its own new definition, calling it fair value (FV), not FMV, and immediately turned the world of financial reporting upside down. You might ask, "What is the difference between FMV and FV? They sure sound similar."

The difference is that the board's new FV definition did not look at both buyers and sellers, but solely at sellers.

What a buyer had paid for an asset was now irrelevant. What FASB asked for was a theoretical price for which an asset could be sold, if it were sold.

THE UNFAIR PART

Here is where fair value becomes unfair. A primary purpose of financial statements is to tell investors and creditors about future cash flows of the organization. It is hard to argue with that objective, and most valuation specialists as well as security analysts and financial executives accept the primacy of cash flow.

The problem is that valuation specialists are now having to determine the theoretical value of what an asset would be sold for when there is absolutely no chance it will ever be sold. Have you ever bought or sold a customer relationship? A covenant not to compete? A trade name? A very few trade names are occasionally exchanged in the market, but every...