In February 2015, the Governmental Accounting Standards Board (GASB) released GASB Statement No. 72, Fair Value Measurement and Application. The new standard will change how fair value is measured, but not the specific items that must be reported at fair value. The new standard will take effect starting with the fiscal period that ends June 30,2016.
GASB Statement No. 72 offers an authoritative definition of fair value that focuses on market price from the perspective of a seller (exit price). That is, fair value is defined 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."
The fair value of a financial asset is determined based on real or potential market transactions in the government's principal market (or in the absence of a principal market, a government's most advantageous market). The fair value of a nonfinancial asset is determined based on the asset's highest and best use, which normally is presumed its current use. For liabilities measured at fair value (certain liabilities related to derivatives), fair value is the price that would have to be paid for a third party to assume the liability, not the price that would have to be paid to the counterparty to settle the obligation.
GASB Statement No. 72 explains that governments could determine the market price of an asset in one of three ways: 1) actual market transactions for identical or similar items (market approach); 2) the current cost to replace the service capacity of an asset (cost approach); or 3) discounting the current value of future cash flows (income approach).
Of course, the quality of the data (inputs) used to determine fair value can vary. Some inputs are directly or indirectly observable (independently verifiable). Other inputs are unobservable (for example, internally generated data). GASB Statement No. 72 establishes a three-tier hierarchy of input quality:
* Level 1 inputs are quoted prices (unadjusted) in active markets for identical items;
* Level 2 inputs are all inputs that are directly or indirectly observable, but not on level 1; and
* Level 3 inputs are all inputs that are unobservable.
GASB Statement No. 72...