When true value really isn't true and fair.

• Author: Cunningham, Colleen
• Position: Fair Valuation of Assets and Liabilities

The Financial Accounting Standards Board (FASB) is on verge of introducing a fundamental change in how fair value of assets and liabilities will be determined. The forthcoming standard simply titled "Fair Value Measurements" has many of the same words we've all grown used to: that fair value is the price that would be received for an asset or paid for a liability in an exchange between a willing buyer and willing seller. Like most new standards, the devil is in the details.

Unlike the past, the fair value measurement objective prohibits consideration of the entity's intentions or plans and its particular facts and circumstances. Instead, the asset or liability will be valued at a hypothetical price between a hypothetical buyer and a hypothetical seller, with the objective of measuring the "exit" price in contrast to the "purchase" price. Sounds simple, right? If applied broadly throughout the financial reporting model, it will represent whole new mindset on how to measure fair value. Consider the following examples:

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* Company A acquires a competitor with the intention of eliminating its brands and redeploying its factories to produce its own products. Company A must record an asset for the brands, tradenames and other acquired intangibles at what a hypothetical market participant would pay with the intention of continuing to use them. It is unclear what should be done on day 2.

* Company B acquires an asset from a bankrupt seller for $500, knowing that a market participant would normally sell the asset for $800. Company A should record the asset at $800 and presumably record a gain of $300. Likewise, if a market participant would sell the asset for lower than the amount paid, a loss would be recorded in earnings.

* Company C has a facility that produces widgets and is running at 30 percent of capacity. It believes that the asset is impaired and intends to write it down to fair value, in accordance with the existing impairment standard. It may be prohibited from doing so, however, if a hypothetical market participant (for example, the most efficient widget-maker) would be able to operate the plant at a higher capacity and with greater efficiency, resulting in a fair value that is in excess of Company C's carrying amount.

* Company D buys a manufacturer that sells to the same customers as it does and must value the acquired customer relationships based on what a market participant, who potentially could have no...