Fair Value Accounting: Hero or Villain

1
Fair Value AccountingHero or Villain?

• Alfred M. King
• Vice Chairman
• Marshall Stevens, Inc.

2
Theory vs. Practice

• THEORY
• Current Values are Better than Historical Cost
• Current Values Represent Actual/Potential Cash
  Flows to Market Participants
• Business Decisions are Made Using Current Values
• PRACTICE
• Same Asset Can Have Different Values to Different
  Market Participants at the same time

3
Objective of Financial Statements

• Provide information useful to creditors and
  investors for projecting cash flowsQUESTION
  Does the provision of FV information, on assets
  that can not or will not be sold, provide useful
  information to help investors and creditors
  project cash flows?

4
How Do You Use the FV of an Asset That Will Not
Be Sold?

• Example
• Exxons service stations
• Coca Colas Trade Name
• Microsofts Windows Software
• In 40 years, no client has ever asked me to
  determine the FV of an asset which is not
  potentially for sale
• FV of readily marketable financial instruments
  may be useful if there is a market and they can
  be sold

5
Fair Value vs. Fair Market Value

• FASB threw out the baby with the bath
• 115 years of experience with FMV
• It worked
• IRS used it
• Courts used it
• FASB wanted to start with a clean slate and
  they succeeded!
• FV, unfortunately, is not how business people
  think or act

6
Oracle Purchases PeopleSoft

• Ellison buys PeopleSoft to obtain their customer
  base
• Has no use for, or need of, PeopleSofts software
  or trade name
• Under todays SFAS 157 and 141R Oracle would have
  to place a value on the trade name and software,
  even though they wont use it and wont (cant)
  sell it
• Result Instant Impairment!

7
Assets Can (And Do) Have More Than One Value

• Last parcel in a block for a real estate
  developer
• State of the art facility to produce hula hoops
• OEM customer relationship with Ford and Toyota
• Empty 100-bed hospital building

8
Level 3 Subprime Mortgages

• Who is a market participant?
• For some securities recently there have been no
  buyers at any reasonable price
• Should holders take a big writedown today, and a
  writepup next quarter?
• If so, who gains what useful information?

9
Who Is A Market Participant?

• In performing an allocation of purchase price
  under SFAS 141 (R) you get different answers if
  you assume market participants are financial
  buyers, vs. strategic buyers

10
Why Did FASB Go Off The Track?

• One word ENRON
• Enron valued their own derivatives and claimed
  instant earnings
• Had Enron tried to sell their derivatives to
  Goldman or Lehman the value would have been far
  less
• FASB the leaped the chasm and said that ALL
  values have to be based solely on market
  participants.

11
Buyers Acquire Assets For Use Not For Resale

• Values should be based on the intended use, not
  what someone else theoretically would pay
• Fair Market Value for 115 years took this
  approach
• FASB simply decided to go in a different direction

12
Fair Value Hero or Villain?

• Appraisers relying on 115 years of experience
  are the heroes
• FASB, with a totally theoretical approach, are
  the Villains
• Unfortunately, the villains have the authority to
  have written the rules!
• We will all pay the price in financial statements
  that are less useful than they could be

13
Discussion from Panel and Participants

• The views expressed may appear controversial
• There is virtually unanimous support by valuation
  specialists for the views expressed
• Accounting rule makers have had their say
• Problems for PREPARERS
• Problems for AUDITORS