Fair Value Definition 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 –Price in hypothetical transaction to sell an asset or transfer a liability (exit price) –NOT price in actual transaction to acquire an asset or assume a liability (entry price) –NOT adjusted for transaction costs

Fair Value Approach THE ASSET OR LIABILITY Indicated Value Unit of Valuation Market Participant Assumptions Fair Value Measurement F/S Presentation and Disclosure Inputs to Valuation Techniques Attribute Value to Asset or Liability at Unit of Account Level Highest and Best Use Exit Market Valuation Premise Unit of Account

FAS 157 – Valuation Terms in Accounting Literature Highest and best use Valuation premise –In use –In exchange Cost, Market and Income Approaches

FAS 157 – Application Issues Separation of unit of account and unit of valuation Interplay within conceptual framework –Exit markets –Highest and best use –Valuation premise –Market participant type Increased rigor and documentation around selection of market participant types Specific applications –Selection of market participants –Abandonment –Defensive value

Unit of Valuation Market Participant Assumptions Highest and Best Use Exit Market Valuation Premise In-use or in-exchange Use by market participants that maximizes value of asset (or asset group) The unit of valuation depends on the highest and best use of the asset, which establishes the valuation premise used to measure the fair value of the asset

FAS Examples

Example 1 Asset Group Entity acquires assets that are used together as a group (Assets A, B, C) –Unit of account is each individual asset –Unit of valuation is the group of assets within which the assets would be used by market participants (highest and best use is in-use) –Exit market is the acquisition market; therefore, market participants are other bidders for the assets (strategic and financial buyers) –Strategic buyers have related assets that would enhance the value of the assets as a group, including a replacement asset for Asset C (billing software); financial buyers do not

Example 1 Asset Group (cont’d) Indicated Fair Value Strategic Financial Buyer Assets GroupGroup A$360$300 B C Total$650$600 –Fair values of Assets A, B, C determined based on use within strategic buyer group because that use would maximize the fair value of Assets A, B, C as a group; need not maximize the fair value of each asset individually (e.g. Asset C)

Example 3 IPR&D Entity acquires IPR&D project Highest and best use/valuation premise –In-use if IPR&D project would provide maximum value to market participants through its use together with other assets as a group; use encompasses use as a completed project or as a locked-up project (to provide defensive value) –In-exchange if IPR&D project would provide maximum value to market participants through its non use (discontinue development)

Example 7 Interest Rate Swap Entity B (securities dealer) enters into interest rate swap with Entity A (retail counterparty) in retail market for no initial consideration (TP = $0) –Entity B would transfer its rights and obligations under the swap to a securities dealer counterparty in the inter-dealer market, not a retail counterparty in the retail market –At initial recognition, the transaction price (entry price) might NOT represent fair value of the swap (exit price) –FAS 157 nullifies F/N 3 to EITF Issue 02-3

Example 8 Restricted Asset Security –Legal restriction on sale for specified period –Restriction is specific to the asset and, therefore, would transfer to a market participant (buyer) –Fair value measurement would consider effect of restriction, even if restriction terminates within one year –FAS 157 applies for restricted securities measured at fair value under FAS 115 and FAS 124

Example 10 Liabilities Entity A (investment bank with AA credit rating) issues 5-yr fixed rate note to Entity B Fair value measurement considers: –Nonperformance risk, including credit risk –Changes in credit spreads generally, even if no changes in specific credit risk –Changes in specific credit risk, even if within the AA spread