From hero to zero: a fair-value nightmare

Unobservable inputs The following is excerpted from Statement of Financial Accounting Standards No. 157: Fair Value Measurement, from the Financial Accounting Standards Board. FAS 157 goes into effect for all reports November 15, 2007, or after. The statement describes three ?hierarchies? called Levels 1, 2 and 3. Levels 1 and 2 relate to assets and liabilities with ?observable? inputs such as stock prices or derivatives with market prices. Level 3 fair value relates most directly to privately held companies backed by private equity firms. The statement stresses that holders of private investments must still determine the ?exit price? of those investments using the ?best information available.? Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. However, the fair value measurement objective remains the same, that is, an exit price from the perspective of a market participant that holds the asset or owes the liability. Therefore, unobservable inputs shall reflect the reporting entity's own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). Unobservable inputs shall be developed based on the best information available in the circumstances, which might include the reporting entity's own data. In developing unobservable inputs, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions. However, the reporting entity shall not ignore information about market participant assumptions that is reasonably available without undue cost and effort. Therefore, the reporting entity's own data used to develop unobservable inputs shall be adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use different assumptions.