7.2 Determining Market-Participant Assumptions
A fair value measurement is not entity-specific; rather, as indicated in ASC
820-10-35-9, an entity must “identify characteristics that distinguish market
participants generally” by considering the asset, liability, or equity instrument
subject to the fair value measurement; the principal (or most advantageous) market;
and the “[m]arket participants with whom the reporting entity would enter into a
transaction in that market.” This approach is consistent with the fair value
objective (i.e., fair value is measured on the basis of assumptions used by market
participants). An entity may not substitute its own assumptions for those of market
participants.
In a speech at the 2009 AICPA Conference on Current SEC and PCAOB
Developments, Evan Sussholz, then a professional accounting fellow in the SEC’s
Office of the Chief Accountant, discussed factors an entity should consider in
determining market-participant assumptions and whether its own assumptions are
comparable or different. Mr. Sussholz stated, in part:
Question #3: Who are the potential market participants
and what are their distinguishing characteristics?
As you may know, Codification Topic 820 does not require a
reporting entity to identify specific market participants. However, when
measuring fair value it is important to understand the characteristics that
distinguish market participants. The identification of these characteristics
will play a significant role in understanding how market participants would
use the asset being measured, along with the value that those market
participants would place on that asset.
For example, let’s say there are two broad groups of market
participants within the M&A market for a customer related intangible
asset: financial buyers and strategic buyers. The strategic buyer group can
be divided further into two categories: regional competitors and national
competitors. In this example, the financial buyers, the regional
competitors, and the national competitors would acquire this asset as a part
of an M&A transaction for the entire entity and maximize value by
operating this asset in conjunction with the other assets of the target
business. However, the ultimate value that each group would place on the
customer related intangible may depend on many factors including financial
capacity, acquisition strategy, market participant synergies, market share,
complementary assets, management capabilities, etc.
Question #4: How do the market participant
characteristics compare to the reporting entity’s own
characteristics?
To answer this last question, a reporting entity should
reconcile the significant distinguishing characteristics of the identified
market participant groups to those of the reporting entity. The results of
this reconciliation process will determine if the entity’s own assumptions
should be adjusted to appropriately measure the fair value of an asset.
In our example, the reporting entity has determined the
principal (or most advantageous) market, the highest and best use of the
asset, along with the distinguishing characteristics of the potential market
participants. For illustrative purposes, let’s say that the reporting entity
has determined that a regional competitor would be the most likely market
participant to acquire the customer related intangible asset and maximize
value by operating this asset in conjunction with other assets. The
reporting entity would then compare its own characteristics (both
quantitative and qualitative factors) to those of a regional competitor to
determine if its own assumptions are representative of market participant
assumptions.
We anticipate that there may be instances when a reporting
entity determines that its own assumptions are not significantly different
than those of market participants. However, it is our expectation that a
reporting entity will apply reasonable judgment when making this
determination. The items that I just highlighted are just examples of the
questions that I anticipate a reporting entity would consider in determining
market participant assumptions. There are likely to be additional factors
that one could consider when performing this analysis. Additionally, I would
like to point out that the process of determining market participant
assumptions can be iterative. Therefore, it is likely that questions will
not always be answered sequentially, but will be answered continuously
throughout the process of determining market participant assumptions.
Lastly, I think it is reasonable to anticipate that the
staff will continue to inquire about the process employed and judgments made
by a reporting entity when developing market participant assumptions.
Furthermore, we have observed that conversations are generally more
productive when a reporting entity has documented how market participant
assumptions were developed when performing a fair value measurement.
The example below further illustrates these concepts.
Example 7-1
Credit Risk of Receivables
Entity A, a financial institution that has loan receivables
from borrowers, is determining whether to include the
borrower’s credit standing in the fair value measurement of
the receivables. Because market participants would
incorporate the borrower’s credit standing into the
valuation of a loan receivable, A must consider the
borrower’s credit standing in performing this measurement in
accordance with ASC 820. The reason for this requirement is
that the borrower’s credit standing can potentially affect
the proceeds that will be received from the borrower and
market participants would take such considerations into
account in determining the transaction price for these
receivables.