Fair-Value Rule Seeks Clearer M&A Deals

Measuring fair value is more challenging than ever these days. But new IFRS reporting standards could help bring more transparency to the process, ...
Kathy HoffelderApril 5, 2013

In his desire to take Dell private, billionaire founder and CEO Michael Dell agreed in February to value his stake of more than 15% in the company at a lower share price than other shareholders. Hoping that would make the deal more attractive to potential suitors, he valued Dell at $13.65 a share, while analysts and other private equity firms claimed it was worth almost double that.  

The Dell buyout saga shows how important measuring fair value (the price at which an asset can be sold in current markets) is, particularly for mergers and acquisition. And with changes in fair-value accounting going into effect during the next financial reporting periods for most corporations, CFOs and other senior executives will need to keep an even sharper focus on it—whether for acquisitions, or simply to re-value land or property.

International Financial Reporting Standard No. 13, or IFRS 13, which gives guidance on how to measure an asset’s fair value, went into effect on January 1. But firms are still in the process of implementing the standard. Both the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) issued IFRS 13 in 2011 to provide investors with an easier and more consistent way to analyze corporate assets that would still be aligned with U.S. generally accepted accounting principles (GAAP).

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IFRS 13 applies to most corporations, explained David Larsen, managing director of the alternative asset advisory practice at Duff and Phelps. Speaking at a Duff and Phelps IFRS 13 webcast yesterday, he said the standard comes into play for any company that must disclose fair-value measurement for M&A activity, asset impairment, or activity involving investment entities (units which obtain funds from investors in exchange for investment management services). “In many ways, that’s almost everybody.”

Corporations must use fair-value measurement when they initiate impairment testing (required evaluations comparing an asset’s book value with its open-market value) under other financial-reporting standards, including, for instance, those covering Recognition and Measurement (IFRS 39), Financial Instruments (IFRS 9), and Business Combinations (IFRS 3).

But not everyone is taking heed of some of the biggest changes outlined in IFRS 13, such as those involving disclosure. “The expansion of disclosures [about fair values] could be a new thing for many; a lot of judgment goes into the disclosure area” said Larsen.

Specifically, corporations now must show more support for the assumptions made on their fair-value measurement and, particularly, more clarity in those assets that may be difficult to value. Under the standard, which has been in development for at least eight years, company’s now must disclose fair values according to a three-level hierarchy: for those assets in which quoted prices in active markets are readily available (level 1); when that’s not available, corporations will have to disclose fair values using inputs other than quoted prices included within level 1 that are still observable (level 2); and if those aren’t available, they need to disclose fair value using inputs that still based on market assumptions though they may be unobservable for the asset (level 3). 

Disclosure also involves performing qualitative sensitivity analysis (where a company provides a narrative discussion if changing inputs would result in altermative assumptions about fair value) and initiating a quantitative disclosure for Level 3 inputs in addition to a quantitative one already in place in the regulation, according to the webcast.

But analyzing a company using the different levels of disclosure is still a challenge. As Larsen pointed out, Google, for one, was valued using level 3 inputs when it was private and then, when it went public, it was valued using level 1 inputs. “It didn’t change from being a toxic (a term commonly used to describe level 3 assets since they are harder to observe) company to non-toxic the day it went public; it’s just  that the way one valued it differed,” he said, suggesting the company used more transparent inputs when it went public.   

Still, the increased disclosure demands of IFRS 13 should certainly help investors. IFRS 13 now requires a lot more substantiation (referred to as “calibration”) of the valuation techniques used in obtaining fair value, such as comparisons of different measurements to observable market data. This could particularly provide more insight into a firm’s non-financial assets, which are still hard to value.

As Larsen noted, “calibration is one of the most important tools in IFRS 13…and likely one of the least understood and least applied.”

Having clearer guidance on how to value assets with IFRS 13 should particularly help corporations when they look to sell assets since no clear exit pricing method exists currently for fair value measurement, added Hilary Eastman, a Duff and Phelps and a former senior manager with the IASB who led the joint IASB-FASB fair-value measurement project. “Companies were applying it (fair value) differently. For example, in an acquisition, they were applying it one way and when they were selling it, they were applying it another way,” she said on the webcast. “There really shouldn’t be a difference between an entry price and an exit price in most cases.” (Under fair value measurement, the entry price is the price at which an asset would be bought–commonly known as the “ask price.” The exit price is defined as the price paid to transfer a liability.)

Additionally, she said IFRS 13’s improved guidance on how to value liabilities should also help firms since too often it was difficult to find quoted prices for the transfers of such a liability. IFRS 13 requires that if a price is not available, fair value of the asset is taken from another market participant that holds the identical asset.”That’s an area that challenges a lot of people and has done for a long time, whether for fair value or for other reasons.”