Question: Part 1: This is a big assignment. Please write at least 2 paragraphs on question 1 and 2 that are posted below. Part 2 is separate assignment but make sure you write at least 1 big paragraph if not then 2 paragraphs for each question. Ask questions before you start working on it.
1. Some think that lawyers are lined up just waiting for the lawsuits to begin since the implementation of FAS 157. Discuss who the parties to the lawsuits might be, what they may be suing over, and how potential litigation might affect the decisions a company is making about their valuations (primarily for Level 2 and 3). There is quite a bit of material on the internet about this, share links to articles or blogs you may have found. How might significant litigation affect the usefulness of the new rules? To start you out, check out the June 2008 issue of Journal of Accountancy Article "A Litigator's Perspective" by Antonio Yanez Jr. (in Weblinks)
2. There is a much controversy about whether or not Fair Value works when markets do not behave in a "normal" pattern such as in late 2008 and early 2009. Discuss Fair Value in both a normal and abnormal market situation; giving recent examples of entities/individuals who have spoken out on both sides of the controversy. Do you think Fair Value is really fair and truly provides the readers of the financial statements accurate information? Why or why not? Did Statement 157 cause in part or in whole, our recent economic crises? Use this discussion amongst your classmates to help you form an answer to the final homework question of the week.
Part 2: Assignment-Fair Value
Make sure your name appears on each page of the homework using the header function. Homework questions:
1. The Fair Value requirement has been blamed by some for the credit market crunch that started in 2007, worsened in 2008 and continues into 2009. Discuss what effect you think Fair Value had on financial institutions and why some believe that it precipitated the current economic recession. Do you agree or disagree that Fair Value caused the collapse of the mortgage and lending markets? There are a number of good articles and links to help you with this such as the article in the Web Links page from the January 20, 2009 Boston Globe about the impact on State Street Corporation's capital from potentially having to permanently write down the value of assets (it will help you understand how marking down the value of assets impacts the banks' capital, and how in turn, this impacts their ability to lend). Also, the JOA May 2008 3 Articles with view pro and con about Fair Value vs. Historic Cost. There are a number of other readings to help with this topic or you may gather your own-please share them if you would on the student section of the Web Links page.
2. You are the CFO of a publicly traded company and are getting ready to prepare you year- end financial statements. In your investment portfolio you have:
a. Long-term bank CD's
b. Stock holdings in 5 publicly traded companies
c. Stock holdings in 2 privately held companies
d. Investment in a real estate trust (REIT) which owns strip malls and other commercial buildings for retail establishments. This trust trades on a market with other similar trusts, although the trades are infrequent. Take into account the current real estate market when evaluating this investment.
e. Private equity investment in a joint venture for the development of a new green energy method to produce electricity.
f. Complex foreign currency hedges that were custom-designed by an investment bank for the company, to hedge their exchange rate exposure on overseas transactions.
What level for evaluation would each fall into and what method(s) would you use to determine the fair value of each? How easy or difficult would each be and why? The Nov 16, 2008 Financial Week Article on the Web Links page about Illiquid Bank Assets may help with this question.
3. Find the financial statements of a publicly traded company that has measured assets and/or liabilities at fair value. You will find this information in the footnotes (just open up the document and search the page with either Fair Value or FAS 157 as a key word). What financial ratios (name at least 2) could be affected by the difference between measuring these assets at historic cost vs. fair value? How would this company's ratios differ from the current presentation under fair value than under historic cost? Do the footnotes tell you if there was an active market for valuing the assets-if so, what was the basis for the valuation? If there was no active market, what did they base the valuation on? Does this sound like an appropriate measure of the asset(s) value? What problems could there be with the measure(s) that was used? If you were a banker preparing to loan money to the company, how much difference would this make in your decision? Take risk into account in this decision and not just the difference in value caused by the methods. Include the annual report with your answer and reference the pages in the report where you obtained your information. Prepare any computations on Excel and submit as a separate document (make sure to use the above naming convention for all files).
4. A company's management and its auditors have the same goal in mind-to prepare financial statements that fairly present the financial position of the company under US GAAP (well, at least until we convert to IFRS!) The auditors "opine" on the fair presentation. For example, here is a statement from the independent auditor's report of Mozilla Foundation:
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Mozilla Foundation and Subsidiary as of December 31, 2007 and 2006, and the changes in their net assets and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
When Fair Value cannot be determined by an actively traded market and management judgment must be applied, such as with Level 3 assets, discuss where disagreements might occur between management and the auditors, and why. In other words, what valuation might management may have computed and the impact it would have on the reporting year, vs. the role that the audit firm plays and the liability they assume in providing an unqualified or "clean" opinion-why might they disagree on the inputs and judgment used by management?
5. So now that you have had 2 full weeks to think about Fair Value, where do you stand on the topic? Don't be wishy-washy! Form an opinion and support it with evidence from the work we have done.