Statement of Financial Accounting Standards No. 157, "Fair Value Measurement" (FAS 157) applies whenever other standards require assets or liabilities to be measured at fair value. Whereas the new standard explicitly states that it is not intended to expand fair value usage in any new instances (not already covered by previous standards), it does provide guidelines for how an entity derives fair (market) value for assets or liabilities.

FAS 157 defines fair value as "the 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." Up to the issuance of FAS 157, fair value definitions (and application methods) were different among pronouncements. The new standard requires that assets or liabilities be measured at a market-based price, not an 'entity-specific' measurement. FAS 157 creates a three level hierarchy to be used to measure fair value.

Level 1 items are based on direct quoted prices from active markets, such as stocks traded on the New York Stock Exchange.

Level 2 items, by contrast, do not have such an observable market price (either directly or indirectly); however, they often do have quoted prices for similar assets/liabilities, or other observable "inputs" such as interest rates, credit risks, default rates, to name but a few.

Level 3 items were formerly based on an entity's assumptions about market value. In other words, these items were previously estimated by management without any clear market basis. Examples of such 'unobservable inputs' include cash flow forecasts, revenue/earnings growth information, etc. With the adoption of FAS 157, the investor will have more insight into the methodology surrounding these measurements in the form of expanded disclosures that will detail an entity's valuation techniques used to measure fair value.

The current economic crisis may prove tricky for valuing such items. For instance, an asset valued under Level 3 of the hierarchy may have to be written down based on the declining market and resultant drop in values of similar assets.

Note: The recent "Bailout Bill" provided some foreshadowing of changes to the standard. Section 132 of the bill states that "the Securities and Exchange Commission shall have the authority under the securities laws to suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board for any issuer if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors". The bill also notes that the SEC shall complete a report regarding FAS 157 effects on companies and its overall impact on the economy, due 90 days after passage of the bill.

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