Financial Accounting Standard 157 (FAS 157)

What Is Financial Accounting Standard 157 (FAS 157)?

Financial Accounting Standard 157 (FAS 157) is the Financial Accounting Standards Board (FASB's) disputable fair value accounting standard, which was presented in 2006, in the approach the global financial crisis, and is currently known as Accounting Standards Code Topic 820.

Understanding Financial Accounting Standard 157

Financial Accounting Standard 157 (FAS 157) laid out a single predictable system for assessing fair value without even a trace of quoted prices, based on the thought of an "leave price" and a 3-level hierarchy to mirror the level of judgment engaged with assessing fair values, going from market-based prices to illiquid Level 3 assets where no discernible market exists and valuations must be based on proprietary internal data, similar to the latest funding round.

Not long after the FAS 157 was presented, the subprime crisis put its subjective measures of fair value to the test. Equity market volatility and illiquid markets played devastation with fair value accounting models and forced private equity firms to mark down the value of assets on their balance sheets - causing a destructive feedback loop of asset compose downs that compromised the solvency of the banking system. Since unstable markets and fair value accounting can give a deceptive image of the true state of an organization's finances, the FASB has since given companies more slack while esteeming illiquid assets.

Different Considerations

Before 2008, valuations were based on historical cost accounting as opposed to liquid mark to market gauges, since it was widely viewed as more conservative and solid. Be that as it may, the private equity industry campaigned for change, since utilizing historical cost doesn't take into account simple likeness among companies, and they wanted to standardize the fair valuation of illiquid assets.

Nonetheless, the limits of imagination valuation maths has been made apparent in 2016, when VC-backed "unicorn" startup Dropbox was marked down half overnight by mutual fund T. Rowe Price, to $8 a share, since it thought $10 billion valuations was irrational. At the point when Dropbox drifted in March 2018, its shares opened at $29 per share, and it's market valuation moved toward $13 billion the day after the IPO.

FASB Levels of Assets

The FASB 157 categories for asset valuation were given the codes Level 1, Level 2 and Level 3. Each level is recognized by how effectively assets can be accurately valued, with Level 1 assets being the most straightforward.

Level 1

Level 1 assets are those valued by promptly discernible market prices. These assets can be marked to market and incorporate Treasury Bills, marketable securities, foreign currencies, and gold bullion.

Level 2

These assets and liabilities don't have normal market pricing, yet can be given a fair value based on quoted prices in latent markets, or models which have discernible inputs, for example, interest rates, default rates, and yield curves. A interest rate swap is an illustration of a Level 2 asset.

Level 3

Level 3 is the most un-marked to market of the categories, with asset values based on models and inconspicuous inputs — suppositions from market participants are utilized while pricing the asset or liability, given there is no promptly accessible market data on them. Level 3 assets are not actively traded, and their values must be estimated utilizing a combination of complex market prices, mathematical models and subjective presumptions.

Instances of Level 3 assets incorporate mortgage-backed securities (MBS), private equity shares, complex derivatives, foreign stocks, and distressed debt. The most common way of assessing the value of Level 3 assets is known as mark to the board.

Features

• The FASB 157 categories for asset valuation were given the codes Level 1, Level 2 and Level 3. Each level is recognized by how effectively assets can be accurately valued, with Level 1 assets being the least demanding.
• In 2006, the U.S. Financial Accounting Standards Board (FASB) confirmed how companies were required to mark their assets to market through the accounting standard known as FASB 157 (No. 157, Fair Value Measurements).
• Presently named Accounting Standards Code Topic 820, FASB 157 presented a classification system which plans to carry clearness to the balance sheet assets of corporations.