The year 1494 marked the beginning of the accounting history when Luca Pacioli, the accounting father, published in Italy his book Summa de Arithmetica. In this book the double entry bookkeeping was written and printed for the first time in history.

Since that date and for more than 500 years, the accounting profession is using the historical cost as the basic model for accounting measurement to the extent that some accountants had believed that nothing new could be added or contributed to the accounting profession.

Recently, the Financial Accounting Standards Board (FASB) starts to move away from the historical-cost model to the fair-value model. On September 2006, the FASB issued the standard No. 157 "Fair Value Measurements" and presented a comprehensive conceptual framework for measuring the fair value with an acceptable level of reliability.

The standard No. 157 defines the fair value as follows:

"Fair value is 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"

Fair Value Measurement

The standard No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.

The standard presents the following three approaches for measuring the fair value:

a) Market Approach:

The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

b) Income Approach:

The income approach uses valuation techniques to convert future amounts (for example, cash flow or earnings) to single present amount (discounted).

c) Cost Approach:

The cost approach is based on the amount currently would be required to replace the service capacity of an asset (often referred to as current replacement cost). The standard No. 157 establishes a hierarchy of fair value measurements for financial disclosure. The hierarchy is intended to convey information about the nature of the inputs (the assumptions, not the valuation techniques) used in creating the reported fair values.

• Level 1 inputs are "quoted prices (unadjusted) in active markets for identical assets or liabilities."
• Level 2 inputs include a) quoted prices for similar assets and liabilities in active markets. b) quoted price for identical or similar assets or liabilities in markets that are not active. c) inputs other than quoted prices that are observable for the asset or liability (for example, interest rate, volatility, and credit risk).
• Level 3 inputs are "unobservable inputs". Unobservable inputs shall be developed based on the best information available in the circumstances, which might include the reporting entity's own data. In developing unobservable inputs, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions. However, the reporting entity shall not ignore information about market participant assumptions that is reasonably available without undue cost and effort. Therefore, the reporting entity's own data used to develop unobservable inputs shall be adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use different assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets (level 1) and the lowest priority to unobservable input (level 3).

The standard No. 157 incorporates and integrates with the other FASB standards that require the use of the fair value, examples of these standards are:

The standard No. 141 "Business Combination" requires that intangible assets acquired in a business combination to be initially assigned an amount based on their fair value.

The standard No. 142 "Goodwill and Other Intangible Assets" states that an intangible asset that is not subject to amortization should be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of an intangible asset exceeds its fair value, an impairment loss should be recognized in an amount equal to that excess.

The standard No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" uses fair value measurement to assess whether fixed assets are permanently impaired.

The standard No. 159 "The Fair Value Option for Financial Assets and Financial Liabilities" allows the use of the fair value measurement for eligible items at specified dates. Any unrealized gain or loss on items for which the fair value option has been elected should be recognized in the current earnings.

In addition to these accounting standards, the Auditing Standards Board "ASB" issued the Statement on Auditing Standard "SAS" No. 101 "Auditing Fair Value Measurement and Disclosures" requiring the auditor to obtain sufficient competent audit evidence to provide reasonable assurance that fair value measurements and disclosures are in conformity with GAAP.

This strong fair-value storm has arrived to governmental accounting when the Governmental Accounting Standards Board "GASB" issued the standard No. 42 "Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries" requiring that the impaired capital assets that will no longer be used by the government should be reported at the lower of carrying value or fair value.

Also, on March 2007, the GASB issued the Exposure Draft "Land and Other Real Estate Held as Investments by Endowments" and required that land and other real estate held as investments by endowments to be reported at fair value at the reporting date. Changes in fair value during the period should be reported as investment income.

In this Exposure Draft, the GASB expressed its opinion about the fair value and stated: "Historical cost provides information on investment results only in the year the investments are sold. The board believes that changes in fair value should be included as a component of net investment income in the year they occur. They are as relevant as other earnings on investments, such as dividends and interest, to assessments of investment management and performance and the financial position of the fund".

In this Exposure Draft and the standard No. 42, the GASB requires the use of fair value without providing valid and reliable measurement techniques. Until the GASB issues its own conceptual framework for measuring the fair value, the government accountants can use the FASB standard No. 157 to estimate the fair value with an acceptable level of reliability.

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