DEFINITION of 'Financial Accounting Standard 157 (FAS 157)'

Financial Accounting Standard 157 (FAS 157) is the Financial Accounting Standards Board (FASB)’s controversial fair value accounting standard, which was introduced in 2006, in the run up to the global financial crisis, and is now known as Accounting Standards Code Topic 820.

BREAKING DOWN 'Financial Accounting Standard 157 (FAS 157)'

Financial Accounting Standard 157 (FAS 157) established a single consistent framework for estimating fair value in the absence of quoted prices, based on the notion of an “exit price” and a 3-level hierarchy to reflect the level of judgment involved in estimating fair values, ranging from market-based prices to illiquid Level 3 assets where no observable market exists and valuations have to be based on proprietary internal information, like the most recent funding round.

Shortly after the FAS 157 was introduced, the subprime crisis put its subjective measures of fair value to the test. Equity market volatility and illiquid markets played havoc 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 write-downs that threatened the solvency of the banking system. Because volatile markets and fair value accounting can give a misleading picture of the true state of a company's finances, the FASB has since given companies more leeway when valuing illiquid assets.

Before 2008, valuations were based on historical cost accounting rather than fluid mark to market estimates, because it was widely considered to be more conservative and reliable. But the private equity industry lobbied for change, because using historical cost does not allow for easy comparability between companies, and they wanted to standardize the fair valuation of illiquid assets.

However, the limits of fantasy valuation maths has been made apparent in 2016, when VC-backed “unicorn” startup Dropbox was marked down 50% overnight by mutual fund T. Rowe Price, to $8 a share, because it thought $10 billion valuation was irrational. When Dropbox floated in March 2018, its shares opened at $29 per share, and its market valuation climbed toward $13 billion the day after the IPO.

RELATED TERMS
  1. Level 3 Assets

    Level 3 assets are assets whose fair value cannot be determined ...
  2. Accounting Standard

    An accounting standard is a common set of principles, standards ...
  3. Exposure Draft

    An exposure draft is a document published by the Financial Accounting ...
  4. Level 2 Assets

    Level 2 assets are assets that do not have regular market pricing, ...
  5. Accounting Interpretation

    Accounting interpretation is a statement, issued by accounting ...
  6. Fair Trade Price

    Fair trade price is the minimum price paid for certain agricultural ...
Related Articles
  1. Investing

    Investment Value Vs. Fair Market Value: How They Differ

    Learn about the differences between an asset's investment value and its fair market value, including why many think fair market value is unrealistic.
  2. Managing Wealth

    When Introducing Illiquidity to Your Portfolio Makes Sense

    Find out when you should consider adding illiquid investments to your portfolio, such as real estate or locked-up investment funds.
  3. Investing

    Mark-To-Market Mayhem

    Did this accounting convention contribute to the credit crisis of 2008? Find out here.
  4. Investing

    Financial History: The Rise of Modern Accounting

    How government regulation and the modern accounting profession grew hand-in-hand.
  5. Small Business

    Is the Private Equity Bubble Still Expanding? (GS)

    Learn about the factors influencing valuations in the private equity market. Find out if there is a private tech bubble and if it is growing in 2016.
  6. Investing

    Methods used in valuing private companies

    There are a few methods for calculating the valuation of a private company. By using financial information from peer groups, we can estimate the valuation of a target firm.
  7. Investing

    Relative Valuation: Using Stocks To Value Other Stocks

    This effective approach will help you understand which stocks you should be investing in.
  8. Investing

    6 IPO Market Trends to Watch in 2016

    Find out more about the outlook for the initial public offering (IPO) market in 2016. Is it expected to improve or will it be more of the same?
RELATED FAQS
  1. How is market to market accounting different than historical cost accounting?

    Learn about historical cost accounting and mark to market accounting, the difference between and the limitations of the two ... Read Answer >>
  2. How do investors and lenders benefit from financial accounting?

    Read about the benefits of financial accounting, including access to information and transparency between companies and their ... Read Answer >>
  3. How does financial accounting help decision making?

    Read a brief overview of some areas where financial accounting helps in decision making for investors, lending institutions ... Read Answer >>
  4. How fair value is calculated in futures market?

    Learn how the fair value for futures stock index contracts is calculated, and understand how differences between those numbers ... Read Answer >>
  5. What are the differences between a change in accounting principle and a change in ...

    Learn how to differentiate between a change in accounting principle and a change in accounting estimate and how accountants ... Read Answer >>
  6. What are the objectives of financial accounting?

    Learn about the principle objectives of financial accounting, including the furnishing of the financial statements for those ... Read Answer >>
Trading Center