Resolving the Issues
Even some of FASB's critics agree, however, that the current system needs improvement, and that fair value can help provide it. "Fair value in general is more relevant than historical cost and can lead to reduced complexity and greater transparency," Barge admits, though he has noted that the use of fair value may also lead to "soft" results that "you can't audit."

For much the same reason, Colleen Cunningham, president and CEO of Financial Executives International (FEI), expressed concern in testimony before Congress last March that "overly theoretical and complex standards can result in financial reporting of questionable accuracy and can create a significant cost burden, with little benefit to investors." In an interview, she explains that her biggest concern is that FASB is pushing ahead with fair-value-based rules without sufficient input from preparers. "Let's resolve the issues" before proceeding, she insists.

Herz concedes that numerous issues surrounding fair value need to be addressed. But important users of financial statements are pressing him to move forward on fair value without delay. As a comment letter that the CFA Institute sent to FASB put it: "All financial decision-making should be based on fair value, the only relevant measurement for assets, liabilities, revenues, and expenses."

Meanwhile, Herz isn't waiting for the conceptual framework to be completed before enacting new rules that embrace fair value. "In the end, we're not going to get everybody agreeing," Herz says. "So we have to make decisions" despite lingering disagreement.

Ironically, one fair-value-based proposal that FASB issued recently may have created an artful means of defusing opposition. The Board's proposal for financial instruments gives preparers of financial reports the choice of using historical cost or fair value in recording the instruments on their balance sheets. That worries some people, who say giving companies a choice of methods will make it harder to compare their results, even when they're in the same industry.

By providing such an option, however, Herz may have, unwittingly or not, come up with an effective means of short-circuiting opponents' attacks. What, after all, can be their gripe about the use of fair value if FASB lets them opt out of such rules? "I think this actually might be a good way for FASB to get things done," says Ciesielski. "If they were going to mandate that all use it, there'd be stalling forever. Offering companies the option will give those that look good under it an incentive to do it — and the others might have to get on the stick."

Critics note that such tactics wouldn't be necessary if there were more demand for the use of fair value from users of financial statements. The CFA Institute's passionate support notwithstanding, FEI's Cunningham contends "there isn't a lot of demand for [fair value] among working analysts." Herz disputes that, noting that FASB's user group, a committee of analysts and investors, has thrown its full support behind fair value. But Cunningham says there may be less to that than meets the eye, since analysts tend to view their ferreting out of such information from footnotes and off-balance-sheet activities as a competitive advantage. Who would need analysts if financial results were as simple and transparent as Herz wants?

The debate is likely to come down to whether the costs involved in applying fair value are worth the benefits. Here again, corporate-finance executives sharply disagree with the CFA Institute. Time Warner's Barge, for one, warns that, "for complex multinational companies like Time Warner, ExxonMobil, or GE, the practicality of providing all of the assumptions may not be cost beneficial."

Dismissing those objections, the CFA Institute's McEnally notes that such disclosure would involve virtually no work that financial managers don't already do for internal purposes. "Managers make assumptions every day for their assets," she says.

Tellingly, FASB's rule for expensing stock-option grants requires just those types of disclosures. And Ciesielski says he expects other new rules embracing fair value to impose similar requirements on management. "The only assurance that investors have that estimated fair values are honest is if the disclosures are robust — and actually exist."

Ronald Fink is a deputy editor of CFO.

The End of Earnings Management?

Although fair-value accounting has been heralded as a cure for earnings management, even its supporters acknowledge that the technique is not immune to manipulation.

In a report last April, accounting expert Jack Ciesielski cited "the boundless opportunities for meeting earnings targets" based on fair-value measurement of just four types of financial instruments—equity securities without trading markets, insurance and reinsurance contracts, warranty obligations and rights, and unconditional purchase obligations. Ciesielski, publisher of The Analyst's Accounting Observer newsletter, also noted in a cover letter accompanying the report: "Fair value was one of the ingredients in the witches' brew that Enron's managers concocted."

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