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In the next quarterly filing, companies should include new disclosures for valuations of assets and liabilities marked against nonexistent markets, according to commission guidance.
Sarah Johnson, CFO.com | US
March 31, 2008
The Securities and Exchange Commission has sent 30 letters to CFOs, offering guidance for use of the new fair-value accounting standard that took effect January 1. For one thing, the regulator will expect companies to explain the reasoning behind their estimates of asset and liability values based on "unobservable" market data.
The SEC expects the explanations to start being included in the next go-round of quarterly filings, due in May.
FAS 157, issued last year by the Financial Accounting Standards Board, provides the framework for marking value estimates to market, rather than to historical cost. FASB gave companies three levels for measurements, ranging from an existing market to the so-called Level 3 category, for which they must develop estimates based on the value that they believe a hypothetical third party would place on an untraded asset.
The new SEC letters guide companies on how they should justify the use of Level 3 estimates. Only after determining that actual market prices or related observable data is unavailable may companies use the third level of measurement, which requires more judgment on the part of management. If those unobservable estimates are deemed material, then companies should explain in the Management's Discussion & Analysis section of the financial statement how they were determined. CFOs should also show "how the resulting fair value of your assets and liabilities and possible changes to those values, impacted or could impact your results of operations, liquidity, and capital resources," the SEC says.
This additional information should include the amount of Level 3 assets and liabilities, and the reason why any of those items can no longer be measured against observable inputs. Plus, companies need to explain why any material fair values changed and share the nature and type of assets underlying any asset-backed securities.
The commission also asks that companies describe their valuation techniques and models and how they're validated. In addition, future MD&As could include a range of values around the derived estimates to show how the numbers could change. These ranges would show investors how "sensitive" fair value estimates are to a company's use of unobservable inputs, the SEC explains.