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Different definitions in London and Connecticut complicate an effort to simplify accounting.
David M. Katz, CFO.com | US
April 1, 2008
The attempt to curb complexity in financial reporting can spawn complexities of its own—especially when it comes to derivatives and their ilk. That's what the Financial Accounting Standards Board is finding as it tries to streamline standards for gauging the value of financial instruments.
On the one hand, FASB is plunging ahead with efforts to push corporations to disclose their use of derivatives more clearly and make the accounting for hedges against risk more timely. In line with those goals, the board wants to push for uniform fair-value reporting.
At the same time, FASB and the International Accounting Standards Board are trying to forge a grand convergence of all accounting regimes into a single, global standard. The effort would seem to jibe nicely with the movement toward clarity.
As it happens, though, the goals of cutting down on complexity and convergence are at loggerheads when it comes to financial instruments. The main reason? U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards measure fair value differently.
As it points out in Reducing Complexity in Reporting Financial Instruments, a comment paper it issued last Friday, IASB's definition, contained in IAS 32, Financial Instruments: Presentation, "refers to an exchange price without specifying that it is the price at which a holder or debtor could sell or transfer its financial instrument. Therefore, that definition could include the price at which a comparable asset could be acquired or a comparable liability could be incurred or settled."
FASB's Statement No. 157, Fair Value Measurements, on the other hand, defines fair value as an exit price: "the price at which an instrument could be sold or transferred in an orderly transaction," according to the invitation to comment.
That sets up a conundrum. While both standard-setters agree on the principle of converging on a single accounting regime based on fair value, the differing definitions of fair value complicate the need to simplify.
Besides the deeper issue of how to resolve the fair-value difference, the divergence in definitions helped create another question for the U.S. standards board: Should it forge on alone in its effort to reduce complexity in the reporting of financial instruments?
To be sure, the staffs of the two standards boards set out to work together on the goal of putting together a single standard covering financial instruments. When they started out in the days before the real estate bubble burst, neither FASB nor IASB had a major project involving financial instruments.
But events took over in the United States, persuading FASB to immediately start working on simplifying hedge accounting immediately. (Turmoil in the derivatives and securitizations market is widely seen as a contributing factor in the current credit crisis.) Now FASB expects to issue an exposure draft in the first half of 2008 of a proposed standard that would amend the hedge accounting rules in FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. Part of the reason that the U.S. board issued its request for comment on financial instrument standards now is to avoid confusing its constituents about the purposes of that document and the coming exposure draft on hedge accounting.
IASB, which seems to be operating in a different time frame, has no such project on hedge accounting. IASB expects to issue a final IFRS on fair value in 2010. For its part, FASB hasn't discussed "what actions, if any, it might take to achieve convergence if the IASB adopts a definition of fair value different from the one in Statement 157."
Meanwhile, in its request for comment, FASB is asking its constituents to comment on a number of potentially complicated issues. How, for instance, should the change in fair values of all financial instruments be divvied up—by separating cash changes from other changes, the fair value of assets from that of liabilities, by the categories of instruments, or in some other way? Where on the income statement should such components be reported?
At the heart of FASB's request for comment, which carries a September 19 deadline for responses, is a more procedural matter: Is there a need for a separate FASB project aimed at simplifying measurement standard for financial instruments? The answer may be more complicated than it seems.