Mulling the Fair-Value, Historic-Cost Choice

Companies shouldn't report each business activity in a mixture of ways, an SEC advisory committee contends.
David KatzAugust 1, 2008

If investors must continue to decipher a puzzling mix of historical-cost and fair-value lingo when they read corporate financials, the Financial Accounting Standards Board should consider requiring companies to be consistent in the kind of measurement they use for each business activity, says FASB chairman Robert Herz.

Speaking at a Securities and Exchange Commission press conference marking the issuance of recommendations by the SEC’s advisory committee on financial reporting, Herz said that if companies continue to report their results using a “mixed attribute” method that blends mark-to-market, historical cost, and other forms of accounting “for the foreseeable future,” FASB should think about requiring them to use a particular method of accounting consistently for each business activity.

Under such a system, companies would depart from current practice and wouldn’t “mix part fair value, part historical cost, or part something else within a particular type of business activity or financial activity,” said Herz, praising the committee’s proposal as “a new thought, very worth our considering.”

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The thought, part of the committee’s first recommendation for cutting down on complexity in financial reporting, is that companies should be required to use just one measurement method for each business activity across all their financial statements. For example, FASB could require companies to value their operating activities according to their historical costs only.

At the press conference, which marked the advisory committee’s presentation of its 184-page final report to the SEC, committee chairman Robert Pozen singled out the proposal for a single measurement method as one of the highlights among the report’s 25 recommendations. “We strongly supported a proposal to differentiate in the income statement what part of earnings were derived from historical cost — what some people might call core earnings — from what part of earnings are derived from unrealized profits, or gains based on fair-value estimates,” Pozen told reporters.

Noting that although the committee wasn’t able “to solve the debate between fair value and historical cost,” said Pozen, “we took the view that we could make the distinction a lot clearer and we could educate investors about the different quality of earnings and the different aspects of earnings.” Very broadly speaking, historical-cost accounting is based on the original price a company pays for an asset, while fair-value reporting focuses on what the company might gain for the asset under current market prices.

The committee did, however, recommend that FASB adopt a go-slow policy in terms of adopting new rules that spread the use of fair value before the standards board comes up with a more-comprehensive approach. “The SEC should recommend that the FASB be judicious in issuing new standards and interpretations that expand the use of fair value in areas where it is not already required,” according to the report.

FASB should hold off on new fair-value rules until it adopts a “measurement framework to systematically assign” measurement methods to different kinds of business activities, according to the committee, which also cautioned that the board should avoid the spread of fair value until regulators come up with plan to educate people on how to use it.

Besides issues of measurement, Pozen thinks the committee’s recommendations on what to do about accounting errors and excessive financial restatements merit special attention by the SEC. “Our position is, we are calling for a stricter rule in terms of more correction of errors and more disclosure about those corrections,” he said at the press conference. “However, the committee takes the position that every correction of an error should not automatically lead to a restatement.”

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