The Global Fair-Value Fight

The International Accounting Standards Board hunkers down into defensive mode as politicians push to suspend mark-to-market accounting.
Sarah JohnsonOctober 6, 2008

The political stampede against fair-value accounting is intensifying outside the United States as much as inside it.

The uproar has U.S. and global standard-setters scrambling to come up with new guidance, examples, and meetings to refute the notion that their guidelines for marking assets and liabilities to market have created the credit crisis. It has also prompted the International Accounting Standards Board to revisit its fair-value rules to make sure they don’t stray too far from U.S. generally accepted accounting principles.

“The IASB is closely monitoring developments in the United States and other jurisdictions to avoid unnecessary inconsistencies in accounting treatments under [international financial reporting standards] and U.S. generally accepted accounting principles,” the board said in a statement released on Friday.

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IASB and FASB have been working to meld their standards for the better half of this decade. Much of that work has seemed to tilt toward international financial reporting standards, since the majority of countries have adopted part or all of IFRS as their own. In fact, before the credit crunch ballooned to a meltdown on Wall Street and affected the borrowing abilities of nonfinancial companies, the United States was poised to also adopt the international rules. In August, the Securities and Exchange Commission voted to release a timeline for moving all U.S. publicly traded companies to IFRS, starting in 2010. It hasn’t published the roadmap yet, however.

To be sure, the SEC has been involved in other matters, including addressing the criticism of fair value. Last week, as lawmakers negotiated the terms of how the federal government would offload distressed assets from financial institutions’ books, the SEC and the Financial Accounting Standards Board offered clarification on how to apply the controversial fair-value standard that has been getting so much attention this year. In addition, on Friday, FASB’s staff proposed an amendment to FAS 157, that would spell out how to determining the fair value of financial assets in inactive markets. (The deadline for comments on that proposal is Thursday.)

Issued in 2006, FAS 157 tells companies to use a three-step hierarchy, with the levels based on how much market information is available, when they apply fair value to their securities. Last week’s SEC/FASB guidance tried to assure companies that they can use their internal models and assumptions to make their valuations for inactive markets. In other words, companies were given the go-ahead to use more judgment, an allowance that advocates of more principles-based accounting say is inherent in IASB’s rules.

The SEC/FASB statement was not enough to assuage the mark-to-market critics, however. Despite pleas from auditors, Congress still barreled ahead with the language in the bailout legislation that confirms that the SEC that has the power to suspend mark-to-market accounting. The law also calls on the regulator to conduct a study looking into the effect fair value has had on the marketplace.

Moreover, the guidance from the SEC and FASB may have inadvertently made European companies — in a financial crisis of their own — nervous about their global competition.

French president Nicolas Sarkozy has reportedly been calling for the suspension of fair value in recent weeks and had been expected to address the issue during a summit with the leaders of Germany, Britain, and Italy this past weekend. In a 19-point document for fixing the economy released soon after, the leaders’ directive toward accounting standard-setters addressed Europe’s ability to compete globally. “We will ensure that European financial institutions are not disadvantaged vis-à-vis their international competitors in terms of accounting rules and of their interpretation,” the leaders proclaimed in a joint statement.

They want European financial institutions to have the same ability as U.S. GAAP users to reclassify some assets in their trading book as “held to maturity.” While noting that GAAP gives this allowance in rare instances, IASB says it is considering the concept.

In addition, IASB plans to discuss next week whether the board should eliminate any differences between IAS 39 — its measurement standard for financial instruments — and FAS 157.

“The IASB will assess the suitability of adopting the U.S. GAAP approach and whether adapting IFRSs will provide relevant information to users of financial statements,” the board said. “The IASB will also consider the potential need to counteract abuse resulting from the ability to reclassify financial instruments and related areas of accounting to ensure consistency between practice in the United States and in those jurisdictions using IFRSs.”

Although the practice isn’t new, fair-value accounting has received a beating lately. The standards have been blamed for creating a pro-cyclical, downward effect on the economy. On the other hand, the proponents of fair value say that the standards merely help companies show how much their assets are truly worth at this very moment — and that the downfall of the financial institutions that took major write-downs after applying fair value was actually a delay in showing investors how much these banks were truly worth and were representative of a move toward a down market.

“If we are to have faith in accounting standards, fair value should be applied when the going is hard, as well as when it is fair,” said Peter Montagnon, director of investment affairs for the Association of British Insurers before Saturday’s summit. “Long-term confidence would be hurt by abandoning this concept in response to short-term pressures.”