A Stroke-of-Midnight Change to Fair Value

Standard-setters propose last-minute guidance, effective for year-end financials, that an accounting expert predicts will boost the apparent value ...
Sarah JohnsonDecember 29, 2008

Standard-setters have thrown their fair-value critics a bone in the waning days of 2008, a year that will be remembered by accounting professionals as — among other things — the true testing ground for mark-to-market measurements of financial instruments.

Critics believe that fair-value rules have faltered under current market conditions, where financial institutions have struggled to assess their financial assets’ worth against illiquid markets and have had to take mammoth write-downs.

Last week both U.S. and global rule-markers issued proposals that will require companies to provide a new measurement of securities that will be held to maturity or are available for sale, as well as loans and long-term receivables. The guidance is open for public comment through Jan. 15, 2009, under an unusually short time-frame for the standard-setters. If approved, the rules will go into immediate effect, for reporting periods ending after December 2008.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

The Financial Accounting Standards Board wants firms to include in their financial statements a table comparing how their financial assets look under three measurements: the reported carrying amount, fair value, and incurred loss amount.

Despite the additional work that FASB’s new disclosures will put on finance departments, Robert Willens, founder and principal of an eponymous tax publishing and advisory service, calls the proposal “a blessing in disguise.” Once in effect, the disclosures will make some debt securities appear “quite a bit better,” he tells, than when put against their fair-value yardsticks.

FASB’s proposal, through a staff position called FSP FAS 107-a, amends the board’s disclosures for certain financial assets. The changes would allow companies to consider — and highlight for investors — the future cash flows of securities that will be held to maturity and are available for sale. While in the short-term, the creditworthiness of these instruments appear dim, the majority of these assets will likely pay off when they mature, Willens notes.

As a result, firms will look financially healthier under the newly provided “incurred loss amount” column, Willens notes in a newsletter published today. The change could also be interpreted as another example of FASB backing away from what once seemed to be a more rigorous interpretation of its fair-value rules: “It can be argued that these new disclosures have the effect of undermining the fair-value model that has been the subject of so much debate and that has been, in some circles, blamed for prolonging the credit crisis,” Willens writes.

The FSP is one of four short-term projects FASB and the International Accounting Standards Board undertook this month “to improve and simplify current practices for accounting for financial instruments,” according to FASB. The two boards have held three roundtables on the credit crisis, and their conversations largely focused on the role fair-value accounting has played. FASB says the proposal will improve comparability of financial assets that have heretofore been assigned different measurement requirements but have similar economic characteristics.

Criticism against fair value diminished toward the end of this year, after it has become clear that regulators are unlikely to make broad changes. Rather, the Securities and Exchange Commission is leaning on FASB to make minor modifications to existing rules. The SEC is expected to defend fair-value accounting in a congressionally mandated report due this Friday.

In a speech earlier this month, SEC chairman Christopher Cox said investors garner transparency from fair-value measurements; however, “in inactive or illiquid markets, additional guidance would be useful to promote reasonable application of the standards.”