Regulation

FASB Adds Fair-Value Fix to 2009 Agenda

The board plans to issue new guidance and require new disclosures this year.
Sarah JohnsonFebruary 19, 2009

The Financial Accounting Standards Board is working on guidance to ease accountants’ confusion over how to measure fair value in illiquid markets.

FASB said that the new guidelines will discuss how to determine whether an asset or liability’s market is active or inactive and whether a transaction should be considered distressed. In addition, the board will discuss how to apply fair value to stakes in alternative investments, such as hedge funds and private equity funds.

Moreover, FASB will call on companies to expand their fair-value disclosures related to how they make estimates. This could mean that companies will need to expand on explanations of their reasoning for moving items among the three measurement levels outlined in FAS 157, which provides a framework for fair-value measurement. Level 3 is designated for assets thinly traded, or not traded at all, and that have a value derived from so-called “unobservable inputs.” It’s this group of measurements that fair-value critics say has caused extreme volatility and massive writedowns in the financial services sector.

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The board announced its plans to complete these new, but expected, projects this year. The application guidance should be available by the end of June, and the new disclosure guidelines will be done in time for year-end reporting, the board said yesterday. “The FASB is immediately embarking on projects that constituents have told us are challenging in the current environment, and which improve disclosures in financial reports,” said board chairman Robert Herz.

The announcement comes after the Securities and Exchange Commission discouraged the lobbying by bankers to suspend mark-to-market accounting in light of the financial crisis. In a congressionally mandated study, the SEC instead supported the existing FASB rules but acknowledged that issuers and auditors “have faced challenges” when applying them during uncertain times, when markets have dried up, making it hard to determine how much a hypothetical buyer would currently pay for a certain asset.

To be sure, FASB and its international counterpart already have issued some guidance in response to criticism that the fair-value rules have aided, or even caused, the economy’s credit problems. For example, last fall FASB issued a hypothetical example for how to estimate the fair value of a collateralized debt obligation security in an inactive market.

However, practitioners were confused over this rushed guidance. And fair-value dissenters still cried foul about the very existence of the fair-value rules, believing that they lead to volatility in financial statements and have a pro-cyclical, downward effect on the markets, particularly for assets whose worth is difficult to value without an active market. In its study released in late December, the SEC disagreed, saying that in fact the majority of financial institutions’ investments were based on observable inputs. The regulator concluded that fair-value-related losses did not a have a “significant” effect on hurting banks’ capital.