FAS 157 Remains in Action

Fair-value accounting won’t be going anywhere, according to a report to Congress issued by the Securities and Exchange Commission (SEC). 

The SEC on Dec. 30 issued its recommendation against suspending fair value accounting standards after studying their impact, as required by the $700 billion bailout package passed by Congress in October 2008.  Instead of suspending the standards, the SEC recommends improvements to existing practices, including reconsidering the accounting for impairments and the development of additional guidance for determining fair value of investments in inactive markets, including situations where market prices are not readily available.

“The study is the culmination of several months of extensive analysis, public roundtables and consultations with investor groups, accounting firms, banks, insurance companies, think tanks, and academics.  It will be a useful source of information and guidance not only to policymakers in Congress but also to the independent standard-setters as they continue their work on these important issues,” said SEC Chairman Christopher Cox.

The report notes that investors generally believe fair value accounting increases financial reporting transparency and facilitates better investment decision-making.  The authors observed that fair value accounting did not appear to play a meaningful role in the bank failures that occurred in 2008.  Rather, the failures appeared to be the result of growing probable credit losses, concerns about asset quality, and in certain cases, eroding lender and investor confidence.

The SEC made eight recommendations to improve the application of fair value accounting standards, including development of additional guidance and other tools for determining fair value when relevant market information is not available in illiquid or inactive markets.  These include consideration of the need for guidance to assist companies and auditors in addressing how to determine when markets become inactive and whether a transaction or group of transactions are forced or distressed; how the impact of a change in credit risk on the value of an asset or liability should be estimated; when observable market information should be supplemented with and/or reliance placed on unobservable information in the form of management estimates; and how to confirm that assumptions utilized are those that would be used by market participants and not just a specific entity.

Other recommendations include:

• Enhancement of existing disclosure and presentation requirements related to the effect of fair value in the financial statements.
• Educational efforts, including those to reinforce the need for management judgment in the determination of fair value estimates.
• Examination by the FASB of the impact of liquidity in the measurement of fair value, including whether additional application and/or disclosure guidance is warranted.
• Assessment by the FASB of whether the incorporation of credit risk in the measurement of liabilities provides useful information to investors, including whether sufficient transparency is provided currently in practice.

The report also called upon FASB to reassess current impairment accounting models for financial instruments, including consideration of narrowing the number of models under U.S. GAAP.  The SEC found that, under existing accounting requirements, information about impairments is calculated, recognized and reported on basis that often differs by asset type.  Among the recommended improvements are reducing the number of models utilized for determining and reporting impairments, considering whether the utility of information available to investors would be improved by providing additional information about whether current declines in value are consistent with management expectations of the underlying credit quality, and reconsidering current restrictions on the ability to record increases in value.

The SEC’s findings did not come as a surprise to the industry.  Cox had foreshadowed the Commission’s position on FAS 157 at a December conference of the American Institute of Certified Public Accountants (AICPA), where he noted that the call to set aside normal approaches to standard setting undermines the credibility of the process and investor confidence in it.

“There are those who say that independent standard setting is important, and who will agree that private sector standard setting is preferable to ensure that the process is not detached from reality, but who nonetheless say that while these things are true in ordinary times, these are not ordinary times.  Therefore, they argue for setting aside the normal approach to standard setting… should be set aside and replaced with a quick fix, whether the standard setters agree or not,” he told the group.  “This view gives short shrift not only to the principle of independence, but also to the credibility of the standard-setting process and investor confidence in it.  The truth is that the value of independent standard setting is greatest when the going gets tough.  The more serious the stresses on the market, the more important it is to maintain investor confidence.”
 

Also in this month's issue:

CFOs Put Tech Investment to Improve Efficiencies at Top of New Year's Resolution List

Nana Asante - Kforce Consultant of the Quarter