By James Hamilton, J.D., LL.M.
While acknowledging concerns about volatility, the IASB said that fair value is the only measure appropriate for all types of financial instruments as it embarks on a major revision of IAS 39, the standard for measuring the value of financial instruments. The overall goal is to reduce the current complexity by using a single measurement method for all types of financial instruments. In the view of IASB Chair Sir David Tweedie, IAS 39 is far too complex; and the Board is determined to simplify and improve it by creating a principle-based standard. In addition, the Board is coordinating its initiative with FASB as part of the overall framework to converge accounting standards. In this spirit, the Board’s proposal will be considered for publication by FASB for comment by its constituents
IASB and FASB standards for fair value measurement are different. The FASB has issued SFAS 157, which establishes general principles for determining the fair value of all types of assets and liabilities. It defines fair value as an exit price and addresses many but not all measurement issues specific to financial instruments. The IASB’s requirements for the fair value measurement of financial instruments are in IAS 39. The IASB published SFAS 157 as a discussion paper in November 2006 and has begun deliberating on the comments received. The boards will need to make decisions about some measurement issues related specifically to financial instruments as part of the broader convergence process.
While the long-term standard will be a general fair value measurement, the Board set forth some intermediate approaches that can help improve and simplify measurement requirements in the short run. One suggestion is to reduce the number of categories of financial assets and financial
liabilities. Another option is to replace the existing requirements with a fair value measurement principle with some optional exceptions and/or simplify hedge accounting.
Regarding hedge accounting, two alternatives are suggested. The first is to eliminate all hedge accounting; and the second is to maintain but simplify the existing fair value and cash flow
hedge accounting requirements, particularly those relating to partial hedges and effectiveness testing.
Obviously, the definition of fair value is crucial. The IASB has an ongoing project to establish general principles in determining fair value. For present purposes, fair value will be deemed to represent a current value that is, in many situations, an exit value.
The proposal divides financial instruments into two categories. The first is financial instruments with highly variable future cash flows, which are most derivatives. Fair value is the only measurement for derivatives, the Board explained, since an accreted cost measurement is not possible because it requires a fixed amount and date to accrete to and derivatives do not have fixed payment amounts or dates.
The second category contains financial instruments with fixed or slightly variable future cash flows. Compared with cost-based measures, the fair value of these financial assets better reflects the price of the asset that would be received at the measurement date. Such information is generally useful. There are often events and circumstances beyond management’s control that create a need to sell. Therefore, even if management has no plans to sell an asset, it is useful for users of financial statements to know the potential effects of such events and transactions.
In addition, fair value is a better measure for use in assessing the effect on cash flow prospects of credit risk for financial assets because it provides both information about anticipated future losses and about improvements in credit risk since origination or acquisition.
The IASB’s definition of fair value for financial instruments in IAS 32 is similar to that in SFAS 157. However, there are some differences. Those differences must be resolved if the two boards are to issue a common standard requiring the fair value measurement of financial instruments.
To that end, in November 2006 the IASB published a discussion paper on fair value measurements that used SFAS 157 as the starting point for its deliberations. The IASB has recently started its redeliberations.
In the IASB’s view, both IFRSs and US GAAP could be simplified if a principle or definition could describe items in a standard on financial instruments in a simple and understandable way.
The tentative decision of the IASB and FASB is to use a definition of a financial instrument to set the initial scope.