FASB to Review Fair Value Accounting; American Bankers Assoc. Urges Use of IASB Formula

Keying on a seminal SEC report and its own internal evaluation, FASB will conduct an intensive review of fair value accounting as part of an effort to improve the guidance used to determine fair values and the disclosure of fair value estimates. The initiative is in response to recommendations contained in the recent SEC report on mark-to-market accounting, as well as on input provided by FASB’s Valuation Resource Group.

The SEC expressed continued support for fair value accounting in its study, but recommended improvements in the guidance on the application of fair value principles. FASB Chair Robert Herz said that the Board agrees with the SEC that more application guidance is needed to determine fair values in current market conditions. Moreover, investors have asked for more disclosure about fair value estimates. FASB intends to ultimately provide guidance that will improve disclosures in financial reports.

The initiative is two-pronged. The project on application guidance will address determining when a market for an asset or a liability is active or inactive; determining when a transaction is distressed, and applying fair value to interests in alternative investments, such as hedge funds and private equity funds. The project on improving disclosures about fair value measurements will consider requiring additional disclosures on such matters as sensitivities of measurements to key inputs and transfers of items between the fair value measurement levels. The FASB anticipates completing the project on application guidance by the end of the second quarter of 2009, and the project on improving disclosures in time for year-end financial reporting.

While praising FASB’s initiative, the American Bankers Association is concerned that critical problems regarding the issue of other than temporary impairment are being overlooked. The ABA is disappointed that FASB has ignored the need to directly repair the problems regarding other than temporary impairment in the planned projects. The ABA noted that the recent SEC study recommended that FASB re-examine such impairment expeditiously.

In the ABA’s view, the international model for other than temporary impairment used by the IASB, which is based on credit impairment rather than fair value, represents a superior approach to US GAAP. As a result, U.S. companies are needlessly required to report higher paper losses than their international competitors. The trigger for determining such impairment in the U.S should be based on actual credit impairment, said the ABA, and the accompanying mark down should be made for the amount of that credit impairment as opposed to marking it to market. Recoveries of impairment should be reversed through earnings, as they are for international accounting.

The FASB and the IASB have simultaneously proposed changes to their standards for disclosure of fair value of financial instruments. The IASB proposed amendments to IFRS 7 that would require an entity to state in tabular form the fair value, amortized cost and amount at which the investments are actually carried in the financial statements. The amendments would also require an entity to disclose the effect on profit or loss and equity if all debt instruments had been accounted for at fair value or at amortized cost.

IASB Chair David Tweedie praised the joint effort as a swift reaction to the accounting issues that have arisen as a result of the financial crisis. Enhanced disclosures for investments in debt instruments will provide greater transparency and help to regain investor confidence in the financial markets, he said. The fact that FASB also issued similar proposals shows a commitment to seek global solutions to a global crisis.

For its part, FASB proposed changes to FAS 107, Disclosures about Fair Value of Financial Instruments, to increase the comparability of information about financial assets that have related economic characteristics but have different measurement attributes. The proposed staff position, 107-a, would apply to debt securities classified as held-to-maturity and available-for-sale and loans and long-term receivables that are not measured at fair value with changes in the fair value recognized through earnings.

The disclosures would be required include a comparison of common measurement attributes for financial assets and the pro forma income from continuing operations (before taxes) under the different measurement scenarios. These disclosures were developed jointly with the IASB, which, as noted above, issued an exposure draft proposing a similar set of disclosures.