More Guidance Expected on Fair Value

FASB Chairman Bob Herz says he’s interested in exploring additional disclosure rules that would make valuation techniques more transparent to users of financial statements. Herz and the FASB Board are awaiting the findings of the SEC’s congressionally-mandated fair value accounting study—due Jan. 2—which is expected to call for additional fair value measurement guidance for auditors and companies. Herz predicted no radical changes in the near term for the fair value accounting standard Statement no. 157.

“The concept of fair value, which was intended to help bring transparency, was scorned by some as a villain, exacerbating the (economic) turmoil, and heralded by others as a savior in revealing the problems on a timely basis,” Herz said Monday during a speech at the AICPA’s 2008 National Conference on Current SEC and PCAOB Developments held in Washington.

SEC Chairman Christopher Cox and other SEC officials who spoke at the conference Monday hinted that the regulator’s preliminary findings on fair value accounting highlight the need to develop robust best practice guidance, particularly in the area of fair value measurement of assets in illiquid markets. (Read Cox’s speech here.)

The scope of the SEC study, which was mandated by Congress as part of the economic rescue package, includes the effect of fair value accounting on the balance sheets of financial institutions and on the bank failures of 2008, whether Statement no. 157 can and should be modified and potential alternative approaches to the provisions of the standard. Cox pointed out that only a minor portion of most financial institution balance sheets are marked to market.

“Although our study is ongoing, the input we have received to date makes clear that there is room for improvement in the current accounting and reporting framework,” said James Kroeker, the SEC deputy chief accountant who is leading the mark-to-market study. “For example, there appears to be general agreement that investors could be better served by a more streamlined model for addressing impairments of assets that are not held for trading purposes. Most agree that the current framework for impairment can be challenging to apply, and the utility of information to investors can be improved.”

Investors who have offered feedback to the SEC during the study have said that fair value has provided meaningful information and a level of transparency about companies that is needed in the current economy. “However, where inactive or illiquid markets exist for a given instrument,” Kroeker added, “we have heard from many that additional training and tools would be helpful as preparers and auditors address front-line issues.”

AICPA Chairman Ernie Almonte, also speaking at the conference, said that while the AICPA supports FASB issuing additional fair value measurement guidance “we also support FAS 157 and the principles of fair value accounting, and do not think those principles should be suspended.” Almonte added, “The current crisis was not caused by accounting standards or their application, but rather by a complex combination of events. Any effort that would suspend transparency, and instead obscure economic realities, would not seem to be a cure for our financial woes and could actually deepen the crisis of confidence.”

The signals sent Monday by Cox, Kroeker and Chief Accountant Conrad Hewitt were met with cautious optimism from Jack Ciesielski, chairman of the conference. Ciesielski, a former member of FASB’s Emerging Issues Task Force and current member of the Investors Technical Advisory Committee, welcomed comments from the SEC officials about the benefits of fair value accounting to investors. “They’re not caving in to the banking lobby,” Ciesielski said.

Some financial institutions have said that mark-to-market rules hurt their balance sheets and worsened the credit crunch by forcing them to write down certain securities. Others, including Federal Reserve Chairman Ben Bernanke, have said that suspending mark-to-market accounting would deprive investors of needed information.

Cox devoted a portion of his 30-minute speech to stressing the need for independence in accounting standards setting. “Accounting standards aren’t just another financial rudder to be pulled when the economic ship drifts in the wrong direction,” Cox said. “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.”

“None of this is to say that standard-setters can or should turn a blind eye to the events in the world around us,” Cox said. “Standards must keep pace with the real world to stay relevant.”

The SEC held two round tables and received more than 150 comment letters on fair value in recent weeks. Separately, FASB and the IASB have held round tables in London, Tokyo and Norwalk, Conn., on financial reporting issues, such as mark-to-market accounting, highlighted by the financial crisis. FASB is weighing input from the meetings and considering potential action both in the short term and long term, Herz said.

Mark Olson, chairman of the PCAOB, named fair value measurement and other than temporary impairment, along with going concern considerations, as areas of audit risk PCAOB is hearing about from auditors and issuers. The application of Statement no. 157 will be a critical issue for audits of 2008 financial statements, Olson told conference attendees. The PCAOB’s inspections in the coming year will review auditors’ compliance with existing audit guidance as auditors evaluate their clients’ accounting in light of the FASB standard and any applicable guidance, Olson said.