SEC Releases Fair Value Findings

The SEC, in a report mandated by Congress, supports the continued use of fair value accounting standards while also making eight recommendations to improve application of the standards. The suggested changes include reconsidering accounting for impairments of financial instruments and developing more guidance for determining the fair value of investments in inactive markets.

The SEC recommends against the suspension of fair value accounting standards and finds that investors believe fair value accounting generally increases financial reporting transparency and facilitates better investment decision making. The 211-page report by the SEC’s Office of the Chief Accountant and the Division of Corporation Finance finds that mark-to-market accounting did not appear “to play a meaningful role in bank failures occurring during 2008.” Rather, the report says, the bank failures “appeared to be the result of growing probable credit losses, concerns about asset quality, and, in certain cases, eroding lender and investor confidence.”

Congress mandated the study as part of the $700 billion economic rescue package passed in October. The SEC was directed to examine the effect of mark-to-market accounting on the balance sheets of financial institutions and on the bank failures of 2008. The scope of the study also included determining whether FASB Statement no. 157, Fair Value Measurements, should be modified and what, if any, potential alternative approaches to the provisions of the standard should be considered.

The improvements outlined in the SEC report include:

• Development of additional guidance and tools for determining fair value when relevant market information is unavailable in illiquid or inactive markets, including consideration of the need for guidance to assist companies and auditors.
• 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 FASB of the impact of liquidity in the measurement of fair value, including whether additional application and/or disclosure guidance is warranted.
• Assessment by 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 recommends that FASB reassess impairment accounting models for financial instruments, including consideration of narrowing the number of models under U.S. GAAP. The report finds that under existing accounting requirements, information about impairments is calculated, recognized and reported on bases that often differ by asset type.

The report recommends improvements, including: reducing the number of models used for determining and reporting impairments; considering whether the usefulness 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 when market prices recover.