On Feb. 5, a FASB advisory group - discussing the SEC’s recommendations in its Dec. 30 report to Congress on mark to market accounting - agreed that further guidance from FASB would be helpful in determining fair value of financial assets in distressed markets.
Don Charles, a partner with Ernst and Young and member of FASB’s Valuation Resource Group (VRG) presented the VRG’s general consensuses reached earlier in the day (during the nonpublic portion of the VRG meeting, followed by the two hour public portion being webcast at www.fasb.org.) as recommending FASB provide further guidance on:
- active vs. inactive (transactions, markets), perhaps by providing a discussion about factors identified in IASB Expert Advisory Panel paper issued last year; possibly some additional factors to consider, or examples, including, e.g. amount of time involved in sale process, amount of time assumed involved in sale process; ability to execute; probability you could execute at [a particular] price
- practical, direct linkage to what’s happening in the marketplace, around what’s active and inactive, including some insight into transition between active and inactive
- distressed markets – besides the 4 factors in FAS 157 for determining distressed market; the real question dealing with- when does distressed market become distressed transactions, particularly relevant discussion around secondary markets; FAS 157’s 4 factors distill down, in essence, to time and intent – but difficult for auditors to obtain evidence as to time and intent; liquidity and credit; there was consensus [among VRG] that segregating elements of value between liquidity and credit would be very complicated and costly, (therefore) some caution … rather than complication of separating, possibly think about presentation, location, geography.
The VRG also recommends, in the longer-term, said Charles, “some research or study around what end-users are really looking for” with respect to potentially separating information on liquidity and credit.
Discussion of Impact of Liquidity vs. Credit Impairment
FASB Chairman Robert Herz told the VRG, “Some of the people who have asked us to do something on liquidity- not the SEC – (have used) code words, like ‘can we factor out liquidity on some things that are not liquid.’”
Charles responded, “From an accounting perspective, if a decision were [made] to factor out liquidity, it might be difficult with some assets to take it out, [for] others it would be relatively straightforward.”
There was also some discussion about ‘bifurcation’ and whether unrealized changes in fair value should be shown in Other Comprehensive Income (OCI) vs. flowing through the income statement.
Noting that an earlier proposal for companies to disclose ‘incurred losses’ was criticized as difficult to determine and of questionable usefulness, VRG members noted that ‘economic’ value or ‘expected loss’ (rather than ‘incurred loss’) would be useful to investors.
There was also some discussion about the difficulty in determining – particularly finding evidence of – a transaction being distressed – vs. factors that demonstrate a market is distressed, which may be easier to identify.
Reluctance–Under Current Literature-to Move Away From Transaction Value as ‘Fair Value’
FASB members and VRG members noted they were surprised at the relatively low level of assets classified as ‘level 3’ assets identified in the SEC’s report to Congress; Charles said he expected the relative amount of level 3 assets to increase.
Charles noted that it was difficult to know if a particular transaction was distressed, and suggested that people simply weren’t comfortable moving from their original interpretation of FAS 157 to the approach outlined in FAS 157-3.
A VRG member noted, “What’s happening, there’s other asset classes, real estate, some other levels of intangibles, some level of liquidity, not a lot, people look at DCF [discounted cash flow] and triangulate a value, when you take something that had been active, [there is] still some of this ‘last trade bias’- this pull toward the trade vs. bringing in other factors.”
Charles added, “I’m not sure the literature gives you a lot of room to stand on, FSP 157-3 helps, there is obviously ‘audit pressure’ … a valid concern.”
FASB Technical Director Russell Golden said he had heard from his staff that some of the reluctance to move away from transaction values as evidencing fair value was due to ‘the relative sophistication of the preparer, [if] they have a transaction price or service, they don’t have [resources] to do independent modeling.” He added, “We don’t’ view [there to be a] rigidness of the hierarchy” between levels 2 and 3 in terms of classification of assets in the FAS 157 fair value hierarchy, but that ‘practice views it as a rigid hierarchy.”
At the conclusion of the meeting, a VRG member reiterated “There continues to be this bias to [use the] last transaction price, and FSP 157-3 provides the guidance, I think, to help us get beyond that, but as articulated, there is still this [bias/leaning] - whether to be able to try to stay in level 2, whether it is an educational issue, a PCAOB regulatory issue on auditors, what it is, I don’t know, but there is still a strong bias in that area.”
Wally Enman, the VRG member from Moody’s Investors Service, said the VRG believes “some additional disclosures would be helpful,” including:
- entity’s estimate of economic value or expected loss, perhaps similar to tabular disclosure that was proposed but rejected in proposed FSP FAS 107-a
- [explanation of] valuation models, relevant inputs
- sensitivity of models to changes in inputs
- how [the entity] determines if the market is active, or if the transaction is distressed
Enman noted there was some discussion around how auditable stress test results would be, and whether such disclosures should be provided in MD&A vs. the footnotes. Responding to a question from FASB board member Leslie Seidman as to the frequency of such disclosures, Enman said if it is useful information at annual periods, it would be useful to provide in interim periods as well.
OTHER ISSUES DISCUSSED
Other matters discussed at the VRG meeting included:
- fair valuing liabilities
- an AICPA paper currently out for comment on alternative investment vehicles
- Goodwill and control premiums
We will post additional information on the VRG meeting in a more detailed summary tomorrow on FEI's website, http://www.financialexecutives.org/.
Will there be legislative or regulatory action to 'suspend' or 'modify' fair value (aka mark-to-market) accounting? Read more on that topic here.