In a statement accompanying the release of the final FASB Staff Position (FSP) of proposed changes to FAS 157, Fair Value Measurements, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Order, FASB Chairman Robert H. Herz said that the revised FSP, along with two others related to fair value measurements, provides additional application guidance and calls for new disclosures. Herz said that the revisions released on Thursday April 9 reflected input from over 600 comment letters, meetings, and discussions with a "broad range of affected constituents.... Virtually all of the investors providing input expressed the need for greater transparency by banks."
Vigorously defending the Board's process and conclusions, Herz said that the three FSPs taken together with their greater disclosures will enhance transparency and are consistent with the principle of fair value. FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, enhances consistency in financial reporting by increasing the frequency of fair value disclosures, and FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, provides greater clarity and consistency in accounting for and presenting impairment losses on securities. FSP FAS 157-4, requires reporting entities to disclose a change in valuation techniques.
The FSP gives emphasis to or enhances the language of the original statement in several areas. FSP FAS 157-4 specifically "reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive."
The staff position revision states that, "Determining the price at which willing market participants would transact at the measurement date under current market conditions if there has been a significant decrease in the volume and level of activity for the asset or liability depends on the facts and circumstances and requires the use of significant judgment."
FSP FAS 157-4 eliminates the two-step approach to determining whether or not a market is active that was in the earlier version. It keeps specific guidance relating to factors to consider when determining whether there has been a significant decrease in the volume and level of activity for the asset or liability when compared with normal market activity for the asset or liability (or similar assets or liabilities), but eliminates the presumption of a distressed market.
FSP FAS 157-4 affirms the need to make adjustments to quoted prices in a distressed market and clarifies the objective of fair value in this context. "Statement 157 does not prescribe a methodology for making significant adjustments to transactions or quoted prices when estimating fair value," the FSP affirms, but "when weighting indications of fair value resulting from the use of multiple valuation techniques, the reporting entity shall consider the reasonableness of the range of fair value estimates. The objective is to determine the point within that range that is most representative of fair value under current market conditions. A wide range of fair value estimates may be an indication that further analysis is needed."
Tying inputs to the objective of fair value, the FSP says, "Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that relevant observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. However, the fair value measurement objective remains the same, that is, an exit price from the perspective of a market participant that holds the asset or owes the liability."
Reporting entities are required to disclose a change in valuation technique and a discussion of the related inputs in interim and annual periods.
The revised staff position provides some guidance about the usefulness of prices quoted by third parties, such as pricing services or brokers. The FSP cautions that reporting entities "should place less weight (when compared with other indications of fair value that are based on transactions) on quotes that do not reflect the result of transactions. Furthermore, the nature of the quote (for example, whether the quote is an indicative price or a binding offer) should be considered when weighting the available evidence, with more weight given to quotes based on binding offers."
Herz's statement commented on the additional disclosures that the two other FSP's will require:
"FSP FAS 107-1 and APB 28-1 relate to fair value disclosures for any financial instruments that are not currently reflected on the balance sheet of companies at fair value. Prior to issuing this FSP, fair values for these assets and liabilities were only disclosed once a year. The FSP now requires these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value.
"FSP FAS 115-2 and FAS 124-2 on other-than-temporary impairments is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and noncredit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains fair value. The FSP also requires increased and more timely disclosures sought by investors regarding expected cash flows, credit losses, and an aging of securities with unrealized losses."
The Board will vote on the final revisions to the FSPs this week.