CPA financial executives evaluate fair value accounting

A majority of senior-level executive CPAs don't blame fair value accounting for causing the subprime crisis, but they don't view it as improving investors' understanding of aggressive lending practices, according to the second quarter 2008 Business and Industry Economic Outlook Survey of the American Institute of Certified Public Accountants (AICPA) and the University of North Carolina's Kenan-Flagler Business School.

In a new partnership with UNC Kenan-Flagler, the AICPA poll contained a survey within a survey that asked questions about executive CPAs' views of fair value accounting.

Recognition of fair values in the financial statements is required for a wide range of assets and liabilities, and recent changes in accounting standards have established a framework for measuring fair values and expanded disclosures about fair value measurements. Fair value accounting has been controversial because it necessitated recognition of significant income statement losses during the recent credit crisis, sometimes for assets that were difficult to fair value. Some commentators have argued that by forcing recognition of large losses, fair value accounting might have shaken confidence in the credit markets and exacerbated the crisis.

"It appears that the jury is still out on fair value accounting, at least among corporate executives with accounting backgrounds," said Mark Lang, the Thomas W. Hudson, Jr./Deloitte & Touche L.L.P. Distinguished Professor of Accounting at UNC Kenan-Flagler. "While most respondents don't believe that fair value accounting exacerbated the credit crisis, relatively few feel that it facilitated investor understanding of banks aggressive lending practices."

Regarding the role of fair value accounting, 17 percent of respondents felt that it contributed to the subprime crisis, while 83 percent felt it had not. Thirty-five percent suggested that fair value accounting had facilitated investor understanding of banks' aggressive lending practices, while 65 percent felt it had not.

Current accounting specifies a fair value hierarchy with Level 1 valuation based on market prices for identical assets or liabilities, Level 2 valuation based on market prices for similar assets or liabilities and Level 3 valuation based on models. Some commentators have raised concern about accuracy of fair values, especially under Levels 2 and 3 where more subjectivity is involved.

In terms of specific valuation approaches, 33 percent of respondents felt that Level 1 fair values should be recognized, while 37 percent felt they should be disclosed but not recognized and 6 percent felt that should be neither recognized nor disclosed (the remainder were unsure). Major concerns about Level 1 fair value accounting included excess volatility (39 percent of respondents) and market prices not reflecting economic value (34 percent).

The proportion of respondents favoring recognition of fair values dropped in cases in which markets for identical assets and liabilities were not available (Levels 2 and 3). Fifteen percent felt that Level 2 fair values (market exists for similar assets or liabilities) should be recognized in the financial statements, 49 percent felt that they should only be disclosed in the footnotes, and 12 percent felt that they should be neither recognized nor disclosed. Only 7 percent felt that Level 3 fair values (valuation based on models) should be recognized in the financial statement, 33 percent felt that should be disclosed in the footnotes and 33 percent felt that they should be neither recognized nor disclosed.

More than 1,400 CPAs who are senior-level executives responded to the latest Business and Industry Economic Outlook Survey conducted via an online questionnaire conducted April 22 to May 5. The margin of error was plus-or-minus 3 percentage points. CPAs who hold leadership positions as chief executives, chief operating officers, CFOs or controllers in their companies hold well-informed expectations for both the U.S. economy and their organizations.

More information and full poll results are available on the AICPA Financial Management Center Web site.

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