Following a hearing at a House Financial Services subcommittee last week, the Financial Accounting Standards Board (FASB) agreed to expedite release of their proposed guidance for the application of FAS 157 "Fair Value Measurement." The proposed guidance was published for public comment on March 17th and will be voted on by the Board on April 2. If approved, the FASB recommends that the guidance be effective for interim and annual periods ending after March 15, 2009. According to CFO.com, FASB chairman, Robert H. Herz, chairman of the Financial Accounting Standards Board (FASB), told legislators",We can have the guidance in three weeks, but whether that will fix everything is another [issue]."
FASB's proposal give more detailed guidance for valuing assets that would be classified as Level 3 under FAS 157, where values are assigned in the absence of an active market or where a sale has occurred in distressed circumstances when prices are temporarily weighed down. The new guidance allows companies to use their own models and estimates and exercise "significant judgment" to determine whether a market exists or whether the input is from a distressed sale. Under FAS 157, financial instruments' fair values cannot be based on distressed sales.
FASB had planned to issue the proposed guidance by the end of the second quarter. A study on mark-to-market accounting standards conducted by the Securities and Exchange Commission (SEC), which was mandated by the Emergency Economic Stabilization Act of 2008, concluded that more application guidance to determine fair values was needed in current market conditions. On February 18, Herz announced that FASB agreed with the SEC study and would develop additional guidance.
Thomas Linsmeier, FASB board member, said that they hoped that the new guidance could lead to more accurate and possibly higher values, CFO.com reports. "What we are voting on will hopefully elevate fair values to a more reasonable price so investors are more comfortable investing in the banking system", he said.
Edward Yingling, president of the American Bankers Association, said in a statement he welcomed the proposal but expressed caution about the ways it might be used by auditors, MarketWatch says. "While we welcome today's news, it will be important to look at the details of the written proposal to see how fully it improves the guidance. It will also be imperative to examine the practical effect the proposal will have based on the various ways it is interpreted."
The FASB proposal recommends that companies take two steps to determine whether there an active market exists and whether a recent sale is distressed before applying their own models and judgment:
Step 1: Determine whether there are factors present that indicate that the market for the asset is not active at the measurement date. Factors include:
- Few recent transactions (based on volume and level of activity in the market). Thus, there is not sufficient frequency and volume to provide pricing information on an ongoing basis.
- Price quotations are not based on current information.
- Price quotations vary substantially either over time or among market makers (for example, some brokered markets).
- Indices that previously were highly correlated with the fair values of the asset are demonstrably uncorrelated with recent fair values.
- Abnormal (or significant increases in) liquidity risk premiums or implied yields for quoted prices when compared to reasonable estimates of credit and other nonperformance risk for the asset class.
- Significant widening of the bid-ask spread.
- Little information is released publicly (for example, a principal-to-principal market).
If after evaluating all the factors the sum of the evidence indicates that the market is not active, the reporting entity shall apply step 2.
Step 2: Evaluate the quoted price (that is, a recent transaction or broker price quotation) to determine whether the quoted price is not associated with a distressed transaction. The reporting entity shall presume that the quoted price is associated with a distressed transaction unless the reporting entity has evidence that indicates that both of the following factors are present for a given quoted price:
- There was a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities (for example, there was not a regulatory requirement to sell).
- There were multiple bidders for the asset.
The proposed guidance also provides examples of measurement approaches in the event that the observable input is from a distressed sale.
At Monday's meeting, Herz deflated any beliefs that FASB's new guidance will be a panacea for the many ills of the U.S. economy. "There's not much accounting can do other than help people get the facts and use their best judgment", he said.
The International Accounting Standards Board, which sets accounting rules followed by more than 100 countries, plans to publish a draft rule to replace and simplify fair-value accounting rules. Critics say the rules have exacerbated the credit crunch by forcing write-downs. "We plan to replace it, the whole thing. We want to stop patching up the standard and we want to write a new one. We are aware that the current model is too complex. We need to simplify.... We will move to exposure draft hopefully within the next six months", said Philippe Danjou, a member of the IASB board.