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FASB and IASB in Sync on New Fair Value Proposals

July 1, 2010

The Financial Accounting Standards Board and the International Accounting Standards Board have managed to agree on the latest set of proposed standards related to fair value measurement, even as they remain far apart on how those same fair value standards might apply to certain types of financial instruments.

The two boards issued exposure drafts of the new proposed standards this week (see FASB, IASB Propose Changes in Fair Value Standards). Among the changes are a three-level fair value hierarchy that categorizes observable and non-observable market data as inputs for fair value measurements. Level 3 inputs are “unobservable inputs” for the fair value measurement of assets or liabilities for which market data are not available.

Accountants would provide a “measurement uncertainty analysis disclosure” to reflect the interdependencies between unobservable inputs used to measure fair value in Level 3 to help users of financial statements assess the effect that the use of different unobservable inputs would have had on the fair value measurement.

Sounds complicated, but Greg Forsythe, a business valuation technical specialist at Deloitte Financial Advisory Services, doesn’t think it will be a big deal.

“The good thing from my perspective is there aren’t a lot of radical changes,” he told me. “On first read, it might seem that a lot of things are changing, but it’s more refining around the edges to clarify how people should do things and aligning with the IASB. The literature has been tweaked, but the concept is meant to be what it was and a couple of new things. That’s the nature of it.”

The controversies around fair value now are emerging more in the financial instruments standards, especially in how loans should be valued when they are considered impaired.

“Loans are a separate issue,” Forsythe acknowledged. “This standard, as it’s proposed, is not introducing new assets and liabilities that need to be fair valued. It’s addressing when you’re fair valuing something, this is the guidance you need to follow. All the mark-to-market is somewhat separate than this document.”

Duff & Phelps managing director David Larsen, who serves on FASB’s Valuation Resource Group, sees it more or less the same way.

“FASB does not expect that there will be any major change from adopting the measurement principles,” he told me. “But it will take time to study the proposal and to respond and comment to FASB to confirm their supposition that there are no major changes.”

The main change is the additional disclosure of the measurement uncertainty, also known as a sensitivity analysis, when investing in a debt instrument. However, he noted, that appears to be only needed for debt instruments and not for equity instruments. “I think there’s an exception for equity investments that are valued using Level 3 inputs, but that is in the process of being confirmed,” he added.

Otherwise, he expects there to be few controversies with the new standards. “One of the possible controversial areas that has turned out not to be controversial is the concept of control premiums,” said Larsen. “FASB has clarified that in certain circumstances a control premium would be appropriate, such as a private equity firm that buys an 80 percent stake in a company. That piece appears not to be problematic. Earlier board discussions left a question mark, which has now been resolved in a pragmatic way.”

However, like Forsythe, Larsen acknowledged that differences remain in the FASB and IASB versions of the financial instruments proposals, particularly regarding the fair value of loans.

“This standard applies if other accounting standards require the use of fair value,” he explained. “The loan question, as to whether loans need to be reported at fair value, is still an open question. This new standard would apply to how you measure fair value, but other accounting standards dictate when or if you apply fair value. That continues to be a difference of opinion between FASB and IASB, but that’s part of the financial instruments project.”

Indeed, such differences have been vexing the two boards, and they recently needed to back away from the original goal recommended by the G-20 of achieving a single set of global accounting standards by June 2011. While they expect to get many of the standards finalized by that date, some of the more controversial standards have been given a longer timetable until the end of next year, and probably will need even more time beyond that.

However, the SEC and the G-20 are cutting the boards some slack, with SEC Chair Mary Schapiro giving her blessing to the new timeline (see FASB and IASB Reshuffle Convergence Plans). For good measure, the G-20 avoided any mention of a June 2011 convergence date in the declaration it issued in Toronto last weekend re-emphasizing the importance of “a single set of high quality improved global accounting standards,” that is, when it wasn’t dodging Molotov cocktails from the protestors assembled there.

Meanwhile, those who have been submitting their comments on the proposed financial instruments standards have been pelting FASB with verbal brickbats of their own. As Compliance Week recently pointed out, the proposals are drawing barbed comments along the lines of “What exactly are you trying to accomplish by doing this? Crush the recovery like a grape? Confuse matters even more?” while another commenter wrote, “Do you not get it?”

The two boards are hoping that their latest set of proposals on fair value won’t provoke a similar reaction. Better get out the plexiglass shields just in case, though.

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