By Glenn Cheney

Norwalk, Conn. — Over the past several years, the Financial Accounting Standards Board has been pushing to base accounting on the fair market value of assets and liabilities. Little by little, in statement after statement, the board has required more and more fair market valuation, moving away from historical cost.

Determining fair value can be a tricky process, however, and companies in the best of faith have used various methodologies for calculating the value of things that do not have a readily determinable market value.

With a proposal issued in late June, titled “Fair Values Measurements,” FASB has suggested a methodology that will establish norms and lead to wider comparability of financial reports. It will also resolve conflicts and confusion among disparate existing guidelines.

“We’ve had a lot of support for this project and lot of people working with us along the way to bring the guidance together,” said FASB project manager Linda A. MacDonald. “As the use of fair value increases and becomes more important, this statement will clear up a lot of confusion that has been created along the way.”

Among the people contributing to FASB’s effort was Michael J. Mard, a managing director with Financial Valuations Group’s Tampa, Fla., office. He believes that the board has succeeded in balancing the relevance of market value and the accuracy of historical cost.

“The board has a rough road to walk between relevance and reliability, making financial reports reflect market information and yet be auditable,” Mard said. “That’s a tough thing to do. It’s tough to audit a current market value without an actual transaction. Auditors like to audit historical cost invoices because they are more reliable, so the tension is between the relevance of the market information, and the reliability of testing the invoices.”

Mard said that the proposal “walks the tightrope” by establishing a process for determining market value.

The proposed standard proffers a seemingly obvious definition of fair value: the price at which an asset or liability could be exchanged in a current transaction between knowledgeable, unrelated willing parties.

Rebecca McEnally, vice president of advocacy of the CFA Institute (formerly the Association of Investment Management and Research), is glad to see the proposal, but is already concerned about what comes next.

“I don’t believe anyone thinks that [this proposal] is the last word on fair value, but it’s an extremely important first step,” McEnally said. “I think it’s significant that they have done this as a full-fledged statement, not, say, a concept statement. Since it’s a full statement, they will have to look to it when they write more guidance.”

McEnally said that as FASB continues its work on fair value accounting, it may arrive at junctures where the criteria of the proposal, and presumably the final statement, cannot be met.

“Until now, when staff wanted to invoke fair value, the decisions were strictly ad hoc, but now we will have a standard,” McEnally said. “That shifts the balance, so this proposal is very important.”

The statement establishes a hierarchy for selecting the appropriate information that should be used in valuation techniques. Those valuation inputs differ depending on whether assets and liabilities are identical, similar or otherwise comparable. It would prohibit the use of the other methods currently allowed under Securities and Exchange Commission ASR No. 118, “Accounting for Investment Securities by Registered Investment Companies.”

A three-level hierarchy
At the first level of the hierarchy, values are determined by available market prices.

At the second level, when bid and asked prices are more readily available than closing prices, fair value may be estimated using bid prices for long positions and asked prices for short positions.

In developing the statement, the board considered changing current guidelines on valuing securities that are sold or bought in blocks. The board wanted to consider the block price, not the individual prices, as the main unit of account. The board was unable to define a clear threshold for a block, however, so it left current guidance unchanged until the board considers the issue again.

At the third level — the absence of quoted prices in active markets — fair value would be estimated using various valuation techniques consistent with market, income and cost approaches whenever the information necessary to apply those techniques is available without undue cost and effort.

The paragraph on the third level acknowledges that estimating fair value may be more costly than calculating historical cost, but that it will produce more useful information.

Michael Mard said that he, too, believes that estimated market value may be more costly to calculate than historical cost, but it will prove more useful for making management decisions.

If approved as scheduled and without significant changes, the proposed statement would be effective for financial statements issued for fiscal years beginning after June 15, 2005, and interim periods within those fiscal years.

The board requests comments on the exposure draft by Sept. 7, 2004. A public roundtable at FASB headquarters in Norwalk, Conn., is scheduled for Sept. 21. The exposure draft is available at

The proposal represented the completion of the initial phase of a long-term, multi-phase project on fair value accounting. In subsequent phases, the board expects to address the relevance and reliability of fair value measurements and the unit of account that should be used for those measurements. The board has not settled on specific issues or scope, but has asked constituents for suggestions. MacDonald expects a future project to deal with conceptual issues relating to fair value.

If issued as proposed, the statement will touch on just about every project that the board is working on. Most immediately significant will be the project on business combinations, for which a document is expected later this year. It is likely to require fair value valuation of acquired businesses.

The International Accounting Standards Board and the staff of the Canadian Accounting Standards Board are researching measurement issues at the concepts level. They are focusing on the relevance and reliability of all possible measurement bases at initial recognition. The research project will provide a basis for the IASB and other national standard setters, including FASB, to initiate projects to improve the measurement guidance in their conceptual frameworks.

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