FASB Reverses Course on Fair Value

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The Financial Accounting Standards Board has taken a step back on previous plans to require companies to report all of their financial instruments at fair value.

FASB tentatively decided Tuesday to permit accounting for “plain vanilla” financial instruments at amortized cost, a reversal of a proposal from last year under which most types of financial instruments, including bank loans, would have to be reported at fair value. This would be closer to the approach adopted by the International Accounting Standards Board, which has adopted a “mixed measurement” model under which some assets would be reported at fair value and others at amortized cost.

Other assets under the tentative FASB proposal would still be reported at fair value, including assets held for sale or trading.

FASB plans to hold additional board meetings to decide on the final standards, which are being worked out with the IASB as part of the two boards’ convergence efforts.

The “plain vanilla” assets that would be eligible for cost accounting would be “those instruments where the entity has a relationship with the borrower and the purpose is to be repaid with the collection of interest and fees,” said FASB chairman Leslie Seidman during a webcast Tuesday. “We wouldn’t expect securities that are traded in an active market to qualify for this, where the purpose is to hold the asset for a period of time [and sell it].”

According to a summary of the board meeting, FASB decided that financial assets for which an entity’s business strategy is managing the assets for the collection of contractual cash flows through a lending or customer financing activity would be measured at amortized cost. Financial assets for which an entity’s business activity is trading or holding for sale would be classified in the fair value-net income category. Financial assets for which an entity’s business activity is investing with a focus on managing risk exposures and maximizing total return would be classified in the fair value-other comprehensive income category.

Seidman said that FASB and the IASB decided in December to agree on a common approach to the impairment of financial instruments and they expect to release an exposure draft in about a week.

“There has been widespread concern that the current impairment models are not providing useful information,” she said. “This has contributed to a lack of confidence in reporting on financial instruments. We want to restore confidence.”

After issuing the exposure draft, FASB plans to hold meetings with investors, preparers and other stakeholders.

Seidman said FASB is focusing on finalizing the financial instruments standards, along with standards on revenue recognition and leasing, in conjunction with the IASB. Under the most recent revision to their convergence timeline, they are aiming to complete those three standards by the end of the third quarter.

Two other standards are also near completion: the definition of fair value measurement and changes to other comprehensive income. Those too are expected to be finalized by the end of the third quarter.

Seidman could offer no additional information on the Securities and Exchange Commission’s plans for voting later this year on whether or not to approve the incorporation of International Financial Reporting Standards into the U.S. financial reporting system. The SEC has encouraged the two accounting standard-setting boards to complete their major convergence projects by the middle of the year, but the timeline has slipped amid changes on the board.

“I don’t have any more information about the SEC decision than the rest of you,” she told the webcast audience. “The SEC has said they plan to make a decision later in the year.”

She noted that the SEC has started to make an inventory of the progress on the various converged standards, but Seidman said she doesn’t know any more than what the SEC has said publicly.

Seidman took over from retiring chairman Robert Herz last fall, and the board recently expanded from five members to seven, adding Daryl Buck and Hal Schroeder (see FASB Gains Two New Members). Seidman said the addition of Buck would provide more input from the private company world, while Schroeder would lend more of an investor perspective to the board. They would also be helpful in meeting requests for FASB representation at various events.

Seidman said that FASB has been trying to bring more of a private company perspective to the board. She said she had reviewed the draft report of the Blue Ribbon Panel on Standard Setting for Private Companies, which recommends taking away responsibility for setting standards for privately held companies from FASB and setting up a new standard-setting board.

“That sends a strong message to FASB that we have not been responsive enough to their concerns,” said Seidman. “Our response is to take their concerns seriously and to take steps, in addition to the steps we have already taken to address their concerns.”

She noted that FASB has already assigned staff to work on private company accounting issues, and the board is developing a white paper on the unique needs of the users of private company financial statements, which the board plans to discuss with constituents next year. Similarly, FASB is meeting next month with nonprofit constituents to discuss the nonprofit reporting model, including net asset reporting.

One concern that FASB has heard with its leasing standards, Seidman noted, is from nonprofits that are worried about leases on donated office space.

The leasing standards are among FASB’s top priorities, but the board has mainly been evaluating changes to the lessee model. Seidman said it would then take a step back and see what the appropriate changes are in the standards for lessors.

Frank Keating, president and CEO of the American Bankers Association, hailed the turnabout by FASB on the accounting for financial instruments.

“The American Bankers Association welcomes the Financial Accounting Standards Board's change in course on mark-to-market accounting,” he said in a statement. “Along with banking investment analysts and other stakeholders, ABA has worked tirelessly to educate accounting rule-makers about the destructive implications of expanding mark-to-market accounting to all financial instruments, including loans. The FASB unanimously approved an accounting model for financial instruments this morning that reverses its proposal to record all financial instruments at fair value. This tentative decision is expected to result in a final standard later this year. Today’s shift recognizes investor concerns that a company’s business model should be a key factor in measuring financial instruments. While mark-to-market can be very useful for a business that trades financial instruments, the most appropriate accounting measure for a loan portfolio is the loan balance minus impairment. FASB’s move today will greatly increase the likelihood of convergence with International Financial Reporting Standards. This is a turn in the right direction and a welcome departure from FASB’s call to expand fair value accounting to nearly all financial instruments.”

However, he indicated that the ABA’s long-running battle with FASB over fair value measurement is likely to continue. “While we recognize and applaud this direction, there is still more work to be done,” said Keating. “We are concerned that FASB may expand mark-to-market to many debt securities that are not traded, but are held to maturity. This would introduce unnecessary volatility to bank capital levels and would fail to reflect how banks are managed. It is our hope that FASB will work expeditiously to clarify these rules and better align them with how entities manage their businesses.”

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