The following is an open letter of encouragement to the Financial Accounting Standards Board.

Dear board members and staff:

First of all, please accept our thanks for standing firm on the role for market values in financial statements. You didn't wilt under pressure despite one hyperbolic misrepresentation about mark-to-market after another, such as that it created the whole financial crisis, it was mandated by Sarbanes-Oxley, it was implemented in 2008 in the midst of this crisis, and it was abandoned 70 years ago to avoid prolonging the Great Depression. (At least no one is blaming it for global warming, at least not yet.) You also stuck with it after your counterparts in London blinked under threats from the Europeans. Near as we can tell, your changes were basically clarifications to help auditors understand SFAS 157.

All that's good, even great, but we think you can build a better foundation for the future by making it clear that mark-to-market is only a means to the end, not the end in itself.


We want to start by describing the end (as in goal, objective and purpose) for reporting values and their changes in financial statements. We know you fully grasp this point, but the public backlash shows that many don't, so perhaps additional clarification is needed from your pulpit.

In particular, we think that many focused on reporting market values as the goal, instead of as a step toward the larger objective of providing capital markets with fully useful information. Indeed, we're convinced that the auditing branch of our profession made this mistake and fixated on amounts that would be easily defensible, even if they don't provide useful representations in the statements.

As a result of their fixation, we urge you to keep reminding everyone that the end for reporting values is providing information that helps users assess the amount, timing and uncertainty of future cash flows related to assets and liabilities. Your predecessors said so in the extant Conceptual Framework, and you have endorsed that objective in your proposed replacement.


The ability to affect the amount, timing, and uncertainty of future cash flows (which we call AAATUC) is the most basic economic essence of all assets and liabilities. Although AAATUC is too abstract to be known or measured definitively, it is the beacon that must guide every phase of the search for useful information. The key point is that AAATUC's existence and magnitude are clearly signaled by values. In fact, values are the best descriptions of AAATUC, because all others are based on obsolete past prices, systematic allocations or unverifiable predictions of future events.

To put it another way: Market value measures are observable and verifiable empirical facts. As such, they are always to be preferred to other compromised methods of putting numbers on events or situations. We think it's time for the board to articulate once again that observable market-based measures of AAATUC are preferable to all others. Even so, these measures are only the means to the end of providing useful information.

For clarity, we encourage you to address these two points:


We think that you went in an unproductive direction in SFAS 157 when you defined fair value as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." Two paragraphs later, you acknowledged that this definition is rooted in the proposition that value is based on a hypothetical transaction, which is tantamount to saying it can never be known for sure. This was a conceptual speed bump in your logical analysis.

We encourage you to redefine fair value by focusing on the best and most reliable amount, specifically, "the prices that are being received from selling identical or similar assets or paid to transfer identical or similar liabilities in multiple orderly transactions between market participants at the measurement date." Changing to the plural and replacing the conditional verb tense ("would") with the present tense ("are") makes a profound difference. This version declares that any party seeking to value assets and liabilities can use the abundant factual and timely information found in others' actual transactions.

There is absolutely nothing hypothetical about these real events and amounts. This redefinition really does change the landscape, because it establishes that values are the best means to the end of providing the most reliable information for assessing future cash flows.


Our second point evolves from the first. We expect it to be controversial because it contradicts the deeply embedded idea that a value is a single amount at a point in time. As we're all learning, the world is not so simple.

We've become convinced that the value of an asset or liability is best understood to be a distribution of various amounts from multiple transactions in a recent and relatively compact time period. For example, trades of a particular public stock on a specific day don't all occur at the same amount. Rather, a variety of prices occur, no one of which can be definitively called "the" value for the day. In a rudimentary fashion, the familiar statistics of high, low and closing prices give some insight into the variability, but this information is sparse. Even the Tax Code acknowledges that value is a distribution by requiring charitable stock contributions to be reported at the mean of the high and low prices on the gift date.

Thus, AAATUC is more likely to be usefully represented by a weighted mean that reflects all the transactions that occurred in the observation period.

In any case, the fact that actual prices are scattered over a range means that finding more faithful representations of fair values requires learning more about the distributions by observing sufficiently large samples of transactions. This principle is well established in statistics and certainly has been embraced in auditing. Just as it would be ludicrous for auditors to infer anything about a receivables population after confirming only one carefully hand-picked account, it is foolhardy to look at only one transaction and infer that its amount reliably represents the population of all related transactions. If recent history is to be a guide, more data needs to be gathered from multiple transactions, instead of only a few or just one.

Importantly, your definition of fair value as a hypothetical leads to an even greater stretch by accountants (and auditors) in that it calls for measuring an anticipated possible future transaction. We think you'll agree that this move takes accounting out of the observable domain into the imaginary. The only consequence can be a diminished ability to verify a reported number's proximity to the real underlying AAATUC.

This analysis also illustrates why your definition makes the auditors' task virtually impossible. Even if a company were to sell an asset shortly after a year begins, there is no good reason to assume that the price in that transaction represents the market value on that date, much less the recent balance sheet date. It is, after all, a nonrandom sample of only one observation out of a much larger population.


We congratulate you on your recent advice in the midst of the current controversy over marking thinly traded exotic and toxic instruments to their market values. You've basically said (with different words) that the lack of market activity means the distribution of actual transactions doesn't have enough data points to justify inferring the mean value. You've also implied that it isn't useful to sample only one or a few transactions, especially those known to not be representative of the population because the seller was severely distressed. So, well done, and perhaps this column will provide some insight to help others understand what you did.


Space limits us from going further, even though there is obviously more to be said. Our purpose in writing is to point out a potentially fruitful avenue, not only for solving the immediate problem of valuing thinly traded instruments, but also for fulfilling the much larger vision of reporting values of all assets and liabilities. Achieving a shift of that magnitude requires looking at the world through a new lens. We think understanding that providing useful information about AAATUC is the end will help you implement mark-to-market accounting as the most reliable means to that end.

Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at paulandpaul

(c) 2009 Accounting Today and SourceMedia, Inc. All Rights Reserved.

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