by Glenn Cheney

When the Financial Accounting Standards Board’s User Advisory Council met in early April, the group heard about the board’s plan to issue a proposal for a new standard on disclosing information about the measurement of the fair value of certain assets and liabilities.

They were surprised, and a bit concerned, when FASB member Leslie Seidman asked whether the group thought it would be a good idea for the board to start a new project that could result in companies and financial institutions being allowed — under certain circumstances — to measure certain assets and liabilities at fair value even if they were normally required to be reported at historical cost.

It was just an idea, and by no means a plan.

It was born of a handful of requests from FASB constituents who have been finding themselves in a bit of a bind. Because of America’s mixed bag of standards, some assets and liabilities are to be valued at historical cost, others at fair value. Sometimes both end up in the same portfolio or derivative mix, and the historical apples don’t match up with the market oranges.

“The primary reason for the request is that there is some mismatch in the assets and liabilities in question versus other elements of a financial statement that are in use in an integrated activity,” Seidman explained after the meeting. “Our constituents were saying that it was difficult for them to qualify for hedge accounting, so when they are marking to market their derivatives but aren’t doing so for the item being hedged economically, they get a mismatch in their income statement.”

Seidman said that FASB staff was doing exploratory research on the advisability of allowing companies in such situations to elect to measure the mismatched elements at fair, or market, value. The International Accounting Standards Board has issued a proposal for just such a standard, so FASB, in the interest of convergence, is considering a similar move.

“I figured that, since I’m the board collaborator for the fair value project, and I was doing a session on fair value measurement with these users, it would be an opportune time to ask them what they thought,” Seidman said. “It was just an idea. We wanted some initial reactions.”

The User Advisory Council, which consists mostly of investment organizations and financial analysts, expressed little support for any standard that would lessen the comparability of financial statements. They were concerned that the IASB’s proposed standard would be exercised mostly by financial institutions, making it difficult to compare financial statements from that sector with statements of other sectors.

“Users would be concerned about carve-outs that are limited to certain entities and are elective,” said Maverick Capital managing director Jane Adams. “That would increase the non-comparability of financial statements. We believe there is support among the user community for moving to full fair value for all financial instruments, with disclosure as to the changes in fair value in the current period — changes realized and unrealized — and some ability to discern the objectivity of verifiability of the fair values.”

At the meeting, two users suggested that, if certain companies could report certain types of instruments at fair value, then it should be possible, and beneficial, to require all companies to do the same.

Aiming for fair value
Some users expressed concern that, while such a project might serve the interests of the preparers of financial statements, users might be better served by other projects on full fair value or better disclosure of intangible assets. It was suggested that there are other, more pressing areas where U.S. standards could be brought into line with international standards.

The FASB project on measuring fair value is part of a general, long-term effort to have all financial assets and liabilities recognized at fair value. Standards issued in the last few years have required many such assets and liabilities to be valued not at the traditional and often more accurate historical cost, but by their estimated market value.

Standards on the measurement of fair value, however, have, over the years, become a confusing jumble of guidance that is often hard, if not impossible, to apply consistently.

The proposal that FASB expects to issue before the end of June is expected to yield an improved income statement that will help the users of financial statements understand the effects of fair value reporting, how those values were derived, and the meaning of realized and unrealized changes in fair value. It would not change existing requirements for the reporting of fair value.

FASB argued that fair value is more relevant, even if, in some cases, less objectively accurate. Current market values are the preferred and most accurate method of determining fair value. When no such values are readily available, however, companies must use other data and means of estimation. FASB intends to require that companies disclose their methods of determining fair value.

At the meeting, the board explained a possible hierarchical system of displaying different sources of fair value estimation, ranging from easily determinable market prices to internal methods of calculating probability.

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