by Paul B.W. Miller and Paul R. Bahnson

This column is the third in our series explaining why reporting market values in financial reports makes good sense. In the first, we showed that the Financial Accounting Standards Board’s Conceptual Framework wisely identified financial reporting’s objective as providing investors and creditors with information that is useful for assessing the amount, timing and uncertainty of future cash flows.

In the second, we showed how up-to-date market values are useful for predicting future cash flows because they are consensus valuations for assets or liabilities that reflect current, and therefore timely, expectations about the amount, timing and uncertainty of those flows. In comparison, an original cost emerges from merely a single nonrandom transaction based on prior expectations based on conditions that existed in the past. That is, a historical cost does not necessarily reflect what many other buyers and sellers were paying at the transaction date. Who is to say that the reporting company’s cost was similar to the others?

Bottom line: The mean of many observed contemporary transactions (the current market value) provides a far more timely, reliable and useful depiction of assets and liabilities in terms of their effect on the amount, timing and uncertainty of the entity’s future cash flows.

For this third column, we go beyond logical analysis to describe what financial statement users have said that they want. As you’ll see, the status quo simply doesn’t meet their needs.

In fact, we have found great support for market values, especially from sophisticated and market-leading professional investors. In particular, a committee of the 68,000-member Association for Investment Management and Research took the trouble a few years back to give all accountants a piece of its collective mind, so to speak, in a significant and highly respected monograph titled “Financial Reporting in the 1990s and Beyond.” This work was published in 1993 under the hand of Peter Knutson, who was supervised by the AIMR’s Financial Accounting and Policy Committee. The goal was to present the members’ collective views on a wide range of topics, including market values.

For starters, the book makes it clear that these users see their needs as paramount: “We must keep in mind that the primary purpose of financial reporting is to provide information that is valuable to financial statement users; it is not merely to produce reports that comply with a variety of arcane requirements nor to provide employment to accountants.”

The motivation for the monograph was to help tilt the standards-setting playing field toward that objective. In contrast, the American Institute of CPAs and Financial Executives International had a long history of participating actively in the process and had shaped standards to serve auditors and preparers. The AIMR committee claimed that “financial statement users need to be heard at least as clearly and resoundingly as other groups involved in financial reporting.”

The committee described its members’ market-shaping role by saying that: “The business of financial analysis and security analysis is to form rational expectations about future events.” To do so efficiently, they said that they need “financial reports written for and directed to the professionals who actually select and otherwise recommend the securities owned by institutional investors.”

Continuing this line of reasoning, they simply state that users “should be viewed as the primary audience for financial statements.” Of course, these assertions reinforce our crucial point that statement content should serve information users, not suppliers.

Working from this foundation, the book shows where existing requirements and practices fall short of that mission. Not reporting market value information is prominently identified as one such case. Specifically, the committee reports that AIMR members strongly prefer having market value information available for their analysis by saying, “There is no financial analyst who would not want to know the market value of individual assets and liabilities.” Another sentence says that it “is axiomatic that it is better to know what something is worth now than what it was worth at some moment in the past.”

These succinct statements make it abundantly clear that people who deny the demands for, and benefits of, reporting market values are totally out of touch with reality. Repeated claims by accountants that historical costs have high reliability do not persuade these users, as shown by this comment: “Inexact measures of contemporaneous economic values generally are more useful than fastidious historic records of past exchanges.” Clearly, this group understands that even imprecise relevant information addresses their needs, while reliable irrelevant information has no usefulness for them.

The analysts put to rest another timeworn and otherwise weak criticism by rebutting the point that fair values are not useful because they are out of date after they are published: “Some argue that if we are to be presented with market values that are bound to be historic by the time they arrive, we are better off with older but transaction-based historic cost. The counter-arguments to that line of reasoning are two. First, many historic costs are seriously out of date. They may have little relation to the current market value of assets, whereas the balance-sheet market values (which are only slightly out of date) still will have a good amount of relevance. Second, market value data are comparable. If all enterprises mark their balance sheets to market on the same date, they are all out of date by the same interval. Historic cost data are never comparable on a firm-to-firm basis because the costs were incurred at different dates by different firms (or even within a single firm).” This comment closes the door on that worthless argument.

Some may recall that value information required supplemental reporting for a few years under SFAS 33. The committee praised that standard (despite managers’ denial of its usefulness) by saying: “We were provided with information that, although imprecise, was a godsend to those financial analysts who understood it and were able to use it.”

It seems to us that anyone (except perhaps generally accepted accounting principles-loving accountants and managers) would give their eye- teeth to be in the position to provide whatever consumers considered to be a godsend. Alas, our system has produced multitudes of auditors and preparers who cast aspersions on users’ desires for useful information and thereby lose a golden opportunity to serve society and earn a better living.

Ultimately, all that these professional investors want is for “current value reporting to be given a chance. We need to be able to assess the extent to which volatility really exists, even though the financial statements themselves may, as a political matter, need to be shielded from it. As long as current values are not seen, financial analysts cannot use them.” We just cannot comprehend how anyone can remain rationally opposed to reporting values after reading these words.

Any holdouts should consider the AIMR report carefully and seriously. The ideas are the views of those who are supposed to be served by financial reporting. Why these users have not gotten what they want is worthy of deep introspection. Could it be that the political system has thwarted the economic interests of the public by elevating preparers and auditors above users? In a word, “Yes.”

Therefore, in closing, we think that the customers out there at the tables in the financial reporting restaurant have spoken clearly (and more extensively than we can present here) that they want more access to market values. It’s up to the chefs and the waiters to get busy preparing and serving what is demanded.

What we’ll look at next time is how to bring market values into the mainstream without disruption. More important, we will describe the advantages that will accrue to managers who voluntarily include them in their reports without waiting for an incredibly ponderous and ineffective bureaucratic and political process to force innovation on them.


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