Derivatives accounting and risk management expert Thomas Linsmeier joins the Financial Accounting Standards Board on July 1, replacing outgoing member Katherine Schipper. Linsmeier, chairman of the accounting department at the Eli Broad College of Business at Michigan State University, previously served as an academic fellow at the Securities and Exchange Commission.
He sat down with CFO.com editors to discuss FASB’s conceptual framework, fair value, pension and lease accounting, as well as the mismatch problem with derivatives accounting. Here’s what Linsmeier had to say a week before stepping into his new standard-setting role.
CFO.com: When considering whether the conceptual framework should move toward full fair value accounting, is it important that assets and liabilities become the primary focus?
Linsmeier: I think there is a misconception about the conceptual framework [regarding assets and liabilities.] It is necessary to start with assets and liabilities because our accounting model should be representative of economic reality. However, to get revenues, gains, expenses, and losses—which are accounting constructs—measured regularly and well, we need a discipline that looks at asset and liabilities and then captures changes in wealth. But that doesn’t make assets and liabilities the primary focus.
What should be the focus?
Let’s consider your question in the context of the income statement. You start with assets and liabilities, but value them using different measurement attributes. This causes changes in the timing of when you recognize revenues, expenses, gains, and losses. That’s an important issue, not because you started with assets and liabilities, but because you used different attributes. On the asset side, for example, you might have some items at fair value, some at historical cost, some at amortized costs. If you add them up, what do total assets really mean? The issue of net differences in measurement attribute is one that effects both the income statement and balance sheet.
So the issue is not a question of fair value versus historical value, or whether companies should focused on assets and liabilities, but rather how preparers estimate value?
In part, that’s correct. It’s not the asset or liability focus in the conceptual framework that drives this particular issue. It’s the measurement attribute used to recognize the asset that people are raising the question about.
It seems that the debate about the use of fair value versus historical cost would end if users and preparers weren’t so focused on assets and liabilities to begin with. Is that true?
When you talk about historical cost and fair value, those two numbers are identical at an exchange transaction date. Then the issue becomes whether or not you want to re-measure the transaction price at a fair value in the future in the [accounting] model, or take the old transaction price and allocate it over time to the income statement. The real open question when you make that trade-off is, how might investors best be served? Further, which provides more relevant information to investors to help them predict the future economic prospects of a company: When you re-measure to fair value or when you allocate that original cost over time? It is a trade-off between relevance and reliability.