Fair Value: Nothing New under the Sun?

Contrary to popular belief, the idea "has been in place for decades," FASB leaders contend.

With the credit crisis adding to already simmering controversies about the changeover to fair-value accounting, the Financial Accounting Standards Board apparently thinks the topic worth revisiting in an informal manner. Last week, the board issued a two-page article on fair value and financial reporting to set the record straight on what it feels are some basic misconceptions.

Indeed, while fair value has been widely cast as a new concept, it has, in fact, “been in place for decades,” according to the article’s authors, FASB chairman Robert Herz and FASB director of planning, development, and support activities Linda MacDonald.

For instance, derivatives (with certain exceptions for hedges), trading securities, and available-for-sale securities have long been marked to market, the authors say. For many years before FAS 157, the new fair-value rule, the method has been used to recognize impairments or declines in value of financial assets in down markets. “Again, this is by no means new. The requirement to recognize impairments has been in place for many years and spans several periods in which there were down markets,” Herz and MacDonald note.

What’s more, although FAS 157 contains the genuinely new requirement that preparers separate the inputs used to estimate the fair value of financial assets and liabilities into three risk-based buckets, “the objective remains the same — a current exchange price for the asset or liability,” they write.

The article also sought to define the limits of the new rule. FASB, which has deferred the use of fair value for all assets and liabilities, currently, only mandates it for financial assets and liabilities, the authors point out. The bottom line on fair value is that it “is not required in many instances,” they assert.

The impetus for the article, the authors say, is to provide “some basic facts” about fair-value accounting to help financial statement users and preparers understand the debate — which has been raging since September 2006, when FASB released FAS 157 Fair Value Measurement.

FAS 157 was an effort to clarify the thinking behind reporting fair value estimates and to lay out a framework within which to value the assets and liabilities. Mainly, the estimates are intended to provide investors with the value of an asset or liability on the measurement day, rather than reporting a value based on some future date, such as a future settlement or maturity date.

Further, the rule requires enhanced disclosure requirements and a measurement hierarchy that separates assets and liabilities into three categories based on risk-related criteria. For their part, investors say they are getting a clearer picture of the company’s financial health, while companies have balked at the accounting volatility the measurement creates. Preparers in the financial-services industry have also complained that the new reporting requirements may have exacerbated the subprime crisis.

The article is part of a FASB series called “Understanding the Issues,” written to bring “clarity on technical issues that is needed,” noted FASB spokesperson Neal McGarity. Launched in May of 2001, the first letter covered expected cash flows, while the second, also released in May of that year, focused on measuring liabilities at fair value — an enduring subject, judging from the most recent release.

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