Coming Very Soon: Fair Value Illustrated

FASB breaks with procedure to push out additional fair value guidance, which it plans to issue by next week.

The Financial Accounting Standards Board will break with procedure and issue new guidance on fair value accounting after only a seven-day comment period. The additional guidance will provide a concrete example of how companies should value illiquid assets under the fair value accounting method described in FAS 157, the rule related to fair value measurement.

The five-member board voted unanimously on Wednesday to issue a staff proposal that contains the example. The accelerated comment period will likely end on October 9, and FASB’s plan is to have the board finalize the draft at its meeting on October 10. When finalized and issued, the guidance will go into effect immediately.

By issuing an illustrative example, the board hopes to quell the controversial issue of how to measure the value of a financial asset under FAS 157 when no market exists for the asset. The additional guidance follows yesterday’s clarification released by FASB and the Securities and Exchange Commission, to reiterate that companies with illiquid financial assets are allowed to use management assumptions — including expected cash flow projections — in their fair value analysis.

The guidance comes amid a swelling chorus of calls from bank lobbyists, trade groups, lawmakers, and the Bush Administration to suspend fair value accounting. Indeed, the bailout bill defeated on Monday in the House of Representatives included sections giving the Securities and Exchange Commission power to suspend mark-to-market accounting “for any issuer” and to launch a probe into the question of whether it contributed to the crisis.

Those who blame fair-value accounting as either a cause or an accelerant in the current financial crisis do so because it forces banks forced to write down the values of illiquid securities. That in turn, has compromised both their balance sheets and their regulatory capital ratios, affecting their actual or perceived ability to lend. Defenders of fair value counter that the accounting simply exposed serious problems with bank investments, and that suspending it would be the equivalent of ignoring those problems, as Japanese banks did during their so-called “lost decade.”

FAS 157 provides a measurement hierarchy that provides ways to value securities depending on how liquid they are. Regularly traded securities are valued on their selling price, where as securities that are thinly traded or in illiquid markets have a different set of inputs. In practice, however, many experts suspect that banks and financial institutions gave undue weight to the last observable selling price of their securities before the markets froze completely.

“We are just elaborating on the brief release that was issued yesterday,” noted FASB member Leslie Seidman at today’s meeting. She said the decision to issue extra guidance in the form of an example is a way of publishing authoritative accounting literature that cross references the paragraphs of FAS 157 that address the measurement of illiquid assets.

“We cannot overemphasize that [the proposal] does not change the objective of FAS 157 regarding the market participation rule,” added George Batavick, another FASB member.

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