No accounting rules were changed, and the guidance to clarify the rules stayed the same as well — except perhaps for the addition of some new examples. Yet in some ways, the 84-page document released today by the International Accounting Standards Board speaks volumes about the future direction of fair-value accounting.
Undeterred by charges that fair-value accounting is the demon at the heart of the credit crisis, the IASB pulled together all its recent guidance on the subject into one document to answer the question of how to account for financial instruments in illiquid markets using the so-called mark-to-market methodology. The new document does not change any of the IASB’s existing fair-value rules, or its proposed amendments to IFRS 7 — the fair-value disclosure rule due out in 2009. Rather, it reiterates all the principles in IAS 39, the IASB’s fair-value measurement rule, and then addresses thorny practice issues, such as using transaction prices, management’s estimates, and pricing service data as inputs to recalculate fair value.
The principles outlined in the guidance formalize many of the recent pronouncements made by the IASB on fair-value accounting and released piecemeal over the past few weeks. Overall, the IASB guidance is consistent with a body of guidance released by the U.S. Financial Accounting Standards Board on October 10. The U.S. guidance also provided illustrative examples, something both boards said constituents were clamoring for.
To arrive at this point, both the IASB and FASB sidestepped usual vetting periods to rush out recent fair-value guidance in response to the worsening credit crisis. Indeed, on October 9 the IASB got the go-ahead from its trustees to “accelerate” its response to the crisis, which included embracing a new clarification of FAS 157, the U.S. fair-value measurement standard.
A week earlier, FASB had reduced its public comment period for the FAS 157 guidance to just seven days, hoping to quell the controversial issue of how to measure the value of a financial asset under the rule when no market exists for the asset. FASB usually allows between one and four months — and sometimes more — to collect and digest public opinions about new guidance. But bankers, who are one of the most outspoken critics of fair-value accounting because the methodology forces their companies to write down assets to current value, needed a quick response.
For its part, the IASB’s new package of information discusses all the key controversies, covering, among other topics, characteristics of an inactive market — which include a significant decline in volume and level of trading activity or significant price variations among market participants. The IASB also underscores the relevance of judgment in uncertain markets, but it makes clear that all judgment calls have to be weighed with other risk factors. Indeed, the document states that “regardless of the valuation technique used, an entity must include appropriate risk adjustments that market participants would make, such as for credit and liquidity.”
Likewise, judgment must be used to determine whether a transaction is “forced,” which could mean a deal is settled at a fire-sale price, and therefore the value may have to be adjusted upward. The guidance also devotes 13 pages to evaluating available market information, including transaction prices, indices, and changes in the company’s own credit.
The guidance was prepared by an IASB expert advisory panel, which was set up in May 2008. The panel was put together in response to a recommendation by the Financial Stability Forum to enhance guidance of valuing financial instruments in illiquid markets, and to strengthen related valuation disclosures. The Forum comprises 26 finance and economic organizations from around the world, including central banks and national treasury departments.
Together, the IASB and FASB will move beyond the Forum’s advisory group by creating a new group of advisers to deal with financial-reporting issues that emerge from the credit crunch. The boards are currently working to identify external chairs and members of the group and expect to hold three roundtables, one each in Asia, Europe, and North America.