A Fair Value Antidote Is Rushed by FASB

In newly proposed guidance, board encourages companies to use more judgment — and do more work — when assessing the current value of assets stuck in an inactive market.

To be sure, FASB board members acknowledged, these days it seems like nearly every financial instrument’s market is inactive, and nearly every transaction is distressed, making the job of accountants that much harder. If a company determines, under the new proposal, that a price cannot be relied upon, then it needs to use another valuation technique, which falls under Level 3.

At Monday’s meeting, Herz deflated any beliefs that FASB’s new guidance will be a panacea for the many ills of the U.S. economy. “There’s not much accounting can do other than help people get the facts and use their best judgment,” he said.

Not surprisingly, the board members ­— used to thorough, often lengthy, deliberations when setting standards — weren’t thrilled about being rushed. They acknowledged, in the words of board member Leslie Seidman, that they were being asked to address problems “on a dime.”

Still, the members were hopeful the new guidance could lead to more accurate — and possibly higher — calculations, which in turn could rejuvenate investors of financial firms. “What we are voting on will hopefully elevate fair values to a more reasonable price so investors are more comfortable investing in the banking system,” said Thomas Linsmeier.

As it is, Linsmeier believes, issuers were not taking the extra steps necessary to figure out the fair value of an asset that is not actively being traded. FASB expects companies to use “significant judgment,” which Herz acknowledges could result in different companies reporting different values of the same type of asset.

If approved, companies will follow a two-step approach to determine whether they’re justified in straying from observable prices because those valuations aren’t truly representative of an asset or liability’s current fair value. First, they will consider the signs that could indicate a market is inactive, such as there being too few transactions on which to judge pricing on an ongoing basis, or that price quotations are derived from outdated information.

Then, if all the evidence indicates the market is not active, companies will evaluate whether the price they are referencing was made under a distressed transaction. If it was not, then the price can be used for estimating fair value. But if it was, companies must use alternative valuation techniques.

FASB will vote on the proposal on April 2, one day after the public-comment period ends. The board will inquire in its proposal whether companies could apply the changes any earlier than interim and annual periods ending after June 15, 2009.  



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