Rarely in history has accounting received such public and media attention as it has in recent months, as debate swirls around the question of whether mark-to-market, or fair-value accounting has exacerbated the difficulties of the financial industry. Last week, the Financial Accounting Standards Board voted to allow companies to change how, or, perhaps more important, where, the impairment of securities are reflected on financial statements. That allows companies to avoid having to show a hit to earnings from holdings of securities that cannot currently be sold, but that may ultimately still be worth more than suggested by current sales prices (or estimated sales prices in cases where the market has completely dried up).
That decision was front-page news in the Wall Street Journal and other national papers, an unusual venue for the normally arcane decisions of FASB. It also prompted an unusual move by FASB itself. Noting the “high level of interest in this week’s actions,” FASB’s director of public relations issued what was described as “some ‘plain English’ commentary” about what was done.
Critics of accounting complexity, including past chairmen of the Securities and Exchange Commission, have for many years suggested that ”plain English” rules could help improve accounting. Indeed, FASB’s counterpart, the International Accounting Standards Board, regularly holds up its own accounting rule summaries as examples of the benefits of simplified explanations. Yet FASB pronouncements continue to be inscrutable to most laymen. In its press release, however, FASB proved that it can render decisions in English if necessary. Perhaps that may yet be the best thing to come out of the recent economic crisis.
Here is FASB’s release:
FASB Reaffirms Original Principles of Fair Value (aka Mark-to-Market) Accounting and Requires More Disclosures. Board Calls for Changes in Accounting for Impairments
The FASB considered three proposals yesterday. Two of the proposals were related to fair value (mark-to-market) accounting, and one was associated with accounting for impaired securities, such as mortgage-backed securities.
The first proposal (on FAS 157) relates to how to figure out fair values when there is no active market or where the price inputs being used really represent distressed sales. After considering all of the feedback we received on our original proposal issued two weeks ago, the FASB yesterday reaffirmed that the objective of measuring fair value has always been and continues to be the same since FAS 157 was published. [Emphasis in the original] The objective is to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements. Specifically, yesterday’s vote said that companies should look at factors and use judgment to ascertain if a formerly active market has become inactive.
Once a company has made that determination, more work will be required to estimate the fair value. In trying to estimate fair value in an inactive market, the company must see if the observed prices or broker quotes obtained represent “distressed transactions”. Other techniques such as a management estimate of the expected cash flows might also be appropriate in that circumstance. However, even if a company analysis is used, it must meet the objective of estimating the orderly selling price of the asset under current market conditions. Some financial institutions have made public statements that they do not expect this proposal to significantly impact their financial statements.