IASB Proposes Its Own Fair-Value Rule

The international standard-setter presents its version of FAS 157, with just a few differences.

In a long-expected move, the International Accounting Standards Board has proposed guidance for how companies should apply fair-value measurements to assets and liabilities. The draft largely pulls parts from the equivalent rule in U.S. generally accepted accounting principles.

While IASB’s international financial reporting standards do require some financial instruments to be measured against current market values, the board has not had a formal definition of fair value or a framework for applying it. In the U.S., the Financial Accounting Standards Board issued its fair value measurement standard in 2006, which was followed by an IASB discussion paper on the subject in November of the same year, which used the American standard as a starting point.

If approved after a four-month comment period, IASB’s version of FAS 157 and their identical definitions of fair value will become part of IFRS.

This draft guidance makes some progress in the IASB and FASB’s ongoing convergence project. However, there are some differences, none of them major, according to IASB. Among the eight differences: Unlike FASB’s version, the IFRS standard would apply to leasing arrangements, and it addresses how to apply the exit price to equity instruments measured at fair value. 

Following banks’ massive writedowns at the start of the credit crisis, some critics inaccurately blamed FAS 157 for creating a brand-new wave of mark-to-market accounting. In truth, the U.S. standard only defines fair value for companies already using it and provides a framework for measurement according to a three-step hierarchy. Under the third level, assets that are thinly traded or traded not at all are held up against “unobservable inputs.” It is under this method that fair-value critics say the accounting standard creates too much volatility and leads to a pro-cyclical, downward effect on the economy.

Like FAS 157, IASB’s proposal explains how to measure fair value but does not tell financial-statement preparers when they should apply it. And it also adheres to the same hierarchy employed by its U.S. counterpart.

IASB’s exposure draft also includes recently rushed changes made by FASB to FAS 157, written under intense pressure by bankers, regulators, and lawmakers. That guidance encourages companies to do more legwork than merely relying on the last traded price when they estimate the fair value of securities that are not actively traded.

Specifically, the FASB guidance tells companies how to gauge whether the market in which a financial instrument is traded is considered not active. It also instructs companies on how to determine if a transaction being used to estimate a financial instrument’s value is not distressed. Under FAS 157, financial instruments’ fair values cannot be based on distressed sales.

Several IASB board members had been wary over the quality of FASB’s most recent fair-value guidelines. For instance, board member James Leisenring criticized FASB, saying the U.S. board was allowing companies to “ignore” the traded price of a financial instrument in favor of using internal models to value the instrument.

But IASB has also faced pressure from politicians and was recently asked by the G20 leaders to align their fair-value measurements with U.S. GAAP, which this proposal does, according to the international board. In a statement, IASB chairman David Tweedie called the proposed guidance “an important milestone” in the financial crisis. “It proposes clear and consistent guidance for the measurement of fair value and also addresses valuation issues arising in markets that have become inactive,” he said.

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