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Can Companies Excel at Fair Value?

Finance departments are using spreadsheets to tackle FAS 157, an approach few regard as optimum.

When FAS 157 took effect last November, many finance departments and business units faced a new accounting requirement but lacked any new technology with which to address it. To determine the fair value of a wide range of balance-sheet items, they turned to that old standby, the spreadsheet, to piece together models that they hoped would make sense to shareholders and auditors.

A year later, not much has changed. Spreadsheets are often still the starting point when trying to figure out what a portfolio of credit default swaps or a series of collateralized debt obligations would fetch on the market. That’s a worrisome thought for auditors and CFOs — especially because many users construct spreadsheets so poorly that the results may be impossible to verify.

FAS 157 builds on an older rule, FAS 133, which forced companies to divulge the fair value of derivative instruments. But FAS 157 goes a major step further, telling companies how to value the assets and liabilities on their balance sheets that they mark to market. It has affected financial companies in a big way. “If the subprime crisis hadn’t happened, FAS 157 would have been a ‘Who cares?’ kind of thing,” says Jiro Okochi, CEO of Reval, a New York–based vendor that recently added a 157 module to its software for managing derivatives. “Auditors wouldn’t have paid much attention.”

They do now. But while FAS 157 introduced a much stronger emphasis on the methodology behind fair-value calculations, that has not inspired software that can automate that process. “I haven’t seen a single solution in the marketplace that would address all the issues,” says Peter Marshall, a principal in Ernst & Young’s treasury advisory practice. “People are using existing systems and doing manual workarounds.”

Information Vs. Data

Most people, anyway. Wesley Walton, vice president of finance at CBC Federal Credit Union, has managed to tap newer technology, in this case an analytics function contained in software from Brick & Associates that allows Walton to perform fair-value calculations. But a credit union with just $300 million in assets and one primary software vendor has an easier time of it than larger companies.

Indeed, big companies face the irony of having too much software. A large bank will typically use different applications to handle accounting for bond transfers, commercial-lending decisions, and foreign-exchange transactions, to cite just three of many activities potentially affected by FAS 157. Therefore, multiple vendors must modify their systems to handle the dictates of FAS 157.

It also isn’t clear that FAS 157 can even be captured in computer code. The rule is partly intended to force companies to articulate how they arrive at valuations for illiquid securities — the so-called Level 2 assets, where there may be some observable inputs in the market; and Level 3 assets, where there is nothing comparable in the market and valuations are determined by models. Explaining valuation methods amounts to disclosure notes in financial statements, a form of information that doesn’t fit neatly into the fields of a database.

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