FAS 140 Reforms; Audit Standards; More

In its work to revise accounting rules around transfers of assets and liabilities, the Financial Accounting Standards Board has decided to remove an exception that allowed companies under certain conditions to skip the fair value measurement if they determine such measurement can’t be done.

Financial Accounting Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, is undergoing an overhaul at FASB as breakdowns in the credit markets exposed possible abuses and distortions of FAS 140 that nobody ever originally intended.

FAS 140 requires both the transferee and the transferor initially to recognize and measure assets and liabilities at fair value, if practical. But the transferor—that is, the entity moving the assets or liabilities off its balance sheet—is allowed an exception from the fair value requirement, if measurement is deemed impractical or simply not feasible. The exception is not extended to the transferee.

When it was adopted, FAS 157, Fair Value Measurement, continued the “practicability exception” in certain cases, including in FAS 140. At the time, FASB acknowledged that loophole would create some inconsistencies, but the Board determined it wasn’t practical to root them all out and fix them in one fell swoop. Instead, FASB planned to address such inconsistencies as they arose via other standard-setting projects.

FASB staff told the board during its meeting last week that the practicability exception in FAS 140 is no longer necessary or warranted, because the FAS 157 framework for measuring fair value and the required disclosures address the concerns that led to the exception in the first place.

Seidman

“It seems to me it adds complexity to the literature to leave it in place,” board member Leslie Seidman said. “Many of the instruments we’re talking about that are financial assets might be transferred under [FAS 140] are subject to other GAAP that requires fair value measurement and does not provide a practicability exception. It seems unnecessary at this point in time and overly complex for us to leave it in place.”

FASB staff said they are proceeding with the drafting of an amended FAS 140 along with revisions to related guidance.

IAASB Acts on Related Transactions, Code of Ethics

The International Auditing and Assurance Standards Board (IAASB) has released a redrafted standard on how auditors should examine related-party transactions, a weak spot in auditing literature that allowed scandals like Enron to explode.

It was just such scandals that prompted the IAASB to revise its “Related Parties” standard to clarify what is meant by the term “related party” for purposes of an audit. The standard makes clear that auditors are responsible for sniffing out evidence regarding the required accounting and disclosure surrounding related-party relationship and transactions. It also implores auditors to understand how these relationship and transactions affect the overall picture presented by the company’s financial statements.

Kellas

The standard will strengthen current auditing practice by focusing auditors on the issues at hand and ensuring they identify the risks of material misstatement that may stem from related parties, including the risk of fraud, according to IAASB Chairman John Kellas. “The revised standard clarifies the auditor’s responsibilities in those cases where the financial reporting framework establishes minimal or no related-party requirements,” Kellas said in a statement. “In addition, it provides enhanced guidance to assist the auditor in understanding and responding to the risks of material misstatement that may arise in relation to related parties with dominant influence.”

IAASB is an independent standard-setting board under the auspices of the International Federation of Accountants. A separate standard-setting body under IFAC, the International Ethics Standards Board for Accountants, also issued a proposal to revise the IFAC Code of Ethics for Professional Accountants.

The proposed revision focuses on clarifying the specific requirements contained in the existing code of ethics and refining the application of the code’s conceptual framework. “The exposure draft does not propose any changes to the technical requirements of the code,” says Jan Munro, senior technical manager at IESBA. “It proposes changes to the language to enhance the clarity and understandability of the existing provisions.”

In a written statement, IESBA Chairman Richard George said: “We believe that the revised code will provide a strong foundation to further the IESBA’s objective of facilitating convergence of international and national ethical standards.”

The proposal is open for comment through Oct. 15.

Fitch Calls for More Fair-Value Disclosure

Fitch Ratings has reviewed the annual reports and 10-K disclosures of the world’s largest banks and says still more disclosure is necessary to improve the use of fair-value measurements.

Assumptions and reliability around fair-value measurements are topics of heated debate as companies wrestle with implementation of FAS 157, Fair Value Measurement—whose arrival unfortunately coincides with unprecedented market turmoil and illiquidity. Fitch highlights a number of specific disclosures that would be helpful to credit analysis in assessing fair value, and it highlights where readers would get a better understanding if they had better or more information.

Dina Maher, senior director with Fitch Ratings, says the biggest area of concern is assets and liabilities measured under “Level 2” of the three-tier hierarchy established under FAS 157 for measuring fair value. At Level 2, companies use a combination of direct market pricing along with less direct inputs to establish fair values.

“It seems as if the majority of assets and liabilities measured at fair value are now getting classified in Level 2,” Maher says. “That’s one of the areas we highlighted where there could be more disclosures similar to the Level 3 requirements.”

Maher says Fitch noted that many companies following International Financial Reporting Standards provided disclosures comparable to those required in FAS 157, even though IFRS doesn’t currently have a requirement comparable to FAS 157. “We thought that was good,” she says.