FASB to Vote on ‘Fair Value’ Delay

The Financial Accounting Standards Board may find itself forced this week to impose an 11th hour delay to its new standard for measuring fair value, boxed into a corner by deep disagreement on both sides of the Atlantic over how to define fair value.

FASB adopted Financial Accounting Standard No. 157, Fair Value Measurements, one year ago to define “fair value” and clarify how it should be measured in the many places where U.S. Generally Accepted Accounting Principles require it. FAS 157 is set take effect with financial statements issued for fiscal years beginning after Nov. 15.

Lately, however, the International Accounting Standards Board has heard feedback that international players dislike how FASB has defined fair value. What’s more, an advisory group in the United States intended to provide much-needed guidance on making valuations has barely started its work, and influential voices in the U.S. accounting community are saying FAS 157 is proving much more difficult to implement than first expected.

Linsmeier

All that has prompted at least one FASB board member, Tom Linsmeier, to say the Board is confronted with some “unusual circumstances” that might warrant putting FAS 157 on hold. The Board is scheduled to vote on the delay tomorrow, Oct. 17.

A chief bone of contention is FASB’s insistence that fair value be defined by an asset or liability’s “exit price”—that is, the price an entity would receive to sell an asset or pay to transfer a liability. No heed is given to the “entry price,” or what would be paid to buy the asset or received to take on the liability. That means FAS 157 focuses not on entity-specific transactions, but on what hypothetical “market participants” would do. Critics say such an approach is too subjective and complex to use.

As companies reporting under GAAP have worked to understand the new standard, the International Accounting Standards Board has floated a discussion paper asking its constituents their opinion of FAS 157, especially its use of the exit price as the basis for measuring fair value. The IASB is moving ahead with efforts to establish its own parallel version of FAS 157, but is not as far along as FASB is here, says Wayne Upton, the IASB’s director of research.

Upton says some IASB members openly oppose the idea of setting aside all consideration for entry prices as a basis for measuring fair value, at least in some instances. But in the interest of convergence, the IASB published a discussion paper floating FAS 157 as a starting point for a fair value standard in International Financial Reporting Standards.

The paper notes that a majority of IASB board members agree that the exit price theory is appropriate, because it reflects current, market-based expectations of economic benefit (or loss) to an entity. The paper also says that some IASB members disagree, believing an entry price also reflects current market-based expectations. The paper adds that those board members believe the term “fair value” should be replaced with terms like “current entry price” and “current exit price.”

Upton

According to Upton, the 136 comment letters the IASB has received are generally not enthusiastic about abandoning the entry price completely. The Accounting Standards Board of the United Kingdom, for example, notes that fair value is more widespread in IFRS than U.S. GAAP, and not all instances might be appropriate for FAS 157’s approach.

“The ASB does not support the proposition that market-based exit values are the most appropriate measure of fair value for all assets and liabilities to be reported in financial statements,” the Board wrote to the IASB. It encouraged the IASB to do work of its own to determine where entry and exit pricing make the most sense. “We would hope that this would lead to principles which could be used in the specification of the measurement basis to be prescribed in individual standards.”

Upton admits that both rulemaking boards are now in a tough spot: FASB has already adopted a standard that IASB’s constituents dislike. The goal of converging both accounting systems would suggest that the IASB follow FASB’s lead in defining fair value, but IASB constituents and even some IASB board members don’t believe FASB’s approach applies to IFRS.

LETTER

Below is an excerpt of a letter to FASB from Financial Executives International, urging a delay in implementing FAS 157.

We observe that FAS 157 lays out a conceptual approach for developing fair values in

the absence of active markets. Valuation experts describe the market participant

approach as an “iterative” approach that is not amenable to a flow chart or decision

matrix. One must evaluate the interplay between unit of account, the valuation

premise, and the principal market in determining how to value a non-traded asset or

liability. Because these assets and liabilities frequently do not have contractual cash

flows, have multiple potential future uses, and could be used by financial or strategic

buyers, the number of iterations and permutations requires significant resource allocations and time. After discussions with accounting and valuation experts, we

have reached the view that the application of FAS 157 could be different for each

asset or liability and that each must be evaluated based on the specific facts and

circumstances.

Given the inherent variability, it will be important for companies to document how they

have evaluated the standard and its application in each specific circumstance. We

understand that is what regulators will expect (an oft-quoted view is that “if it isn’t

documented, it didn’t happen”). That leads to two significant issues: (1) one must first

understand the model in order to document how to comply–and as a group we have

concluded that we do not (at least as it relates to non-traded assets and liabilities),

and, (2) in order to have a control framework that is compliant under Section 404, we

must document the procedure and have our auditors review and opine on it. Given the

uncertainties related to the first problem and the lack of available time and capable

technical resources, we believe it is unlikely that most companies will be ready by

December 31, 2007.

Some have argued that the fact that several large financial institutions have early

adopted the standard is proof that deferral is unnecessary. We would observe that

those early adopters deal primarily with financial assets and liabilities, many of which

trade in active markets, and had been working closely with the FASB Staff during its

deliberations in order to be in a position to adopt the standard as of January 1, 2007.

The rest of the Board’s constituents are not in a similar position. We also observe that

the leasing issue, which was relevant to a number of companies currently applying

FAS 157, provides specific evidence that the Board should take no comfort from early

adopters on the sufficiency of FAS 157 or the readiness of the preparer community to

implement the standard.

Source

Financial Executives International (Oct. 1, 2007).

“The FASB said fair value is exit value. Some of our board members disagree with that very strongly,” Upton says. “Some say the entry value is also useful. That would be pretty fundamental, but it’s something certainly a majority of our commenters said we should do. What happens if we fundamentally disagree with something FASB did?”

Upton says the IASB will soon begin reviewing the comments and determining what it wants to say about fair value measurements in an exposure draft of a proposed standard. That exposure draft is probably a year into the future, he adds.

“We’re not even close to deciding this,” Upton says. “From our standpoint we have to acknowledge the possibility that we may get a significantly different answer. But when you think of the implications, it’s just not acceptable. It would be like having fundamentally different definitions of what an asset is. We can’t live with that.”

Fires on the Homefront

Linsmeier tells Compliance Week that the IASB debate over entry and exit pricing is one of the “unusual circumstances” that may give FASB reason to consider delaying FAS 157. The Board may also have to give consideration to the recent creation of its own Valuation Resource Group, he adds.

FASB established the group to help ease the transition into FAS 157, yet the 25-member body met for the first time at the beginning of October, only a few weeks before the standard is due to take effect. FASB may want to consider giving the group more time to issue recommendations before putting FAS 157 into effect, he says.

“Do we as a board want to see a standard go into effect that we may, at some point in the future, have reason to consider changing?” Linsmeier asks.

At least two prominent voices in the financial community want a delay, although their concerns are focused more on implementation issues than convergence. Financial Executives International sent a 12-page letter to FASB on Oct. 1 asking for a delay in FAS 157 and listing numerous challenges companies are encountering as they prepare for FAS 157 to take effect. A second group, the Institute of Management Accountants, followed FEI’s letter with a similar request last week.

Companies are finding the modifications necessary to comply are “more onerous than what they had initially anticipated,” says Arnold Hanish, chief accounting officer at Eli Lilly & Co. chairman of the FEI Committee on Corporate Reporting. “There’s also the issue of available resources and complexities around modeling.”

Linsmeier says he hasn’t reviewed the letter personally, but he was unaware from early reports of any issues the FEI raised that hadn’t already been considered and addressed by the Board in the standards-setting process.

Hanish cites FASB’s recent decision to cut lease accounting out of FAS 157 as evidence that the standard does have unresolved issues. The Board voted—albeit reluctantly—to amend its definition of fair value to exclude lease transactions, based on feedback from early adopters of the standard who found the definition unworkable in that context.

A staff position is expected in the near future to scope lease transactions out of FAS 157. Linsmeier says he sees the lease issue as unrelated to other factors that might give the Board reason to consider a delay.

Hanish says lease accounting may be only the tip of the iceberg. “There’s obviously a recognition that while the standard may be out there, the discussion may not be finished,” he says.