The Financial Accounting Standards Board is developing last-minute guidance for its new standard on measuring fair value, delaying the effective date for certain non-financial assets and liabilities by one year and offering more advice on how to apply the measurement principles to liabilities generally.
In a split decision last week, the Board directed FASB staff to draft guidance that would give companies an additional year to apply Financial Accounting Standard No. 157, Fair Value Measurement, to measuring all non-financial assets and liabilities except for those that are recognized or disclosed at fair value on a recurring basis, at least annually.
The Board also directed the staff to draft separate guidance that would help companies better understand how to apply FAS 157 principles to the measurement of liabilities to clarify how to apply hypothetical measurement attributes to such obligations. Both measures will be drafted and exposed for public comment before final adoption by FASB.
FAS 157 was approved by FASB in September 2006 to define fair value as it is used throughout accounting literature, to establish a framework for how to measure fair value, and to expand fair value disclosures. It did not require any new uses of fair value. The standard takes effect for fiscal years beginning after Nov. 15.
The FAS 157 definition of fair value is meant to establish a market-based measurement, rather than an entity-specific measurement, to establish a more consistent, comparable approach across entities. It focuses on the price that would be received to sell the asset or paid to transfer the liability, commonly referred to as the “exit price,” and gives less weight to what an entity might actually pay in a real transaction. Opponents and critics alike agree that the concepts are more complex than traditional approaches.
As the Nov. 15 effective date approached, however, professional groups representing preparers of financial statements alerted FASB to numerous problems with implementation and called for a one-year deferral for the entire standard. In a 4-3 vote last month, the Board declined to defer the entire standard but agreed to consider carve-outs or guidance to help smooth implementation.
Arnold Hanish, chairman of the corporate reporting committee at Financial Executives International and chief accounting officer at Eli Lilly & Co., says the partial deferral helps, but was disappointed the Board didn’t see the need for a full deferral. “My concern is that the implementation issues are more far reaching than maybe they believe,” he says.
Pascal Desroches, chair for the financial reporting committee at the Institute of Management Accountants, says he too would have preferred a delay for all of FAS 157. “We believe the deferral provided by FASB for non-financial instruments represents a step in the right direction and will allow some key implementation issues to be addressed in a thoughtful manner,” he says.
What Gets Delayed
FAIR VALUE TALK
Below is an excerpt of a FASB staff discussion paper on FAS 157.
A number of constituents have suggested to the staff that a fair value measurement of a liability embodies a hypothetical measurement attribute
because it is based on a transfer notion that would not occur in the marketplace. For example, some constituents have even suggested that the quoted market price of a publicly traded debt instrument does not represent the fair value of the issuer’s liability. Those constituents observe that the quoted market price of a publicly traded debt instrument represents the price at which an investor could sell the instrument to another investor, so it may constitute a Level 1 fair value measurement for the asset from an investor’s perspective. However, those constituents suggest that such an amount might not represent the amount that the issuer would be required to pay a transferee to assume the debt obligation in a hypothetical exit transaction.
The staff believes that the following clarification, which is intended to be consistent with the existing guidance in Statement 157, might assist issuers in measuring the fair value of liabilities:
“Statement 157 specifies that the fair value of a liability represents the amount that would be paid to transfer that liability in an orderly transaction between market participants at the measurement date (an exit price). Statement 157 clarifies that the fair value of a liability is the amount that would be paid to transfer a liability to a new obligor, not the amount that would be paid to settle the liability with the creditor. Under that transfer notion, the liability to the counterparty would continue (it is not settled) and the nonperformance risk relating to that liability is the same before and after its transfer.
“Based on that guidance, the amount that would be paid to transfer a liability at the measurement date is the amount that a market participant with the same level of nonperformance risk (including credit risk) would demand to assume that liability. Because the reporting entity and the market participant have the same level of nonperformance risk, the reporting entity may be more readily able to determine the amount that it would demand to assume an identical liability at the measurement date. Consequently, the fair value of a liability (a current exit price) may equal the amount the reporting entity would require to receive in order to assume an identical liability at the measurement date prior to consideration of differences in assumptions between the reporting entity and market participants. In those circumstances, the reporting entity’s own data used to develop its assumptions about fair value would then be adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use different assumptions in pricing the liability.”
The above guidance would indicate that, in many cases, the amount the reporting entity would require to assume a liability at the measurement date would be considered in determining the fair value of that liability. However, that amount would be adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use difference assumptions. The staff believes that such a clarification is consistent with the transfer notion in Statement 157 and would be a useful concept for entities to apply when working through more detailed fair value measurement judgments relating to liabilities. Additionally, the staff observes that paragraph 17 already specifies that, in many cases, a transaction price will equal the exit price at initial recognition. Because a market participant in a transaction to transfer a liability has comparable nonperformance risk to the reporting entity, the proposed guidance would clarify that the entity should consider certain of its own attributes in a fair value measurement of a liability.
Source
Financial Accounting Standards Board (Nov. 14, 2007).
FASB provided some examples of instruments that will not be subject to FAS 157 immediately based on its plan to defer the effective date for non-recurring, non-financial instruments. They include certain non-financial assets and liabilities measured at fair value in the context of a business combination or impairment testing, certain intangible assets or long-lived asset groups, some asset retirement obligations, and some liabilities recorded for exit or disposal activities.
Instruments for which FAS 157 would not be deferred include derivatives, servicing assets and liabilities, and loans and debt that are subject to recurring fair value measurements.
Three board members—Leslie Seidman, George Batavick, and Larry Smith—originally favored a full delay, but agreed to the partial delay as the Board’s direction cemented. Seidman feared the partial delay would add a new layer of complexity to an already complicated standard. She quipped, for example, that non-financial items are rolled into pension plans, so how might companies measure those under the staggered implementation?
“I haven’t event spent a lot of time thinking about where else it might crop up,” she said. She agreed to the carve-out proposal “because it’s the quickest and easiest to explain.”
Crooch
Most of the rest of Board seemed sympathetic to implementation problems but believed they could be addressed by the partial deferral with some guidance in key areas. Board member Michael Crooch said he has a “deep-seated fear” that a deferral will open a door to re-examining the standard itself. “If we delay it, people will work to change it,” he said. “I understand, however, that there’s a lot of angst out there.”
FASB Chairman Robert Herz reminded the Board that FAS 157 doesn’t require new items to be measured at fair value and that investors have responded favorably to the disclosures they’ve seen so far in the financial statements of early adopters. “It’s very value-added in terms of information,” Herz said. “It’s incumbent on us to get that kind of information out there. I understand there will be issues, and some judgments have to be made by some people. We’re better off getting to these items sooner rather than later.”
Herz
As for guidance on applying FAS 157 to liabilities, the Board hopes to help preparers better understand how to apply the measurement objectives of the standard to instances where a liability is not subject to trading. “There are all sorts of mental gymnastics around these hypotheticals in this sort of instance to get to anything that is potentially useful,” said Herz. “If this is a way of helping people more quickly to some measure that is a current measure, I’m fine with that.”
The Board rejected a staff suggestion to consider offering guidance on how FAS 157 principles apply to unit of valuation and exit market concepts. The staff said it has heard questions on how an asset should be valued if the sum of its components is worth more than the whole asset itself—as in an airplane, disassembled and sold for its scrap parts.
Linsmeier
Board member Tom Linsmeier bristled at the thought of issuing guidance that would be applied rigidly. “I don’t think there’s any guidance that can say you should do it one way or another, always,” he said. “There are going to be trade-offs that are going to be made. The principles are already present [in FAS 157] … There isn’t only one way to do this. That may be problematic, but that’s what a framework-based standard might suggest would be the outcome.”
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