FASB has fast-tracked its comment period to 15-days in response to pressure from Congress and by bankers and regulators to modify fair-value accounting rules. The new proposal for comment guides companies on how to determine whether an asset's market can be considered not active, and whether a transaction being used to estimate an asset's value is not distressed. FAS 157 states that fair value of a financial instrument cannot be based on distress sales.
FASB chairman Robert Herz was was repeatedly asked at Congessional hearings last week to “fix” mark-to-market accounting in three weeks. At the same time, Congress stated that they did not want to “interfere with accounting standard setting," Herz stated that that the FASB is preparing some material and that due process is necessary. The members of Congress present threatened Herz with legislation that would “fix” mark to market.
Members of Congress present at the hearings seemed to be of the opinion that changes in accounting rules would suddenly turn the economy around. Herz stated that changes to accounting guidance would not guarantee economic changes.
The emphasis is on FAS 157 Level 3 judgements. Such judgements on measurement of financilal instruments require the most judgment, and are designed for thinly traded or untraded assets that have a value derived from "unobservable inputs." Measurements at Level 3 seem tainted by some readers of financial statemetns. Potenmtitally , the FASB’s new guidance will remove the stigma attached to Level 3.
Level-3 measurements are based on inputs that require more judgment. More judgement means more attention from auditors and regulators and more work on the part of accountiants and possible the need for outside valusators. Approximately 9 percent of financial instruments measured at fair value were classified as Level 3 under FAS 157. Level 1 is at 76 percent and Level 2 15 percent (per SEC study).
Herz stated that "There's not much accounting can do other than help people get the facts and use their best judgment," he said.
FASB expects companies to use "significant judgment," in determining when assets were not trading in active markets or were distressed. This could result in different valuations for the same asset by different companies.
The new guidance requires a two-step approach to determine whether a company is justified in not using observable prices. First is assessing indicators that a market is inactive, i.e. too few transactions to determine prices or the prices are out of date.
Second, if the firsrt step indicates an inactive market, companies will look for indicators of distressed pricing of transactions. If a price is made under distress, then the price cannot be used for estimating fair value and other valuation techniques are required.
The comment period ends on April 1 for adoption for interim and annual periods ending after June 15, 2009.
Here is the actual text of the decision from the FASB web site:
Fair value measurement. The Board discussed the following issues:
Determining when a market for an asset or a liability is not active and determining when a transaction is not distressed. The Board decided to provide additional guidance to help an entity in determining whether a market for an asset is not active and when a price for a transaction is not distressed. The Board meeting handout described the proposed model the Board agreed to.
The Board decided that the changes would be effective for interim and annual periods ending after March 15, 2009. The proposed FSP would be applied prospectively and early adoption would not be permitted.
The Board directed the staff to proceed to a draft of the proposed FSP for vote by written ballot and plans to issue that document for public comment on March 17, 2009, with a comment deadline of April 1, 2009. The Board expects to discuss the comments it receives at its meeting on April 2, 2009.
Other-than-temporary impairments. The Board discussed proposed changes to the guidance for other-than-temporary impairments. Currently, an entity is required to assess whether it has the intent and ability to hold a security to recovery in determining whether an impairment of that security is other than temporary. The proposed FSP would change that guidance as follows:
- If the entity intends to sell the security or it is more likely than not that it will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an other-than-temporary impairment.
- If the entity does not intend to sell the security and it is not likely that the entity will be required to sell the security before recovering its cost basis, only the portion of the impairment loss representing credit losses would be recognized in earnings as an other-than-temporary impairment. The balance of the impairment loss would be recognized as a charge to other comprehensive income.
For a debt security within the scope of EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,” an entity would estimate the amount of the total impairment charge representing the credit losses in accordance with that Issue.
The proposed FSP would result in a new category within other comprehensive income for the portion of the other-than-temporary impairment that is unrelated to credit losses for held-to-maturity securities. The impairment recognized in other comprehensive income would be amortized over the remaining life of the debt security in a prospective manner based on the amount and timing of future estimated cash flows unless there is an indication of additional credit losses. That amortization would be recognized in other comprehensive income with an offset to the asset and would not affect earnings.
The Board decided that the guidance would be effective for interim and annual periods ending after March 15, 2009, and applied prospectively. The Board directed the staff to proceed to a draft of the proposed FSP for vote by written ballot and plans to issue that document for public comment on March 17, 2009, for a comment period of 15 days. The Board expects to discuss the comments it receives at its meeting on April 2, 2009.