The US Financial Accounting Standards Board is working to improve guidance on the application of fair value accounting and disclosure of fair value estimates. Their efforts may help to clarify the valuation of assets in illiquid markets, but could also result in a greatly increased workload for fund managers.
As part of the Emergency Economic Stabilization Act passed last year, the SEC undertook a review of fair value accounting. The study concluded that while mark-to-market accounting should not be suspended, the FASB should issue more guidance on how to apply some of its principles.
“We agree with the SEC and with our Valuation Resource Group that more application guidance to determine fair values is needed in current market conditions,” FASB chairman Robert Herz said in a statement. “Additionally, investors have asked for more information and disclosure about fair value estimates. Therefore, the FASB is immediately embarking on projects that directly address areas that constituents have told us are challenging in the current environment, and which will improve disclosures in financial reports.”
Some areas FASB is looking to improve include determining when a market for an asset or a liability is active or inactive, and determining when a transaction is distressed. The board has previously said managers may use their own judgment to value assets in inactive markets, and that they needn't accept prices arising from distressed transactions as market prices.
Also, the board is examining the application of fair value to stakes in alternative investment funds, such as hedge funds and private equity funds, which could help limited partners.
The board is considering requiring additional disclosures on such matters as sensitivities of measurements to key inputs and transfers of items between the fair value measurement levels. This aspect of the FASB's efforts has the potential to increase the workload on already overburdened CFOs.
The FASB and the SEC released clarifications on mark-to-market accounting in October 2008 concerning how to value illiquid assets in distressed markets. But many in the finance industry said the clarifications weren't sufficient.
The FASB will finish the projects by the end of the second quarter of 2009.
The SEC weighs in
While the Staff does not recommend a suspension of existing fair value standards, additional measures should be taken to improve the application and practice related to existing fair value requirements (particularly as they relate to both Level 2 and Level 3 estimates.)
•+++ Fair value requirements should be improved through development of application and best practices guidance for determining fair value in illiquid or inactive markets. This includes consideration of additional guidance regarding:
•FASB should assess whether the incorporation of changes in credit risk in the measurement of liabilities provides useful information to investors, including whether sufficient transparency is provided.
•Educational efforts to reinforce the need for management judgment in the determination of fair value estimates are needed.
•FASB should consider implementing changes to its Valuation Resource Group.
What market heavyweights have said in recent weeks about fair value