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IASB Clarifies Stance on Fair-Value Accounting
November 5, 2008
The International Accounting Standards Board (IASB), the London-based organization responsible for European accounting rules, has offered new guidance on how firms should value financial instruments in illiquid markets.
The 81-page document, which consolidates all of IASB’s recent rulings on fair-value accounting, is consistent with guidelines issued Oct. 10 by the U.S. Financial Accounting Standards Board (FASB). According to both standard-setting bodies, “fair value” is the price at which an “orderly transaction” would take place between market participants at the measurement date--not the price that would result in a forced liquidation or fire sale.
“Although the IASB does not use the term ‘exit price’ akin to the FASB, nor rely on tabular disclosures based on a three-tiered hierarchy, it does say that a company can group its financial assets and liabilities into separate classes depending on the types of inputs used,” explained Nicholas Tsafos, audit partner with New York-based accounting firm Eisner.
The characteristics of an inactive market, according to the IASB guidance, released Oct. 31, include a significant decline in the volume of trading activity or dramatic price variations among market participants. IASB also highlights the relevance of judgment in uncertain markets--as has FASB--but adds that “regardless of the valuation technique used, an entity must include appropriate risk adjustments that market participants would make, such as for credit and liquidity.” Judgment must be used to determine whether a transaction is forced, says IASB, which may mean that value has to be adjusted upward.
Despite the current financial environment, neither organization is backing away from the mandate that companies use the fair-value methodology. On Oct. 15, IASB proposed amendments to International Accounting Standard (IAS) 7 that would require any change in valuation techniques be disclosed, as well as the reason for the change. The draft rule--comments are due Dec. 15--also asks companies to provide more details about liquidity risk and calls for a “maturity analysis” for derivative and non-derivative financial liabilities, based on how the company manages the risk associated with the instruments.
On Oct. 13, however, IASB issued an exception designed to level the playing field with the U.S. The revised IAS 39 mirrors Financial Accounting Standard 115 in allowing companies to reclassify, under “rare circumstances,” financial assets that are currently “held for maturity” in trading accounts--a financial meltdown is deemed such a circumstance by IASB. Assets held for trading are subject to fair-value accounting, while those held for maturity are not. However, on the day the assets are reclassified, any gains or losses associated with the switch must be included in the company’s financial statements.
Fair-value accounting has been a hot-button issue on both sides of the Atlantic, with many blaming the methodology for exacerbating the credit crisis. In the U.S., bank lobbyists and industry trade groups are calling for a return to historical cost methodology for instruments in inactive markets. Under the Emergency Economic Stabilization Act, the Securities and Exchange Commission has until January to review the effects of fair-value accounting on the economy and has the authority to suspend the methodology for certain products.
On Nov. 3, IASB and FASB announced that they have established a group of regulators, auditors and investors to provide advice to the boards on dealing with the current credit crisis, including the application of fair value in frozen markets.
