FASB Will Propose All Financial Instruments Should Be Carried At Fair Value

Jonathan Weil of Bloomberg observed that decisions reached by FASB earlier this month on its financial instruments project “ha[ve] received almost no attention in the press,” and yet “the scope of the FASB’s initiative… is massive.”

Specifically, he notes in his July 23 commentary, Accountants Gain Courage to Stand Up to Bankers, referencing decisions reached at FASB’s July 15 board meeting:

All financial assets would have to be recorded at fair value on the balance sheet each quarter, under the board’s tentative plan. This would mean an end to asset classifications such as held for investment, held to maturity and held for sale, along with their differing balance-sheet treatments. Most loans, for example, probably would be presented on the balance sheet at cost, with a line item below showing accumulated change in fair value, and then a net fair-value figure below that. For lenders, rule changes could mean faster recognition of loan losses, resulting in lower earnings and book values.

The board said financial instruments on the liabilities side of the balance sheet also would have to be recorded at fair-market values, though there could be exceptions for a company’s own debt or a bank’s customer deposits.

The FASB’s approach is tougher on banks than the path taken by the London-based International Accounting Standards Board, which [on July 14] issued a proposal that would let companies continue carrying many financial assets at historical cost, including loans and debt securities. The two boards are scheduled to meet [July 24] in London to discuss their contrasting plans.

Weil’s characterization above closely tracks the official FASB Summary of Board Decisions – July 15 meeting, which states:

1. The Board agreed to propose that all financial instruments will be presented on the balance sheet at fair value with changes in value recognized in net income or other comprehensive income with an optional exception for own debt in certain circumstances, which will be measured at amortized cost. For those financial instruments whose change in value is recognized in other comprehensive income, amortized cost will be displayed on the balance sheet in addition to a fair value adjustment to arrive at fair value.

2. The Board agreed to propose that changes in an instrument’s value may be recognized in other comprehensive income on the basis of qualifying criteria related to an entity’s management intent/business model and the cash flow variability of the
instrument. The Board will provide additional guidance on how to apply those qualifying criteria. The Board agreed to propose that changes in value for derivatives, equity securities, and hybrid instruments containing embedded derivatives requiring bifurcation under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, will be recognized in net income.

The Board agreed to propose that for all financial instruments, interest and dividends will continue to be recognized in net income. Credit impairments, as well as realized gains and losses from sale and settlement, also will be recognized in net income. The classification of instruments will be determined at initial recognition of the instrument and will not be subsequently changed.

3. The Board agreed to propose to require one statement of financial performance with subtotals for net income and other comprehensive income. It also agreed to propose to continue to only require earnings per share for net income.

For all intents and purposes, the terms fair value and mark-to-market are often used interchangably in the press and by the general public, and although there are technical differences between the two, the substance is largely the same in that FASB’s fair value hierarchy under FAS 157, Fair Value Measurement (“FAS 157” under the pre-codification nomenclature) emphasizes a preference for using market-based data vs. other models such as discounted cash flow, based on availability of the data, the extent to which markets are liquid or active vs. illiquid/inactive, and other factors.

Bloomberg’s Weil thus describes FASB’s July 15 decision to require fair value treatment for all financial instruments as demonstrating that: “America’s accounting poobahs have some fight in them after all…. [FASB] is girding for another brawl with the banking industry over mark-to-market accounting. And this time, it’s the FASB that has come out swinging.”

He adds, “The debate over mark-to-market accounting is an ancient one. Many banks and insurers say market-value estimates often aren’t reliable and create misleading volatility in their numbers. Investors who prefer fair values for financial instruments say they are more useful, especially at providing early warnings of trouble in a company’s business.”

[NOTE: my two cents-one point on which I differ with Weil is he characterizes FASB’s action in releasing additional guidance on fair value accounting in April as ‘caving’ to Congress and industry – have you noticed some people sometimes describe FASB’s response to Congress/industry as ‘caving,’ and describe their response to analysts, investors and others as simply being ‘responsive’? We have pointed out previously in this blog our view that FASB’s April guidance may have represented a relatively accelerated timetable in finalizing guidance, but the substance of the guidance was based on feedback from FASB’s own advisory committees and roundtables, and followed from recommendations in the SEC’s Dec. 31 report to Congress on mark-to-market accounting. ]

Weil notes some interesting commentary that took place during FASB’s July 15 board meeting, in light of the strongly held views among FASB’s constituents:

“It’s been a religious war,” FASB member Marc Siegel said at [the July 15] board meeting. “And it’s been very, very clear to me that neither side is going to give, in any way.” So, the board devised a way to let readers of a company’s balance sheet see alternative values for loans and various other financial instruments — at cost, or fair value — without having to search through footnotes…….

… FASB member Tom Linsmeier called this a “very useful approach that addresses both sets of those constituents’ concerns.”

On the general subject of the need to balance diverse interests, see also our post from Friday, Yin-Yang Time For Regulators, Standard-Setters.