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Accounting Board: You CAN Use Judgment

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An advisory panel at the International Association Standards Board says company managers and auditors should feel free to use their judgment when valuing financial instruments affected by dysfunctional markets.

The IASB, London, a board that helps develop international accounting standards, has released the advisory panel’s report on use of fair value measurement methods when markets become inactive.

“Determining fair value in a market that has become inactive depends on the facts and circumstances and may require the use of significant judgement about whether individual transactions are forced,” advisory panel members write in the report. “Any transaction determined to be forced does not form part of a fair value measurement.”

When auditors or others estimate the value of a financial instrument affected by an inactive market, they may come up with different estimates, the panel members write.

Companies should cope with the conflicts by striving to use consistent methods and disclosing how they came up with their values, the panel members write.

“Regardless of the valuation technique used, an entity must include appropriate risk adjustments that market participants would make, such as for credit and liquidity,” the panel members write.

IASB is using the panel report to prepare a draft on improving financial instruments disclosure rules.

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The report has come out 2 days after emotional accounting experts complained at a fair value roundtable organized by the U.S. Securities and Exchange Commission that IASB appeared to be allowing much less room for use of valuation judgment than the SEC was allowing.

Relatively new U.S. accounting rules that started taking effect in 2007 now require publicly traded banks and life insurers to adjust the value of some holdings of stocks, bonds, mortgage-backed securities and other instruments to reflect their current fair value, rather than the original purchase price, when compiling financial statements.

Some accounting executives say insurers would have had to report big asset writedowns for the latest quarter even if the shift to fair value reporting had not taken effect.

Others, including Brad Hunkler, the controller for Western & Southern Financial Group Inc., Cincinnati, who represented the American Council of Life Insurers, Washington, Wednesday at the SEC roundtable, blamed rigid use of fair value accounting for dramatic, possibly unnecessary fluctuations in life insurance company balance sheets and income statements.

During the SEC panel discussion, several speakers said accountants and auditors fear they could be sued, or go to prison for 20 years, if they try to use their professional judgment to record anything other than the current “fire sale” prices for some types of financial instruments.

The IASB notes that the new fair value report simply talks about efforts to estimate true values when markets are inactive, not whether fair value is an appropriate measurement basis for a particular financial instrument or class of financial instruments. IASB published a discussion paper on that topic in September.