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FASB Unveils Fair Value Proposals

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The Financial Accounting Standards Board has posted two drafts of guidance that could ease the effect of mark-to-market accounting rules.

One, FASB Staff Position FAS 157-e, Determining Whether a Market Is Not Active and a Transaction Is Not Distressed, would establish guidelines that banks, insurers and other entities with “hold-to-maturity” securities could use to decide when to use actual market prices and when, in times of market turmoil, to shift to other methods of valuation, such as valuations based on estimates of the present value of future cash flows.

The other draft guidance, FSP FAS 115-a, FAS 124-a, and EITF 99-20-b, Recognition and Presentation of Other-Than-Temporary Impairments, would explain how reporting entities should go about recording losses on troubled securities.

Written comments on the drafts are due April 1. FASB, Norwalk, Conn., expects to vote on the drafts at a board meeting April 2.

If approved, both staff positions would apply to “interim and annual periods” ending after March 15, including the first quarter of 2009, FASB says.

Mark-to-market rules require holders of some categories of securities to try to use the current market value of the securities, rather than the purchase price, in financial statements.

Executives at banking trade groups and many financial services companies, including life insurers, have complained that mechanical use of mark-to-market principles leads to unrealistically low valuations during times when temporary crises disrupt markets.

Defenders, such as officials at FASB and the U.S. Securities and Exchange Commission, contend that an “unrealistically low” price obtained in a free but disrupted market does reflect the true current market value of the security.

FASB Chairman Robert Herz said last week at a hearing organized by the House Financial Services Committee’s capital markets subcommittee that FASB believes existing guidelines clearly permit reporting entities to base securities valuations on anticipated cash flow rather than the last market price when markets are distressed.

Although some lawmakers expressed support for mark-to-market principles, and at least one accused FASB’s critics of wanting to change the rules to paper over losses, the majority pressed Herz to have FASB release mark-to-market guidance by early April.

FASB already has been working on guidance modifying use of the mark-to-market rules for months, and FASB’s own Valuation Resource Group told FASB in February that new guidance is needed, FASB says.

One constituent concern is that, in the real world, even though FASB has tried to encourage companies to use cash-flow-based valuation methods for securities affected by distressed markets, the FASB staff position now in effect “indicates that market participant liquidity risk must be considered,” FASB says. “[Constituents] point out that many have interpreted that to mean that entities must use the liquidity risk implied in the last transaction price, since it is argued that there is no better indicator of market participant liquidity risk.”

If the proposed guidance drafts are adopted as posted, entities usually would use market prices to value a type of security currently being traded in an orderly, non-distressed market, but the entity could consider other relevant factors, even for securities trading in non-distressed markets, FASB says in a summary of the guidance.

If the seller involved in the transaction used as the basis for pricing a security did not have the “usual and customary” amount of time to market the security and did not attract multiple bidders, then an entity could treat that transaction as a distressed transaction and shift from use of current market prices to another valuation method, such as a present value method.

The inputs used in coming up with present value estimates “should be reflective of an orderly (that is, not distressed or forced) transaction between market participants at the measurement date,” FASB says. “An orderly transaction would reflect all risks inherent in the asset, including a reasonable profit margin for bearing uncertainty that would be considered by market participants (that is, willing buyers and willing sellers) in pricing the asset in a non-distressed transaction.”

The asset impairment reporting guidance would require entities to separate reporting of losses related to credit deterioration and losses related to other market factors on the income statement. Market-related losses would be recorded in “other comprehensive income,” rather than earnings, if it were not likely that the investor would have to sell the affected security prior to recovery, FASB says.


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