The global credit crisis has sucked AC-counting rulemakers into a political maelstrom. The Financial Accounting Standards Board, along with its European counterpart, the International Accounting Standards Board, is being bombarded with criticism from lawmakers, the banking sector and investor groups who demand they soften the impact mark-to-market accounting is putting on balance sheets already pressured by market turmoil.
Critics of the accounting rule insist that financial institutions had to take billions of dollars of write-downs unnecessarily when market prices on assets such as subprime securities plunged.
The accounting regulators are getting the message. In the past three weeks, they have issued guidance easing the impact of applying mark-to-market, otherwise known as fair value, during volatile markets.
FASB went first, on Oct. 10 issuing guidance on how those securities should be valued when an active market for a security doesn't exist. Companies will be allowed to use their managers' estimates of value, taking into account expected future cash flows and risk-discounted rates. FASB also emphasized that the security, not the market, must be distressed to consider factors other than price.
Roger Siefert, a managing director of global consulting firm LECG LLC in New York, says the issue is not whether fair value is a good idea, but how it should be applied. Siefert notes that accountants are good at "crunching numbers but horrible at timing." Historical cost accounting has been under fire for years, and fair value was supposed to create a much better framework. "If the new fair value rules had been issued at a time when markets were not disintegrating, then there would have been opportunity to refine methodologies, and financial institutions would have been better prepared to cope with the current situation," Siefert says.
Two weeks ago a European Union regulators' committee unanimously accepted IASB changes giving banks a less damaging option for valuing assets they intend to hold rather than sell. The revision allows companies to reclassify financial assets to avoid marking the assets to market in some limited cases. The proposal was approved by the EU Parliament Oct. 16 and took effect immediately.
IASB had to be pushed and agreed to make the change only after the European Union threatened to override the IASB's rules legislatively.
Not everyone is happy with the new leniency. Accountants, auditors and some investor groups complain that easing fair value rules gives investors a distorted picture. Financial assets that are held for trading are subject to fair value accounting, while financial instruments that are recorded as being "held for maturity" are not. There is no immediate benefit for companies that make the switch to hold for maturity, points out Jack Ciesielski, editor and publisher of the Analyst's Accounting Observer. Indeed, on the day the assets are reclassified, any gains or losses associated with the switch must be recorded in the company's financial statements. If the original value of the instrument has dropped, then a reclassification will show the loss. But it does help companies avoid fair value accounting in the future.
The IASB also confirmed that distressed transactions should not be considered in fair value measurements, noting that even during "market dislocation" not all activity "arises from forced liquidations or distressed sales."
Meanwhile on this side of the Atlantic, FASB and its overseer, the Securities and Exchange Commission, are getting similar pressure. Bank lobbyists, industry trade groups, lawmakers and even Republican presidential candidate John McCain are calling for a return to the historical cost methodology for financial instruments in inactive markets. The Emergency Economic Stabilization Act, the law that authorizes the Wall Street bailout package, also requires the SEC to study the effects of fair value accounting and gives the regulator the power to suspend fair value "for any issuer" if the SEC deems appropriate. That study is due out in January.
Donna Block covers accounting regulation for The Deal.