Call it what you want

Bankers cheered the changes accounting standard setters made to fair-value, or mark-to-market, rules earlier this month, getting new tools to make balance sheets look healthier.

After months of congressional pressure, and despite a Securities and Exchange Commission study that concluded mark-to-market assessments didn't cause the financial meltdown, the Financial Accounting Standards Board, headed by Robert Herz, voted to give companies more discretion in how they account for "distressed assets."

Two proposals are related to fair-value accounting and one with accounting for impaired securities such as mortgage-backed securities. The proposal on fair value doesn't change the rule but clarifies how to get a value when there is no active market or where comparable prices are the results of distressed sales. FASB says that companies should look at relevant factors and use judgment to determine if a market is inactive.

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Once a company decides there is no market, it must estimate fair value. In an inactive market, it must weigh factors such as expected cash flows or any other evidence of value that may be appropriate. However, this type of analysis relies on estimations of the "orderly" selling price of the asset under current market conditions. And while banks now have more leeway in deriving a market value for assets, including so-called toxic securities, they must also work much harder to justify their numbers.

"The board is giving [banks] more flexibility, but with that comes the burden of proof," says Christopher Wright, a managing director at Protiviti Inc., a consulting and internal auditing firm. "If you are not using an observable input [a price that is easily discovered], the economic reality of it is you will have to provide more data and documentation as to how a value was derived."

Wright says this will mean more scrutiny by auditors, who will have to attest to the claims.

The second proposal is for disclosures for financial instruments not now on the balance sheet of companies at fair value. Such disclosures will be made quarterly rather than annually.

The most controversial proposal deals with other-than-temporary impairment, or OTTI. The revised rule addresses how companies account for assets whose market value has fallen below the reported balance-sheet value, but it doesn't change the accounting measurement with regard to fair-value.

Although companies will still record the paper loss, it will no longer affect their bottom line. If, for example, a mortgage-backed security drops in market value but the underlying mortgages are still largely sound, banks can split off that noncredit loss. So companies can now reach back, grab all the impaired financial assets they still hold and dump the noncredit losses into a part of the balance sheet called other comprehensive income, or OCI, says Jay Hanson, national director of accounting at McGladrey & Pullen LLP.

The noncredit losses that wind up in the OCI sit on the balance sheet but are not run through the income statement, so they don't hit earnings and are excluded from a bank's regulatory capital calculation. In theory, banks can reduce the amount of regulatory capital they must set aside and can lend more. Whether they do is another question.

Hanson adds that preparers will find it hard to follow the credit-loss portion. "Many comment letters called for more guidance on this issue, but the board decided not to add any," he says.

"Investors lost on this vote," wrote former FASB Emerging Issues Task Force member Jack Ciesielski on The Analyst's Accounting Observer. "And they will have to pay more attention to other comprehensive income in the future, as it becomes a more frequently used receptacle for unwanted debits. When investors note these 'detoured charges' in earnings, they should skip the detour and factor the full charge into their evaluation of earnings."

The other change to OTTI is in the language about an entity's "intent and ability" to hold the security. Under the revised language, no impairment charge is required if there is both no current intention to sell and, more likely than not, no requirement to sell before recovery, unless management expects at the balance-sheet date that all of the cash flows won't be 100% collected.

The new rules will take effect in the second quarter.

Donna Block covers accounting for The Deal.

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