NORWALK, Conn. — The debate in accounting and financial reporting circles over whether to book financial assets and liabilities at historical cost or fair value has been long-running and emotional. It may intensify in coming months as U.S. and international standard setters work toward issuing preliminary views on the topic late this year.

To oversimplify the debate, on one side are financial statement preparers who dislike fair value accounting because it entails constantly updating estimates of the market value of assets and liabilities, a difficult process entailing loads of estimates, and now governed by a complicated new standard from the Financial Accounting Standards Board on how to measure fair value.

On the other side are investors who seek relevant, reliable and timely information on companies in which they invest. They argue that accounting standards have often focused on information that is easy to measure and which produces consistent results rather than useful information to investors. Fair value accounting and reporting is the most relevant measure for financial instruments, they argue.

High Emotion, Unusual Candor

Recently, the debate has sparked rare displays of high emotion and unusual candor in the buttoned-up world of accounting rulemaking. At stake are potentially huge dollar amounts in balance sheets and how changes to them are reported in income.

Last September, for example, Donna Fisher, the director of tax and accounting at the American Bankers Association, suggested that FASB’s issuance of Statement of Financial Accounting Standard 157, Fair Value Measurement, amounts to a bigger wedge in the door that would allow entrance of full fair value into banks.

"FASB's goal with FAS 157 is to prepare the world for fair value accounting, which makes our hair stand on end," Fisher told BNA (2 APPR 779, 9/22/06).

In the same month, FASB member Don Young, an outspoken advocate of comprehensive fair value accounting for financial instruments, charged that companies oppose dropping cost-based reporting for financial assets because they want to continue to "misrepresent the economics,"and head off swings in earnings.

FASB and the International Accounting Standards Board already incorporate fair value reporting either for individual items or categories of similar options in some standards, according to Rebecca McEnally, director of capital markets for the CFA Institute.

The newest FASB standard incorporating fair value is SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, adopted by FASB Feb. 15. That standard permits companies to elect fair value for certain financial assets and liabilities.

Debate May Get Louder

The debate over full fair value for financial instruments may get a bit louder in coming months as FASB and IASB work on a comprehensive discussion paper on the topic. FASB and IASB plan to issue that "initial due process document" or "discussion paper" in the fourth quarter of 2007.

FASB and IASB have agreed to work toward a standard that would have all financial instruments measured at fair value with realized and unrealized gains and losses recognized in the period in which they take place.

However, the contentiousness of debate on fair value could derail the FASB-IASB schedule. Over the years, accounting rule makers have joked that full fair value of financial instruments will come after they retire — or settle into a more permanent form of rest.

FASB Chairman Robert Herz recently suggested it could take six or seven years to complete a joint project with IASB on full fair value. Herz also observed that the European and Asian business communities are even less ready for full fair value of financial instruments than are U.S. firms.

Herz, who has expressed reservations on fair value for instruments for which there is no ready market, also pointed out that the joint FASB-IASB project on financial statement presentation has an impact on progress towards fair value. Under that project, the entire landscape of the income statement could be altered to include the effects of more unrealized, non-owner gains and perhaps move away from emphasis on the traditional bottom-line figure of net income.

Members of FASB’s new Investors Technical Advisory Committee on January 17, urged FASB to show progress on the shift to full fair value for financial instruments. Lynn Turner, a former SEC chief accountant, now with shareholder services firm Glass, Lewis & Co., Denver, said that "six years is too long."

New Views at the SEC

At the Securities and Exchange Commission, Chief Accountant Conrad Hewitt told BNA in a September 27 interview, that he has some reservations about fair value accounting. He noted drawbacks and challenges, such as the key role that valuation consultants would play.

However, the SEC's 2005 report to Congress on off-balance-sheet financing (mandated by the Sarbanes-Oxley Act) points to the benefits of the fair value accounting model.

"Fair value accounting for all financial instruments would appear to have benefits in terms of reduced complexity, more understandability, and less motivation to structure transactions to meet accounting goals," the SEC staff wrote in the 2005 report. "In addition, many believe that fair value is simply the most relevant measure for financial instruments." The SEC staff report recommended further efforts to employ fair value in financial reporting.

Hewitt, on the other hand, registered skepticism about fair value accounting for both financial instruments and for fixed assets.

"Some financial assets and liabilities may lend themselves to fair value," Hewitt said. If so, “it might be possible for that fair value to be disclosed in a supplemental footnote or a supplemental financial statement."

"From an audit perspective, it would be extremely difficult to measure," Hewitt said. "You would have to measure it quarterly, annually. The frequency alone would be a tremendous burden." He also said the many estimates and judgments to be made raise significant measurement issues.

Lack of Support

When asked for his thoughts on the fair value accounting debate, Neel Foster, who served on FASB from 1993 through 2000, observed, "People in business don't want it."

Foster, who also is a former top financial executive at Compaq Computer and now a consultant in Houston, suggested that standard-setters could do a better job of getting out the message about the suitability of fair value accounting for financial instruments.

Foster also pointed out that the investor community is not without ambivalence on the topic. "When you throw in volatility, that makes it much harder" to forecast earnings, the former FASB member said. "Analysts look like they can't do their job if they can't predict earnings."

However, Foster added, "The volatility's there whether you report it or not."

FASB’s staff update on the joint fair value project is at http://www.fasb.org/project/financial_instruments.shtml.

Copyright©2007 by The Bureau of National Affairs, Inc., Washington D.C.