Implications of Accounting Standards on Market Value for Banks

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INTRODUCTION

The Statement of Financial Accounting Standards (SFAS) No. 115 entitled "Accounting for Certain Investments in Debt and Equity Securities" is one of the challenging accounting standards covering financial institutions, especially the banking industry. sup 1 SFAS No. 115 attempts to: (1) provide better uniformity in financial reporting of financial institutions; (2) standardize portfolio accounting practices across industry lines; (3) establish guidelines for the recognition and measurement of investments in debt and equity securities; and (4) discourage financial institutions from selectively selling securities recorded at historical cost in an attempt to manage their reported earnings (gains trading). The Statement has generated widespread interest and criticism primarily because it requires the use of market value accounting (MVA) for certain investments in debt and equity securities. Critics of SFAS No. 115 have argued its significant adverse volatility impact on the reported earnings and shareholders' equity resulting from recognition of unrealized holding gains or losses for market adjustment and its failure to properly reflect the economic reality of financial institutions. sup 2

The effective date of SFAS No. 115 is for fiscal years beginning and after December 15, 1993. Thus, calendar-year financial institutions would have to apply the Statement in 1994. The affected institutions are allowed to adopt SFAS No. 115 earlier in financial statements for fiscal years beginning after the issuance of this Statement and should not be applied retroactively to prior years' financial statements. Adoption of SFAS No. 115 will have a significant impact on asset/liability management strategies and funding decisions of financial institutions. Thus, it is important for financial institutions to understand provisions, effects, and implementation concerns of adopting SFAS No. 115. This article: (1) examines the provisions of SFAS No. 115; (2) discusses the possible financial and managerial impact of adopting SFAS No. 115; and (3) describes implementation challenges of the Statement.

PROVISIONS OF SFAS NO. 115

The Statement will provide comparability and usefulness of financial reporting by financial institutions. Because different measurement attributes apply to the categories, SFAS No. 115 requires investment securities to be classified into one of three categories: held-to-maturity, trading, and available-for-sale. The FASB set forth the following guidelines in SFAS No. 115:

1. Uniformity: provides more uniformity in reporting for certain investments in debt and equity securities;

2. Comparability: standardizes portfolio accounting practices across the industry;

3. Measurement: addresses concerns expressed by the financial community regarding the recognition and measurement of investments in debt securities;

4. Method of MVA: requires a piecemeal MVA approach of marking to market for a portion of assets, but not related liabilities utilized to fund them;

5. Restriction: restricts the circumstances in which debt and equity are reported at amortized cost;

6. Gains Trading: prevents financial institutions from selectively selling securities recorded at historical cost in an attempt to manage their reported earnings;

7. Held-to-maturity Investments: these securities are those debt securities with positive intent and ability to hold to maturity, with no anticipation that they would be available to be sold in response to changes in circumstances such as changes in market rates, needs for liquidity, or changes in foreign currency risk. These securities should be initially accounted for at cost and be subsequently adjusted for amortization of premium and accretion of discount;

8. Trading Securities: these securities are invested for profit and should be reported at market value, and resulting realized or unrealized holding gains and losses should be included in the determination of net income;

9. …