Magazine article The CPA Journal

Fair Value Is Here to Stay

Magazine article The CPA Journal

Fair Value Is Here to Stay

Article excerpt

The fair value guidance in SFAS 157, Fair Value Measurements, does not represent, as many perceive, a radical departure from previous accounting rules. SFAS 157 is the result of a natural evolution that has been taking place for more man 30 years.

Many who oppose SFAS 157 do so because of the current economic environment. This current economy, during which many hedge funds and other institutional investors face significant other-than-temporary write-downs on illiquid assets, is, however, an anomaly. Any valuation method that does not require significant write-downs in the current environment would fail to provide a reasonable representation of fair value for those illiquid assets.

When it was introduced in 2007, SFAS 157 amended, deleted, or otherwise affected more than 40 areas of accounting guidance, including SFAS 13, Accounting for Leases. SFAS 13, issued in 1976, introduced the fair value concept when it described an asset being sold in an "arm's length transaction between unrelated parties." Since oben, the accounting framework has continued to move away from a historical cost model and toward a fair value model.

Throughout this transition, accounting standards were issued that discussed fair value in different contexts. SFAS 157 was designed primarily to provide a uniform definition of fair value and a universal measurement framework. Contrary to popular perception, SFAS 157 does not require any new items to be measured at fair value; it specifies the framework to be used wherever other standards require that items be measured at fair value.

Along the Way

Many accountants were educated during an era when colleges taught the tenets of historical cost as part of the fundamental framework of accounting. To those watching the fair value model slowly supplant the cost model during the past 30 years, it may seem like a dramatic change in thinking has recently occurred, but much of this shift is attributable to the ongoing development of accounting standards and rules, rather than a change in approach.

The first widespread application of fair value occurred between 1985 and 1990 with the overhaul of accounting for pensions and postretirement benefits. Prior to SFAS 87, Accounting for Pensions, and SFAS 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, many companies paid for these benefits on a pay-as-yougo cash basis, with little attention given to the fair value of the plan assets that were needed to be set aside to cover the cost of such benefits or how to account for them on an accrual basis. SASs 87 and 106 required companies for the first time to factor in the fair value of plan assets when determining their benefit obligations.

The next sweeping implementation of fair value took place when companies began to adopt SFAS 133, Accounting for Derivatives and Hedging Activities, in 1999. Prior to SFAS 133, companies were not required to put all derivatives on their balance sheet at fair value; derivatives were not even defined in the literature. For the first time, complex financial instruments, many of which were involved in hedging relationships, were subject to fair valuation. Soon after, SFAS 140, Transfers of Financial Assets, gave rise to difficult-to-value securitized financial assets, such as residential and commercial mortgage-backed securities (RMBS and CMBS), which in turn gave rise to collateralized debt obligations (CDO) and other financial instruments. A barrage of valuation techniques based on higher math designed to account for securitization followed.

SFAS 157 had a significant impact on fair value accounting for illiquid securities, which are typically among the most difficult assets to value. Prior to SFAS 157, companies often cherry-picked information to support valuations for illiquid positions, regardless of accuracy. Now, they are required to consider all "reasonably available" information and use the best data available to support their market assumptions and parameters. …

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