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Fair value: Much debated but here to stay

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15th Dec 2009
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David Larsen outlines the latest developments in the fair value accounting debate.

As the global economy begins climbing out of recession, the G20, other world governments, the International Accounting Standards Board (IASB) and its US counterpart, the Financial Accounting Standards Board (FASB), are focused on establishing uniform accounting standards. The accounting principle often blamed for contributing to the recent financial crisis – fair value or market-to-market – is once again at the heart of the debate.

Some claim that fair value accounting contributed to the financial crisis of 2008-09. Others maintain that fair value accounting allowed investors to quickly identify and react to massive decreases in market value. Despite this, the debate continues over which assets and liabilities should be recorded at fair value and which should be recorded on another basis, such as amortised cost. At times this debate is misfocused on ‘how’ to estimate fair value rather than on ‘what’ assets and liabilities should be recorded at fair value.

As pressure continues during 2010 to harmonise or conform international accounting standards, it should be clear that fair value is here to stay. What is less clear is which financial instruments will be recorded at fair value and how the definition of fair value will be harmonised. The IASB recently released International Financial Reporting Standards 9 (IFRS) which uses a single approach to determine whether a financial asset should be measured at amortised cost or at fair value. FASB continues with its due process of determining a comprehensive model for valuing all financial instruments. Current thinking is that FASB will apply fair value to all financial assets, resulting in a potential conflict with IFRS 9.

While the debate continues about which assets to record at fair value, how to determine fair value is also being reconsidered. FASB issued statement 157 in 2006 (now known as ASC Topic 820). In 2009, the IASB issued an exposure draft on a fair value standard for IFRS. The IASB proposed fair value definition and the FASB fair value definition are identical. However, key underlying provisions differ, potentially resulting in different fair value conclusions. For example, the current IASB proposal uses a ‘minority’ position model to determine the fair value of individual instruments, while FASB allows ‘control’ to be considered for certain financial instruments. The IASB is currently conducting a series of roundtable discussions to assist in its deliberations as it determines whether to follow existing FASB guidance on fair value or to deviate from FASB.

At their joint meeting in October 2009, the IASB and FASB reaffirmed their commitment to improve IFRS and US generally accepted accounting principles (US GAAP) and to achieve convergence. Given the differences noted above, it remains to be seen how this will occur. Every investor and every preparer of financial statements must continue to monitor developments and seek assistance from qualified experts as needed, as conclusions by the accounting standard setters on both sides of the Atlantic will impact the future of how fair value is estimated and applied.

David Larsen is a managing director at Duff & Phelps. David serves on FASB’s Valuation Resource Group, the AICPA Net Asset Value Taskforce and the International Private Equity and Venture Capital Valuation (IPEV) Board of Directors.

 

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