(April 13, 2009) - On April 9, 2009, The Financial Accounting Standards Board (FASB) voted to adopt three new guidelines under the so-called mark-to-market accounting rule, addressing concerns over the application of fair value accounting standards given the current market conditions. All three pieces of guidance are effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.

FSP FAS 157-4
Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly

Currently, companies are valuing assets at prices that reflect current market conditions, essentially matching their investments’ value to the market’s ups and downs. Thursday’s revised FAS 157-4, now allows companies to value assets at what they would sell for in an “orderly” sale, as opposed to a forced or distressed sale. This includes certain hard-to-value troubled mortgages, corporate loans, and consumer loans.

The new rule establishes a process, suggesting that companies look at several factors and use their judgment to decide whether a formerly active market has become inactive. If found to be inactive, a company must then determine if broker quotes, observed prices, or a discounted cash flow analysis indicate distressed transactions.

In addition to giving companies more leeway when valuing assets, The FASB’s decision also assists U.S. banks, who complained that the former rule forced them to undervalue their assets at deeply discounted prices due to current economic conditions. These banks can now use their own judgment when valuing assets as long as there are no willing bidders to set a market price.

This not only provides a boost to battered banks’ balance sheets, but also gives them incentive to keep bad assets on the books.

The new ruling comes at a time when the Treasury Department is trying to rid the banks of those same toxic assets. The government’s Public-Private Investment Program calls for the government to join with private investors to buy approximately $2 trillion in bad assets from banks.

FSP FAS 115-2 and FAS 124-2
Recognition and Presentation of Other-Than-Temporary Impairments (OTTI)

Currently, companies are calculating OTTI based on management’s assertion it has both the intent and ability to hold an impaired security until recovery. Existing guidance for determining whether impairment is other than temporary has been changed, and the change is limited to debt securities. Under the new guidance, management only has to assert that the company does not have the intent to sell the debt instrument and it is more likely than not it will not have to sell the debt instrument before recovery of its cost basis. As such, when adjusting the debt instrument to fair value on the company’s balance sheet, the credit component of an other-than-temporary impairment of a debt security will be recorded through earnings and the remaining portion in Other Comprehensive Income (OCI). The credit portion of the change in fair value of the debt security should be measured on the basis of an entity’s estimate of the decrease in expected cash flows.

The guidance also changes the year end and interim financial statement disclosure requirements to assist the reader in understanding the changes in the debt security fair value.

According to the FASB, the new guidance is "intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and noncredit components of impaired debt securities that are not expected to be sold."

FSP FAS 107-1 and APB 28-1
Interim Disclosures About Fair Value of Financial Instruments

This last of the three pieces of guidance increases the frequency of disclosures that provide qualitative and quantitative information about fair value estimates for financial instruments not currently measured on the balance sheet at fair value. The FSP now requires disclosures typically only reported in annual report to be included in the quarterly reports. The FSP does not require any new disclosures related to fair value estimates.

For more information, please contact Brian Mandell-Rice, Denver Partner-in-Charge, at 303.298.9600 or bmandell-rice@heincpa.com

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