FASB Eases Guidance on 'Mark to Market' Rules

Until recently, U.S. accounting policy and politics have remained distant relatives, an environment which the FASB (Financial Accounting Standards Board) could draft policy in a vacuum rather independently from outside pressure.  Unfortunately, the FASB’s guidance on mark-to-market accounting has caused banking companies and politicians to increasingly apply pressure due to the large losses companies are incurring to comply with the new guidance.  

In particular, a House Financial Services Subcommittee hearing held on March 12, 2009 criticized mark-to-market accounting and the FASB for the impact recent accounting changes have had on these banking companies.  Committee Chairman Barney Frank commented, “You are the FASB, you cannot be the SlowsB.”

In response to this criticism, FASB Chairman Robert H. Herz held board meetings on April 2, 2009 in which three proposed accounting rules were approved by vote.  Two proposed changes clarify aspects of Statement of Financial Accounting Standards No. 157 (FAS 157), Fair Value Measurements.  The third proposed change related to disclosure of losses related to impaired securities.   

The first FAS 157 position gives additional clarity on assessing fair values on securities where there is no active market or where the price inputs which are being used really represent distressed sales.  The position includes language which now allows companies to use more judgment to ascertain if a formerly active market has become inactive.  In doing so, companies have greater ability to use internal cash flow estimates to project these fair values. 

The second FAS 157 position requires more frequent disclosure of financial instruments that are not disclosed at fair value on companies’ balance sheets.  Commercial banks will be required to disclose these assets at fair value on a quarterly basis.

The third proposal provides a more transparent view of impairment losses related to many of the mortgage backed securities which financial companies hold on their books.  The guidance states losses determined to be permanent in nature related to credit issues need to be reflected through the company’s current earnings and all other related losses be recorded as a change to equity on the balance sheet.  Companies will be required to disclose these losses in aggregate on their income statement; however, only a portion of these losses will be reflected in current earnings.

These proposals approved by the FASB will be effective for companies after June 15, 2009 with an optional early adoption for the first quarter in fiscal year 2009.  Of note from these proposed changes is the general trend towards allowing firms greater flexibility to apply judgment to fair value principles related to various financial instruments. 

Some argue that this guidance allows companies too much room to manipulate their financial statements and hide large losses on their balance sheet.  Many pundits wonder whether these measures have come too late as many large firms have already incurred significant write-downs which cannot be reversed.  Banking firms are often assessed using metrics such as Tangible Common Equity which are not impacted by these new positions.