The financial media often ignores accounting issues in favor of sexier stories about markets and companies. I thought my readers might benefit from a review of what the FASB (Financial Accounting Standards Board) has done lately and how these changes might impact investors. If nothing else, its interesting to see how the financial crisis has changed the attitude of the FASB:
New FV Guidance Planned
By far the most interesting development of the FASB recently comes out of their July 15 board meeting. During this meeting, the board agreed to a complete re-organization of fair value accounting. This is important for two reasons. First, it is a response to its previous move to ease fair value accounting, which was the result of government pressure for forebearance to troubled banks. Second, the guidance will completely change the pace at which firms recognize losses. The FASB wants companies to record almost all financial instruments at fair value, removing such designations as held for investment or held for sale. You can read more about the potential changes here. I see little point in discussing them, because I see little possibility of this being implemented in the near future. I think it is mainly a way for the FASB to maintain its legitimacy and explain the fair value rule change was due to special circumstances--in a way reaffirming its commitment to fair value accounting, though it is powerless to implement it at the present time. The real accounting authority, after all, is the SEC, which is still too concerned with bank's toxic assets to even consider such a change. I think the FASB will push for these changes eventually, and, when they do, it will be very interesting to see how the political power of the banking industry has weathered the crisis. (Banks are very opposed to stricter fair value rules, as it will cause them to recognize loans earlier.)
SFAS 166 and SFAS 167
The objective of FAS 166 is to ensure the transferor of a financial asset has surrendered control in conjunction with derecognition, meaning some institutions will have to bring assets they have derecognized back on their books. This abolishes the accounting loophole that allowed banks to exclude Qualified Special Purpose Entities (QSPEs) from consolidation accounting. It also prevents firms from using sale accounting for mortgage securitizations when a transferor has not surrendered control of an asset. Needless to say, this statement significantly changes off-balance sheet accounting.
This effectively destroys a large reason for the subprime debacle. SFAS 140 (which is amended by the new FAS 166) allowed firms to recognize a sale of an asset if the asset can be considered a QSPE. This enabled financial firms to leave entities holding mortgage securities off their books. FAS 166 has eliminated QSPEs. These ex-QSPE entities are subject to reclassification as VIEs and subject to consolidation (and disclosure). However, the language describing this process in FAS 167 is still vague and subject to interpretation, perhaps another example of forbearance towards banks. You can find a response from a structured finance group (among those most affected by this change) here.
FSP FAS 157-4
This is guidance about how to determine FV amongst decreasing volumes and fire sales. It shows ways to determine whether markets have low volume or forced selling.
FSP FAS 107-1
This guidance requires companies to disclose the fair value of their financial instruments, meaning companies have to disclose the fair value of their debt in the 10-Q footnotes.
FAS 168: Codification
The most drastic change recently is the new FASB Codification. FAS 168 is the last SFAS that will ever be released because it replaces the financial accounting standards with a new codification, organized by number in a manner similar to the tax code. The purpose of this is to simplify access to authoritative GAAP.
This is a big change, and not just aesthetically. First, it means everywhere you have previously seen FAS 157 you should now see ASC 820 (Accounting Standards Codification). Secondly and more importantly, it removes the hierarchy of GAAP. Previously, some FASB pronouncements superseded others, meaning a DIG is less authoritative guidance than a FAS. Now, all various kinds of pronouncements are incorporated into one code, meaning they are all equal. One byproduct of this is that the concept statements are no longer considered authoritative GAAP.
Codification doesn’t just mean financial statement references need to be re-done (they do, I have become intimately involved with this process after I recently translated the financial statements for the company I work for). It also means firms will have less interpretative power in choosing between vague language at the different levels of GAAP.
