In a just-completed review of Financial Accounting Standard (FAS) 157, Fair Value Measurements, which established a single definition of fair value and set a framework for measuring and disclosing it, the Financial Accounting Foundation (FAF) said that the measure achieved its purpose, and that the Financial Accounting Standards Board (FASB) made the right call when it issued the rule in 2006.

The FAF, the parent organization of the FASB, has been examining the implementation of the standard since 2010,  and released a final report in February. The foundation routinely conducts post-implementation reviews as part of an effort to evaluate the effectiveness of the standards-setting process.
FAS 157 was created to establish a clear definition of fair value for accounting purposes, build a framework for measuring fair value in generally accepted accounting principles (U.S. GAAP) and expand the disclosures that entities must make regarding how they performed their fair value measurements. Prior to its passage, there was a variety of definitions for fair value, which, according to the FASB, created inconsistencies that added to the complexity of applying the concept to GAAP.

By providing a singular definition and methodology, and by mandating additional disclosures—which included the classification of investments to Level 1, 2 and 3, based on how easily one can assess the actual value of the investment—the FASB was looking to create consistency and comparability in fair value measurements among different entities, as well as help the reader to better understand how the entity came to its conclusions.

When the idea was first brought forth, critics contended that the switch would be expensive—as companies had generally used historical costs to value assets—and that the method proposed by the FASB was overly subjective, according to CFO.com. The NYSSCPA, in a 2004 comment letter, said that more explanation and additional implementation examples would be needed.

Moreover, while some applauded the FAS for bringing the actual economic value of assets to light, others voiced concern that the rule would render it more difficult to finance debt, by making companies look more vulnerable than they really were and exposing them to credit downgrades. Banks also complained that the FAS required them to value assets at what amounted to fire-sale prices during the height of the financial crisis. Indeed, the rule became embroiled in controversy during the recession, culminating in a congressional hearing about the standard in 2009, where lawmakers called for additional guidance from the FASB.  In response, the FASB introduced revisions that relaxed the rules for mortgage assets, allowing banks to have more discretion when valuing these securities. 

In its review, however, the FAF said that the standard adequately resolves the underlying issues that it was created to address, provides investors with decision-useful information, is generally easy to use and understandable, and “did not result in any significant unintended consequences.” 

Joseph A. Maffia, a member of the NYSSCPA’s Financial Accounting Standards Committee and the FASB’s Small Business Advisory Committee, generally shared this opinion. When the standard first came out, he said, his initial view was that it was “overkill,” but as time went on and he worked with the rule, his thinking changed.

“I do recognize the need for it,” he said. “Level 3 disclosures were confusing at first, but it’s pretty basic once you deal with it year after year.” 

Jo Ann Golden, also a member of the Society’s Financial Accounting Standards Committee, said she had a similar reaction at first.

“It looked incredibly complicated,” she recalled.

Like Maffia, though, as she applied the standard, she came to appreciate what it was meant to do and how it managed to do it, saying that it captured much of the risk areas that a stakeholder would be interested in, and compartmentalized those risks in a way that was useful to a reader. So, she said, “if you’re looking at your Level 1 [investment], you don’t need to be so worried about money market accounts or straight-off investments that are reported on the market.

“As you get a little less clear [in Level 2 and Level 3 investments], it makes a lot of sense to get them into these three pockets, and I like that; being an accountant, you like things being organized and stable,” she said.

She added that FAS 157 is still relevant, particularly as more people turn to private equity as an investment vehicle, which, she said, is still a very unregulated area compared to other investments. Coupled with investors who might not be as sophisticated, she added, categorizing investments according to the standard “is very appropriate.”

“When looking at what the responsibility of the presentation of financial information is, you need to be able to assess the quality of what you’re investing in,” she said. “So, from a private equity market perspective, FAS 157 is very important.”  

The FAF report did acknowledge, though, that smaller practitioners have found there to be an increased compliance cost with FAS 157, recognizable mainly through the extra time and effort required to organize the Level 1, 2 and 3 disclosures. Maffia noted that he has seen this increased cost in certain smaller entities.

“When you’re auditing a pension plan, gathering sufficient appropriate evidence across the classification and value of those investments at fair value that are not Level 1 requires more time,” he said.

Golden said she is sympathetic to smaller entities that have reported higher accounting costs as a result of FAS 157, but added that “unfortunately, sometimes there is a cost to doing business, particularly if you do business in a riskier area” that requires Level 2 or 3 disclosures.

But even though the standard might be tough, she said, it responds to real needs, even in areas like pension accounting and not-for-profit entities that, according to the report, have also expressed frustration over higher costs. Both have a responsibility of stewardship to their respective stakeholders, particularly since investment activities in both sectors have been moving into vehicles that might not be as familiar.
“This offers another level of protection for these stakeholders,” Golden said.

The FASB, in a March 10 response to the FAF’s postimplementation review, said that, given the report’s conclusion, it sees no need to undertake its own comprehensive review of the standard.  However, the board added that it “acknowledges the feedback,” indicating that some find aspects of the rule to be challenging, but adding that it plans to conduct research and outreach with stakeholders.