SFAS 157 – How 'Fair is Fair' Value?

No matter if you believe that “fair value” drives unnecessary market instability or that it provides enhanced transparency of financial information, the question remains unchanged.

No matter if you believe that “fair value” drives unnecessary market instability or that it provides enhanced transparency of financial information, the question remains unchanged. What is a supportable fair market value that reflects an orderly transaction between two or more willing market participants?

The SEC’s recently issued “Report and Recommendations Pursuant to Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark-To-Market Accounting” concludes, amongst other things, that “..additional measures should be taken to improve the application and practice related to existing fair value requirements – particularly as they relate to both Level 2 and Level 3 estimates”. In the report, the SEC’s Committee on Improvements to Financial Reporting (CIFiR) further recommended the SEC issue a statement of policy articulating how it evaluates the reasonableness of accounting judgments and include factors that it considers when making this evaluation, as well as that the PCAOB should also adopt a similar approach with respect to auditing judgments.

In light of these conclusions, and unlikely forthcoming judgment “guidance” for valuing financial instruments with primarily Level 2 and 3 inputs, it is important to gather all pertinent information and variables potentially used in building a valuation model. There are several keys to doing this including:

  • Monitor your investments and those similar throughout the reporting period, not just at the reporting date.
  • Stay in touch with general economic indicators.
  • Consider your true plans of instrument liquidation and whether the Company has the ability to wait out the market.
  • Get your non-accounting finance and analyst types involved as they are generally more comfortable with assumptions and judgment than most accounting types.
  • Provide your assumption documentation to your auditor as soon as possible – it is generally not difficult to audit the fair value model itself, however, getting reasonable documentation related to assumptions is where the time is spent, particularly when there is a difference in opinion as to what constitutes reasonable.
  • Try to keep it simple concise and as straightforward as possible. Tying certain assumptions to the lining up of the planets will likely not pass your auditor’s smell test.

By the way, the SEC’s Report concluded that the fair value accounting standards did not cause the bank failures of 2008.

Proactively Controlling Your Audit Fee

For many firms it is that time of year.  The annual invasion of that group of  mind numbing, routine interrupting, standards spouting unwelcome invaders – your independent auditors!  And they are expensive!  Reflectively they can make you want to trade their presence  for an unannounced three month visit from your cantankerous incontinent father-in-law who never speaks directly to you and who for fifteen years has  referred to you only  as “him / her”.  An article published in cfo.com, Auditor Angst, has some great points to not only help you survive, but to reduce the expense at the same time.  While the article primarily focuses on what the company can/should do there is obviously a lot the auditors can do as well. Continue reading “Proactively Controlling Your Audit Fee”

Uncle Sam Needs You!

Uncle Sam Needs YouIn 1966, the finger pointed directly at you from the fierce visage of a red white and blue top hatted bearded Uncle Sam on the recruiting poster.  I couldn’t look away in good conscience then and it is no less difficult now.  In an article posted on CFO.com titled Walker Makes Plea to CFO’s http://www.cfo.com/article.cfm/12448209/c_12447541 David Walker the former U.S. comptroller general asks CFO’s to help bail the country out of its’ current economic crisis and a $50 trillion deficit.  While, as with most of you, I’d be the first in line to offer my services, it won’t happen.  The first responsibility of every politician is to get re-elected.  Correspondingly as long as we have a system that allows for ‘pork’ trailers in legitimate bills, legislators unwilling to make the unpopular decision and lacking the intestinal fortitude to enforce a balanced budget, I’m not sure there is much we can do as advisors.  Because they just won’t listen!

The government bureaucratic system is not predicated on economic motivation from ‘self interest’ and individual benefit and correspondingly can’t be successful as a participant in a capitalistic economy. As Adam Smith, the father of modern economics, summarized in The Wealth of Nations – “I have never known much good done by those who affected to trade for the public good”.  If you haven’t read Free to Choose by Milton and Rose Friedman this would be a good time.  Here’s a great example found on the internet last week: Continue reading “Uncle Sam Needs You!”

How to create profits out of thin air

In my last posting I tried to make assets out of liabilities.  Now I want to make some profits out of my liabilities.  This is a piece of cake under current GAAP but my current favorite again relates to the issue of the convertible debt that seems to be so popular with companies with a bit of a going concern problem. Continue reading “How to create profits out of thin air”

Now to make silk purses (assets) out of sows’ ears (liabilities)

I have noticed a few companies using some ingenious accounting to create assets by issuing liabilities.

I have noticed a few companies using some ingenious accounting to create assets by issuing liabilities. One would have thought that debit cash credit liabilities would be a fairly simple transaction when you issue debt.  Not so when that debt is convertible debt issued with a warrant.

The way the scheme runs is a follows. The text books and the ancient APB 14 tell us that when you issue debt with detachable warrants you have to separate the warrants out from the debt and take the value assigned to the warrants to paid in capital. Continue reading “Now to make silk purses (assets) out of sows’ ears (liabilities)”

Convertible Debt and Its Never Ending Financial Statement Destruction

While preparing for the next client argument, I mean discussion, involving the issuance of convertible debt I was reminded of the additional effects certain provisions of EITF 00-19 has on other outstanding financial instruments / derivatives.

As anyone with outstanding convertible debt is aware, the key point to simplifying the accounting for any conversion feature that appears to require derivative accounting is to force the feature into being classified as permanent

While preparing for the next client argument, I mean discussion, involving the issuance of convertible debt I was reminded of the additional effects certain provisions of EITF 00-19 has on other outstanding financial instruments / derivatives.

As anyone with outstanding convertible debt is aware, the key point to simplifying the accounting for any conversion feature that appears to require derivative accounting is to force the feature into being classified as permanent equity.   In general, the best way to classify the resulting derivative as permanent equity is to convince yourself, your auditor, and in most cases the SEC, that your debt qualifies as a “conventional convertible debt” as unclearly defined by paragraph 4 of EITF 00-19 and then by the equally obscure EITF 05-02. Continue reading “Convertible Debt and Its Never Ending Financial Statement Destruction”

Does anybody know what an accounting policy is?

Until FAS 154 came along I thought I understood what an accounting policy was.  They were the things that went into note 1 to the financial statements for situations where there was an accounting choice between two alternatives.  Rather curiously whatever choice you made ended up providing a fair presentation as long as you were consistent and disclosed it in Note 1.

Until FAS 154 came along I thought I understood what an accounting policy was.  They were the things that went into note 1 to the financial statements for situations where there was an accounting choice between two alternatives.  Rather curiously whatever choice you made ended up providing a fair presentation as long as you were consistent and disclosed it in Note 1. Continue reading “Does anybody know what an accounting policy is?”