PwC IFRS blog

Can you see the join?

Few subjects stimulate as much debate in accounting as fair value measurement. It has been blamed for many things over the past few years, including contributing to the credit crisis. The IASB and the FASB have committed to a joint response, and they have both issued discussion documents over the past few months. However, despite the focus on convergence and the Standard Setters working together to achieve one set of Global Standards, it’s clear these documents are not wholly consistent with each other.

Pressure from the US Congress in March resulted in the FASB publishing staff position papers (FSPs) on fair value and impairment of debt securities. The IASB sought views and concluded that the FASB guidance on fair value measurement was broadly consistent with IFRS guidance contained in last October’s report from the IASB’s Expert Advisory Panel (EAP).

The FASB and IASB documents have different emphases (for example, the FSP focuses on indicators of inactive markets; the EAP requires management to consider all available information and to apply judgement) and a few subtle differences (for example, on transactions that are not orderly), but these aren’t expected to result in differences in practice.

Guidance from the FSP and the EAP has been included in the IASB’s long-awaited exposure draft on fair value measurement, published last month. It addresses the question of how to measure fair value but not when. So it is perhaps not the most controversial topic of the moment.

The proposed standard is based on the US equivalent, SFAS 157, ‘Fair Value Measurements’. The definitions of fair value are identical – that is, “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” (the ‘exit price’ approach) – but there are some important differences. The IASB has proposed not to permit recognition of day-one gains for those financial instruments whose values are impacted significantly by unobservable inputs (so called Level 3 financial instruments).

This looks to be a sensible move in response to recent market conditions, but nonetheless it is an interesting departure from the US position. The IASB has also proposed a different unit of account for financial instruments measured on the basis of anything other than unadjusted prices in an active market (so called Level 2 and 3 instruments – that is, at the level of an individual instrument rather than a portfolio). This appears contrary to the approach typically adopted by  banks of valuing certain risks in their derivatives portfolios (such as credit risk) across the whole portfolio rather than by individual instrument. There are other subtle changes that could also result in differences in practice. 

As I mentioned, the IASB and the FASB have committed to a joint response to tackling the reporting issues arising out of the credit crisis; something called for by the G20 and most recently reflected in the US White Paper on Regulatory Reform from the Obama Administration. This is also reflected in continuing calls from many for an accounting level playing field between IFRS and US GAAP, notwithstanding that there are some fairly significant underlying differences between the two GAAPs.

There are clearly real challenges in seeking to move forward and improve accounting standards quickly, while at the same time avoiding the creation of new differences, some of which may be subtle and perhaps of lesser significance while others may well have greater impact.

As always, I would be interested in your thoughts, either by commenting here or by email.

Son of IAS 39 - or several sons?

One of the conclusions reached by the G20 leaders at their summits in Washington DC last November and in London at the beginning of April was that the accounting standards for financial instruments are too complicated. They called for the standard setters to take action by the end of 2009 to reduce that complexity.

This shouldn’t come as too much of a surprise to any of us. IAS 39, ‘Financial instruments: Recognition and measurement’, has been subject to criticism since before it was issued. While the IASB did issue a discussion paper ‘Reducing complexity in reporting financial instruments’ last year, we have seen it accelerate its programme rapidly over the past few months.
 
In March, the IASB and FASB reaffirmed their commitment to a joint approach to the financial crisis and to the goal of seeking convergence between IFRS and US GAAP. The IASB also decided to prioritise development of a new financial instruments standard rather than making further amendments to existing requirements. Then, a couple of weeks ago, it decided to accelerate this project further, splitting it into separate work-streams with the aim of publishing a series of proposals, one after the other, on the following themes:

• Classification and measurement. The current premise is that a new standard should contain two measurement categories – fair value and amortised cost. As a starting point, the IASB is considering a classification approach similar to that in the forthcoming IFRS for small and medium-sized entities (SMEs), which distinguishes between basic financial instruments that are measured at amortised cost and other financial instruments that are measured at fair value. The IASB says that its goal is to publish an exposure draft on classification and measurement by the end of next month and to publish a final standard in November, which will provide the option of implementation in time for 2009 year-end financial statements.

• Impairment of financial assets. An impairment model will need to be determined if some financial assets are to be measured at amortised cost. Possible models under consideration are the incurred loss model currently in IAS 39, an expected loss model or fair value. The IASB’s plan is to request views from interested stakeholders in July, possibly to be followed by an exposure draft in October.

• Hedge accounting. The thinking about hedge accounting is not as advanced, but the IASB still intends to issue an exposure draft perhaps by the end of 2009 or in 2010.
 
There is undeniably a need and political pressure to address this area. But it is a huge undertaking to overhaul and simplify such a complex subject and to ensure in so doing that the learning points from the extreme stress-testing encountered through the financial crisis are addressed.

Some questions spring to mind: Can the standard-setters meet such an ambitious timetable? Are the issues too contentious for such a short comment period? Would it be better to have a shorter term solution and allow time for FASB and IASB to have a proper debate? Is their approach likely to see global convergence penalised to achieve a quick answer?

As always, I would be very interested in your views, either by email or by commenting here.