SEC Alert: Fair Value Accounting: SEC and FASB Issue Updates
10/22/2008
On September 30, 2008, the SEC’s Office of the Chief Accountant and the staff of the FASB jointly issued a press release (2008-234), “Clarifications on Fair Value Accounting.”
Among the major points are the following:
• When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows—including appropriate risk premiums—is acceptable.
• Broker quotes may be an input when measuring fair value, but are not necessarily determinative if an active market does not exist for the security.
• The results of disorderly transactions are not determinative when measuring fair value.
• A quoted market price in an active market for the identical asset is most representative of fair value and thus is required to be used (generally without adjustment). Transactions in inactive markets may be inputs when measuring fair value, but would likely not be determinative. If they are orderly, transactions should be considered in management’s estimate of fair value. However, if prices in an inactive market do not reflect current prices for the same or similar assets, adjustments may be necessary to arrive at fair value.
The press release also addressed impairments by stating that “the greater the decline in value [of a security], the greater the period of time until anticipated recovery, and the longer the period of time that a decline has existed, the greater the level of evidence necessary to reach a conclusion that an other-than-temporary decline has not occurred.”
Subsequently, (October 10, 2008), the FASB formally issued guidance as a FASB Staff Position (FSP 157-3), “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.” The FSP expressly reaffirms that fair value is an estimated exit price, and it gives an example of how to estimate fair values when relevant observable data are not available. The FSP adds that in disorderly markets, judgment is required when deciding to accept or reject market prices as evidence of fair value. Further, judgment about fair value is required at the individual transaction level, meaning that distressed prices in a disorderly market do not automatically suggest that all prices in that market are similarly distressed. The FSP is immediately effective, including for prior periods, for which financial statements have not been issued.
Fair Value Accounting: IASB
Shortly after the above actions in the U.S., the IASB issued on October 13, 2008, an amendment to IAS 39, “Financial Instruments: Recognition and Measurement,” and to IFRS 7, “Financial Instruments: Disclosures.” The amendments permit the reclassification of some financial instruments that had been measured at fair value through income (trading assets) to a different accounting basis that allows deferral of fair value changes in equity. Previously, IAS 39 did not permit reclassification of these instruments. The reclassifications may be applied retrospectively to July 1, 2008. Therefore, companies will not have to report some of the adverse fair value adjustments in the third quarter of 2008 and can defer recognition of these losses. However, since the initial transfer must be made at fair value, the reclassification will not result in reversals of previous write-downs. Nonetheless, the amendments will prevent new write-downs from affecting net income immediately. Sir David Tweedie, chairman of the IASB, stated:
“In addressing the rare circumstances of the current credit crisis, the IASB is committed to taking urgent action to ensure that transparency and confidence are restored to financial markets. The IASB has acted quickly to address the concerns raised by EU leaders and others regarding the issue of reclassification. Our response is consistent with the request made by European leaders and finance ministers; it is important that these amendments are permitted for use rapidly and without modification.”
Money Market Funds: Restrictions on Withdrawals
Responding to a technical inquiry, the AICPA has addressed the issue of liquidity restrictions resulting from the right of a money market fund or other short-term investment (or its trustees) to restrict withdrawal. The AICPA cites an example where the fund (or its trustees) may limit (with little or no notice) withdrawals to 20 percent of the balance of the fund, with the remainder spread over six months to two years. In such situations, clients may need to consider whether such investments would now meet the definition of cash equivalents and whether they qualify as current assets.
In their response to the technical inquiry, the AICPA did not address whether such investments met the definition of a cash equivalent prior to the imposition of the withdrawal restriction. When a company prepares a non-classified balance sheet, consideration should be given to the sequencing of assets on the balance sheet and to disclosures in the notes about liquidity and maturity. Furthermore, the company may need to provide disclosures about risks and uncertainties that pertain to significant estimates, such as violations of debt agreements and concentrations of investments. If these events occur subsequent to the balance sheet date but prior to issuance of the financial statements, clients may need to reflect these events in the financial statements either through adjustments or disclosures.
We recommend that companies check their money market fund agreements to see if such restrictions exist.
To discuss how these issues may affect your company, please contact Kenneth Nielsen Goldmann, Capital Markets and SEC Practice Director, at kgoldmann@jhcohn.com or 973-618-6232.