Alert October 07, 2008

FASB Staff and SEC Propose Clarifications on Fair Value Determinations in Inactive Markets

The staff of the Financial Accounting Standards Board (“FASB”) and the SEC’s Office of the Chief Accountant issued a joint press release, and FASB has proposed complementary interpretative guidance, on how to determine the fair value of a financial asset when the market for that asset is inactive. 

Neither the joint press release nor FASB’s proposed interpretative guidance, if adopted as drafted, are designed to change the fair value measuring principles currently articulated in Financial Accounting Statement 157 (“FAS 157”).  FAS 157, among other things, defines fair value as the price at which a transaction would occur between market participants at the measurement date, and it establishes a framework for measuring fair value under U.S. generally accepted accounting principles (GAAP).  Generally, under FAS 157, in a situation where there is little, if any, market activity for an asset, the asset’s fair value price should be equal to the price that the holder of the asset would receive in an orderly transaction at the measurement date.  The joint press release and the FASB’s proposed interpretative guidance, among other things, clarify that management, under certain circumstances, would be permitted to (a) use its internal assumptions, including expected cash flow, as inputs in measuring fair value when relevant market evidence relating to the asset does not exist, and (b) consider, but not rely exclusively on, various observable market factors (i.e., those observable market factors would not necessarily be determinative) if an active or orderly market for the asset does not exist, including if observed transaction prices are a result of distressed or forced liquidation sales.

Comments on FASB’s proposed interpretative guidance are due by October 9, 2008, and, recognizing the importance of this issue, FASB has indicated that it expects to review the comments and finalize its guidance on October 10, 2008.

In a related development, the SEC announced additional details of the study of “mark-to-market” accounting the SEC is required to conduct in consultation with the Secretary of the Treasury and the FRB under the terms of the Emergency Economic Stabilization Act of 2008.  Specifically, the Act calls for a study of mark-to-market accounting as provided for in FAS 157, as those standards apply to financial institutions, including depository institutions, with a focus on:

  • the effects of  mark-to-market accounting standards on a financial institution's balance sheet
  • the impacts of mark-to-market accounting on bank failures in 2008
  • the impact of mark-to-market accounting standards on the quality of financial information available to investors
  • the process used by FASB in developing accounting standards
  • the advisability and feasibility of modifications to mark-to-market accounting standards
  • alternative accounting standards to those provided in FAS 157
The SEC must complete the study by January 2, 2009.