Accounting Observer > Public Blog - Principles, Rules & Fair Value Option Gaming

The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis. All posts prior to September, 2007 are in the public domain, but after September 4, 2007, only subscribers to The Analyst's Accounting Observer will see all posts going forward. Only selected, occasional posts will be released to the public domain from September 4 forward.

Principles, Rules & Fair Value Option Gaming

Location: Blogs AAO Weblog (Public)
Posted by: Jack Ciesielski	4/13/2007 5:56 AM
A very good speech by James Kroeker, the SEC's Deputy Chief Accountant, was delivered last week at a conference on principles-based accounting dealt with the misconceptions about the distinctions between "principles" and "rules." And he makes a pretty good case The favorite whipping boy of those criticizing current accounting standards is Statement 133; it's often vilified for its 800-page heft. You never hear WHY it's 800 pages, though. Kroeker deftly explains how the standard got that way: "... I believe that Statement 133 at its core is based upon sound principles. The objectives of the standard are laid out in a few paragraphs and seem fairly straight forward (derivatives represent assets or liabilities, such assets and liabilities should be recorded at fair value, changes in fair value should be recorded in income and special accounting for hedging should be provided only for qualifying items). However, the standard is accompanied by 800 plus pages of implementation type guidance providing a host of well meaning scope exceptions, bright-lines, and rules. It is the volume of guidance, that in many cases makes it more difficult, rather than easier, to apply the standard. Accordingly, it is not hard to understand why someone could lose sight of the bigger picture." It's the FASB's need to please everybody that's the real culprit. Kroeker also offers that the new standard on the fair value option (Statement 159) is a principles-based/objectives-based standard, but that those who wish to push the envelope of such a standard have already found a way - because it doesn't SAY you can't do something that runs counter to the intentions underlying the standard. Check Jim's discussion here, and pay close attention to the emphasized parts: "... Statement 159 allows entities the option to elect to account for certain financial assets and liabilities that they hold upon adoption on a fair value basis. Further, companies can pick and choose which assets and liabilities, if any, to account for on a fair value basis. Upon electing fair value measurement any difference between fair value and carrying value of the asset or liability, including any amounts recorded in other comprehensive income, are recorded directly to retained earnings. However, once adopted for a given asset or liability the fair value election is irrevocable. Accordingly, some might suggest that an entity should elect the fair value option for certain existing investment assets where the carrying amount is less than fair value. This would provide for the ability to in effect write down the value of the asset without a charge to the income statement. While this might be provided for in the transition provisions, the series of events does not stop here. Rather, some might suggest that entities would then have the ability to sell the asset right after adopting the fair value option without recognizing a loss and then repurchase the same asset shortly after the sale and designate the assets as something other than a fair value investment. Unfortunately, in this case the "opportunity" appears to be one that could confuse investors rather than provide more meaningful information to investors. Engaging in this type of activity does not appear to promote the objective of the accounting standard. Accordingly, you can expect the SEC staff to continue to have an interest in such activities." Interesting, isn't it? It leads one to believe that the problem isn't with the objective of the standard or the standard-setters; the problem might be the objectives of those who actually apply the standards.

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