Yesterday, the FASB voted to propose a deferral of Statement 157 - not the full Monty, but a portion of it.
The part of Statement 157 that applies to financial instruments - the spaghetti hitting the fan these days - will not be deferred. So come next year, investors will still be able to pore over filings, trying to gauge their tolerance of Level 3 valuations of collateralized debt obligations and the like.
The part of Statement 157 that will be deferred for one year - presuming the proposed staff position will be favored by constituents (a process not unlike asking a bear if it likes meat) - is its application to all nonfinancial assets and nonfinancial liabilities, except for those items that are recognized or disclosed at fair value in the financial statements on a recurring basis. Some examples: non-financial assets and non-financial liabilities that are measured at fair value in a business combination; indefinite-lived intangible assets; asset groups in impairment tests; and asset retirement obligations initially measured at fair value.
No deferral on derivatives – financial and nonfinancial ; servicing assets and liabilities measured at fair value on a recurring basis under Statement 156; loans; and debt. So investors can relax a little bit - the scary stuff of the moment will still be uncovered by Statement 157. (Hopefully.)
One has to wonder what the deferral really accomplishes: the items on which 157's applicability is deferred are mainly the things of acquisitions and impairments. The (eternally) forthcoming standard on business combinations, Statement 141R, is expected to address these issues, and sounds as if it won't be effective until 2009 - just like this deferral.
Is this just your regular double-strength, double-secret deferral? Or is the arrival date of 141R even later once again? Or is it good public relations so that the FASB appears to be receptive to the requests of preparers who have coughed up concerns about Statement 157 late in the game? Maybe all three. Insufficient data to evaluate, for now.
One note: in the FASB's handout materials for the meeting, they mention that "Preparers that advocate a deferral note that the early adopters had been following the deliberations of the Statement more thoroughly and extensively than those that did not early adopt. They also observe that the early adopters are primarily large financial institutions that have significantly more experience and dedicated resources in valuing financial instruments (as well as nonfinancial instruments).
Not so fast. In connection with an upcoming piece on fair value reporting, we've tracked down 88 publicly-traded firms that adopted Statement 157. They were definitely not "primarily large financial institutions that have significantly more experience and dedicated resources in valuing financial instruments." (Although they were mostly financial institutions.) Of the 88 firms, 56 of them - over 60% - had a market capitalization of less than a billion dollars. The median market cap: under $300 million. Check the chart at left: of the ones we found, the vast majority were in the lowest market-cap decile. (Deciles measured in billions.) So let's not assume that all of the 157 early adopters are the now-stumbling financial giants; there were quite a few tiny community banks in the group.
Statement 157 is often blamed for asset writedowns in the colossal financials, amid whining about "Level 3" valuations - as if they're something new. Statement 157 didn't cause the problems - it's making the problems (crummy lending practices) visible, and opening up dialogue on handling them. Critics worry that the giants have diddled here and there with "mark-to-model" valuations and blame Statement 157 for allowing this to happen. The truth is that the standard had nothing to do with that - the diddling possibility always existed. The irony is while the big firms got the blame, the small firms were the ones actively gaming the standard, in conjunction with the fair value option, earlier this year. Remember when many small banks were trying to flush their losses on impaired held-to-maturity assets through retained earnings? That was genuine standard gamesmanship, but it's largely forgotten now.
We'll be examining more of the myths and misconceptions about fair value reporting in the next report. Coming to your inbox soon, I hope. If your firm doesn't subscribe to our research, maybe this would be a good time to start.