Like it or not fair value is here to stay: arguments aside, FAS 157 has been issued, and financial managers and audit committees need to focus on the challenges it poses and the benefits of achieving fair value accounting.

• Author: Ferguson, Lewis H.
• Position: FINANCIAL REPORTING

Statement of Financial Accounting Standards 157 (FAS 157)--issued last September by the Financial Accounting Standards Board (FASB)--has attracted much attention, because its application poses a number of challenges for financial managers and directors of public companies.

It's a definitional standard--one that provides guidance on how entities should measure fair value when they are required to or have elected to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles (GAAP).

Fair value measures have been permitted or required in the preparation of financial statements for many years and in many places. Some are onetime and event-driven, such as the recording of assets and liabilities acquired in a business combination; impairment of financial assets, inventory or long-lived assets; stock-based compensation measured at fair value on the grant date under FAS 123 and FAS 123R; and asset retirement obligations initially recognized at fair value.

Other fair value measures are recurring, such as the fair value accounting for marketable securities, derivatives and the optional fair value measurement of certain servicing rights and obligations (FAS 156) and other financial assets (FAS 159).

Historically, there were several problems with fair value measurements: they were defined inconsistently, measurement approaches differed among users and disclosure was both inadequate and inconsistent. In too many cases, it was simply impossible to tell what a purported fair value measure of an asset or liability meant and how it had been determined. Over the past several decades, there has been a movement in public accounting to shift the basis of financial statements from static, historical-based measures to more dynamic and market-based measures of value; the movement to fair value accounting reflects that trend.

Proponents of the move argue that financial statements based on fair value measurements are more relevant and useful, more accurately reflect real-world volatility, simplify financial reporting and are more understandable and comparable to other financial statements.

Opponents have argued that, particularly in the absence of an actively traded market, fair value measurements are, in fact, less rather than more reliable, more subjective, result in meaningless volatility in reported earnings, are difficult to measure and audit and create opportunities for second-guessing by auditors and regulators. Perhaps most importantly, critics argue that fair value measurements in the absence of an actively traded market offer opportunities for earnings management.

Whatever the merits of the arguments, fair value accounting seems to be here to stay, and FAS 157 has created new rules for applying it. First, FAS 157 offers a new definition of fair value: 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.

This means that...