Fair value accounting: fair for whom?

• Author: Sayther, Colleen
• Position: President's Page

It was no surprise when the Financial Accounting Standards Board (FASB) added a fair value measurement project to its agenda last June. Both Bob Herz, FASB chairman, and Sir David Tweedie, IASB chairman, have a fair value orientation to financial reporting. Herz's view, in particular, is that income should be measured by change in value or net worth. FASB, which has concluded in many recent pronouncements that fair value information is the most relevant, wants to develop a Fair Value Statement establishing a framework for measuring fair value and codifying the relevant guidance.

[ILLUSTRATION OMITTED]

FASB has revised the definition of fair value to "the price at which an asset or liability could be exchanged in a current transaction between knowledgeable unrelated willing parties when neither is acting under compulsion." Willing parties are "all marketplace participants ... that are willing and able to transact, having the legal and financial ability to do so." FASB has also been working on appropriate valuation techniques and a fair value hierarchy to prioritize the required market inputs for all fair value estimates. IASB is also discussing fair value measurements, and probably has an even more solid bent towards that method.

It is hard to argue that fair value is not a relevant measure. However, other aspects of financial reporting are just as--and perhaps more--important: reliability, understandability and comparability. I recently read "The Smartest Guys in the Room." Bethany McLean's book about Enron, and if ever there was an example of why not to support fair value accounting, Enron is it. CEO Jeffrey Skilling even included the ability to use fair value accounting in his employment contract.

The beginning of the end for Enron was its ability to manipulate fair value calculations to its advantage--recording revenue on transactions that would not be profitable for several years out. It was a great earnings story, but didn't match up with the fact that the company had no cash and continually had to increase borrowings. That's when it began creating off-balance-sheet debt transactions to hide this mismatch.

Clearly, fair value accounting creates the potential for either unintentional or intentional bias. Companies could significantly manage earnings with slight changes to valuation procedures. Fair value models require a number of assumptions, and minor changes can substantially affect the results. Is this model superior to historical...