An article I wrote recently with Wil Pfeiffer on the issue of fair values in Canada, USA and under IFRS. The “fair value game” as I call it. It appeared in the December issue of the Association for Financial Professionals Newsletter on Financial Accounting and Reporting (reprinted with permission).

The Financial Crisis
What does it mean for IFRS and FAS 157?
Darla Sycamore and Wil Pfeiffer
Every cloud has a silver lining, so they say. The most notable part of the events over the last few months has been the degree of international cooperation in attempting to resolve the credit crisis. Governments have been cooperating on all aspects and on a timely basis.Financial reporting has had a starring role in these events.
This move to international cooperation in financial reporting did not happen overnight. Over 100 countries have either adopted or converged with the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB).
In Canada, the Accounting Standard Board (AcSB) has been working very closely with the IASB. Canada
is requiring “publicly accountable enterprises” to report using IFRS effective for years beginning after Jan. 1, 2011. However, there has been close cooperation with the IASB over the last several years and work still continues on further convergence to the adoption date. In the U.S., the Norwalk Agreement has been in place since 2002. This agreement sets out a plan for U.S. GAAP promulgated by the Financial Accounting Standards Board (FASB) to converge with IFRS. There has been a lot of progress on this exercise.
Recently the Securities and Exchange Commission (SEC) has proposed a roadmap for adoption of IFRS for U.S. public companies. It is currently out for comment by February of next year. Some U.S. issuers may be required to comply with IFRS as early as 2014.
This international cooperation has been stress-tested of late. In focus has been the valuation of financial instruments, their classification in the financial statements and the related disclosures. This has been especially problematic for banks. Some of the newer financial instruments such as subprime mortgage pools and credit derivatives have become difficult and nearly impossible to value in these times of illiquid markets.
We have a mixed valuation model for reporting financial instruments. Some instruments, typically those that are held to maturity, are carried at amortized cost with disclosure of fair values. Others are valued at fair value. It is complicated. FAS 157 has become the starting point for fair values under an ongoing study by the IASB. It uses a hierarchical approach to valuation depending on the availability of market data. The U.S. standard has come under attack recently for the approaches used when markets are illiquid. Over the last three months, there has been a lot of cooperation among standard setters on the development of appropriate fair values in illiquid markets. The FASB and the SEC issued joint guidance and the IASB has issued similar guidance. Recently similar guidance has been issued in Canada.
There has been a lot of pressure on standards setters to abandon fair value accounting for the difficult-to-value financial instruments at least. The G20 has asked the IASB  and other key accounting bodies to study the issue of complex financial instruments among other matters and report back by March 31, 2009.
It is generally believed that the use of fair values in financial reports did not actually cause the credit crisis. This seemed to be confirmed by the G20 at its recent meeting.  The jury is still out on whether the continuing use of fair values leads to “procyclical” effects. Depressed values lead to a need to shore up bank capital, for example.
The debate is still going on. The SEC has held two recent roundtables on the issue. Here are some of the points raised:
• Include some types of financial instruments in a special
hold-to-maturity category (providing the institution
is able to hold on, which is a difficult call these days).
This would lead to an amortized cost model rather than
a fair value model
• Have a separate “regulatory accounting” model other
than GAAP to use for regulation of financial institutions
• Significantly improve the disclosures about valuations
in financial reports. Sensitivity analysis disclosure has
been suggested by some.
• Provide additional guidance on fair value methodology.
Of course, also on the table is the abandonment of the
fair value model itself. User groups are very opposed to this.
The Chartered Financial Analysis (CFA) group continues to
support the fair value model. Some users would support a
model that abandons the use of mixed valuations of financial
instruments with all financial assets and liabilities being
valued at fair values. This dream may be a long way off in
the current environment.
In order to be compliant with new standards, many companies are going to have to invest in new trade management technology that has been designed specifically to handle many of the more complex financial instruments. An area of specific concern is the complex and customized nature of the OTC derivative market. One thing is for certain: The days of the corporate treasury using spreadsheets to manage transactions will be rapidly coming to an end.
For further information on this topic or the authors, please
contact:

Darla Sycamore, independent IFRS consultant, writes a
blog on IFRS She can be reached at darla@ifrsexorcist.com or Wil Pfeiffer,
director at Finrad, wpfeifffer@finrad.com or www.finrad.com

© 2008 Association for Financial Professionals Reprinted with the permission of AFP

The Association of Financial Professionals describes itself as
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Tagged as: AFP, Credit crisis, Fair Values, IFRS