Fair Value Expertise in Demand
Fair value accounting has been blamed for exacerbating the credit crisis – mainly for its contribution to billions worth of dollar writedowns. Also known as FAS 157, the measure forces companies to use complex methods to assign a value to an asset based on what the current market would be willing to pay for it. Critics contend, however, that market prices in the current distressed environment don’t reflect the asset’s true value. Asset values have been hit by falling home prices, loan delinquencies and foreclosures. FAS 157 requires firms to use market data to value assets. Since the market for most mortgage-backed securities has dried up however, there is little active trading to price CDOs or other complex investments.
Mark-to-market, or fair value accounting, took full effect this year. And despite the criticism, SEC Chairman, Christopher Cox, says fair value accounting is here to stay, according to CNBC. The report quotes Cox as saying, “No one is seriously proposing getting rid of fair-value accounting.” Cox adds that current mark-to-market models provide great benefits to some of the alternatives.
Now, as public firms grapple with the challenges of fair value accounting, they are investing in the infrastructure necessary to comply with the measure. As a result, candidates seeking accounting jobs and business valuation jobs are poised to gain from the trend. Executive search firm, A.E. Feldman, says demand is intensifying for accountants with expertise in fair value measurements, specifically FAS 157 and FAS 159.
FAS 157, Fair Value Measurement, provides accountants and auditors with methods required to value assets and liabilities at fair or market values. FAS 157 defines fair value as “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.” Essentially, fair value is no longer based on what you pay for something, it is based on its “exit price” or sale price.
According to the PCAOB:
- Fair value is the amount at which an asset or liability could be bought or sold in a current transaction between willing parties.
- Quoted market prices in active markets are the best evidence of fair value and should be used as the basis for the measurement, if available.
- The estimate of fair value should consider prices for similar assets
- Valuation techniques should incorporate assumptions that market participants would use in their estimates of value.
Building on FAS 157, FAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, permits companies to elect fair value for certain financial assets and liabilities. In short, it provides the option to report investments at fair value (using FAS 157 as a valuation guide).
Fair value measurements divide bank assets into three “levels.” Level one assets must have quoted prices in active markets such as U.S. government bonds. Level two assets are not as fully marketable as level one, but still sufficiently tradable to have a definite value. Level three assets, on the other hand, do not have quoted prices in active markets. Mortgage backed securities comprise a significant part of all level-three assets, along with higher-quality mortgages and leveraged bridged loans for buyouts.
Renewed Fair Value Debate
The debate over “fair value” accounting has been heating up recently after the Institute of International Finance (IIF) proposed relaxing some of the rules. The proposal sparked criticism from regulators and the IIF itself.
IIF Managing Director Charles Dallara, has since issued a statement clarifying the group’s position on fair value accounting. Dallara says by engaging in informal consultations involving market participants, central bank and finance officials, securities and banking regulators, auditing authorities and accounting standard-setters, the IFF has found that views differ widely on about how best to address a number of complex and important valuation issues.
Dallara also says that while fair value accounting remains an essential element of global capital markets, there is a need for clarification in several areas, including pricing inputs in illiquid markets. Dallara adds that for some products in particular circumstances, there is merit in considering other refinements in valuation methodologies and greater flexibility regarding the transfer of assets between accounting categories.
As firms face the challenge of complying with FAS 157, experts in valuation are in high demand. Web CPA quotes Mark Olson, Chairman of the Public Company Accounting Oversight Board, as saying, “determining fair value requires training, and many auditors may not have extensive training in valuation techniques.” Olson goes on to say that auditors must ensure that preparers have considered some alternative valuation scenarios.
