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IASB Proposes Overhaul of Fair Value Accounting Rules

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It has been a year of significant changes to the way assets are valued and it seems that more are still to come. This week the International Accounting Standards Board (IASB) released its long awaited proposals for a revamp of the often controversial fair value accounting rules.

The IASB’s proposals are, in fact, four months ahead of its original schedule as a result of just how controversial these rules have proved. In May, the IASB faced pressure from European Union finance ministers who kicked up a fuss about the disparity between accounting standards in the region and the more relaxed rules in the US. As a result, it was forced to expedite its decision making process on the subject in order to appease political lobbyists. The IASB had originally planned a revision of IAS39 to be published in October, but was forced to promise a draft of the revisions for July, which has subsequently been released this week.

According to the IASB, the proposals answer concerns raised by these interested parties during the financial crisis, for example, eliminating the different impairment approaches for available for sale assets and assets measured using amortised cost. The IASB indicates that it plans to finalise the classification and measurement proposals in time for non-mandatory application in 2009 year end financial statements. It has also said that it plans to complete the replacement of IAS 39 during 2010, although mandatory application will not be before January 2012.

The proposals are the accumulation of the work that has been conducted jointly with the US Financial Accounting Standards Board (FASB) to eradicate the differences between the applications of accounting rules on both sides of the Atlantic. Earlier this year, the FASB relaxed the rules for mark to market accounting in order to give more leeway to financial institutions when valuing hard to value assets in illiquid markets.

David Tweedie, chairman of the IASB, explains: “The financial crisis has demonstrated that investors need to be given a better understanding of information presented in the financial statements about financial instruments held or issued by a company. Making it easier for investors to understand financial statements is an essential ingredient to the recovery of investor confidence. The proposals today are an important first step in this process. They also respond directly to concerns raised about the accounting for financial instruments. In finalising these proposals we will continue to work jointly with the US standard-setter, the FASB, to achieve a common and improved accounting standard on financial instruments.”

The IASB proposals provide principles for financial institutions to follow when deciding whether to value an asset as a long term holding or as a trading position. Derivatives and other more illiquid instruments would therefore be valued at current market levels, whereas more traditional, standardised assets would be permitted to be valued using an accounting mechanism that smoothes out market fluctuations.

The likely outcome of these new rules is that more financial instruments will be reported at current market values, thus increasing both transparency and volatility within valuations. They will allow firms more freedom in the way they value assets, much like in the US, and permit them to use “significant judgement” where market prices are unavailable.

Not everybody is an opponent of the fair value rules, however: last month Lloyd Blankfein, CEO of Goldman Sachs, praised the rules as a means of forcing firms to face up to their losses. He said the rules could have even provided an early warning of the financial crisis: “Had fair market been implemented more widely then people would have had an early warning and seen value erode. It’s painful to mark these things down, but it’s more painful to have to mark them down beyond the point where you can no longer afford the capital.”

The slackening of these rules is therefore seen as a potential threat to the stability of the financial markets by some corners of the market. The danger of allowing more freedom in valuation is that off balance sheet assets may accumulate and pose underlying risk exposures. However, given that the subject has proved to be such a political hot potato, the measures are likely to be introduced without any problem.

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