Volume 19, No. 8


Fair Value & Financial Instruments: FASB's Better Idea:  The accounting standards governing financial instruments are a rickety stack of piecemeal fixes for problems arising at different times in the history of financial reporting. What the FASB has done with a pair of proposals covering reporting of financial instruments and other comprehensive income is novel: they’ve come up with a sweeping overhaul that’s better than what it replaces, and better than the approach taken by its standard-setting counterpart, the International Accounting Standards Board.

The financial instruments accounting proposal is the more dramatic of the two. It eliminates thefamiliar classification of financial instruments as held-to-maturity, available-for-sale, and trading, replacing them with just two: fair value and amortized cost. Both classifications earn a place on the balance sheet, and both will affect income statement presentation. Depending on the business model of the firm using them, some financial instruments may be reported on a fair value basis with changes in fair value reflected in earnings. Some financial instruments may be reported on a fair value basis, with cost basis-figured interest income (and impairments, where necessary) reported in net income. The fair value changes for such instruments would be reflected in other comprehensive income. That’s where the second FASB proposal comes into play. To give the effects of all fair value reporting equal prominence, the proposal requires that firms present a “continuous statement” of comprehensive income. No longer can firms bury the statement of comprehensive income in a stockholders’ equity schedule. Now, comprehensive income gets its due - on the same page as net income.

The proposals provide a smorgasbord of accounting presentations: there’s something for every appetite. Regulators can tuck into the amortized cost information in setting capital requirements; cautious investors can savor fair value basis presentations; and companies can pridefully cook up their earnings presentations on an old-fashioned, net income basis - with their favorite adjustment seasonings, to boot. The presence of more information should make investors think more critically. So far, however, there’s been little support for the proposal from any quarter. Financial institutions have roundly criticized it: their financial statements would bear the most striking changes.

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