The FASB Decides on Changes to Fair Value and Impairment Charges

Yesterday, April 2, 2009, after agreeing to make a number of revisions to the original proposals, the Financial Accounting Standards Board (FASB) decided to move forward with issuing three FASB Staff Positions (FSPs) related to fair value and impairment charges. The first FSP will amend the FASB Statement of Financial Accounting Standards No. 157 (FAS 157), “Fair Value Measurements,” to address when a market is not active. The second FSP will change the recognition and presentation for impairment charges on debt securities. The third FSP will require more frequent disclosures of fair value for public companies.

Attention has been focused mostly on the first two proposals, which were issued on March 17. (Read our prior communication.) At yesterday’s meeting, the FASB also discussed its outstanding proposal to require more frequent disclosures of fair value.

Those closely following these developments will recall that the comment period for the first two proposals closed on April 1, 2009. Given the accelerated time frame for these projects, the FASB staff and board members did extensive outreach to preparers, users, and auditors to identify issues in the intervening comment period. Toward the end of yesterday’s meeting, there was an acknowledgment that as the board and staff continue to review comment letters and draft the final FSPs, there might be additional issues identified and clarifications made. The following is based on yesterday’s board meeting and is subject to change upon issuance of the final FSPs.

FSP to Change FAS 157
The proposed FSP FAS 157-e, “Determining Whether a Market Is Not Active and a Transaction Is Not Distressed,” included a two-step model. The first step determines whether factors exist that indicate that a market for an asset is not active. If step one results in the conclusion that there is not an active market, step two evaluates whether the quoted price (a recent transaction or broker quote) is not associated with a distressed transaction. The proposed model included a presumption that a quoted price from a market that is not active is a distressed transaction, unless there is evidence otherwise.

Yesterday, the FASB retained the basic approach described above but removed the presumption that all transactions are distressed unless proved otherwise. However, the FASB plans to include additional circumstances that indicate a transaction is not orderly. Under the forthcoming FSP, entities will conclude whether a transaction is orderly based on the weight of the evidence. Quoted prices that are not representative of an orderly transaction are not solely determinative of fair value. In estimating fair value, more weight should be placed on transactions that are orderly. Less weight should be placed on a transaction for which there is insufficient information to conclude whether it is orderly.

The FASB also agreed to emphasize that the FSP does not change the objective of a fair value measurement, even when market activity for the asset has decreased significantly. Fair value is the price that would be received to sell the asset in an orderly transaction, not a forced liquidation or distressed sale, between market participants at the measurement date in the current inactive market.

This FSP will also require additional disclosures. In particular, entities will now disclose any changes in valuation technique and related inputs resulting from the application of the FSP and, if practical, quantify the effect.

FSP to Change FAS 115 and EITF 99-20
The proposed FSP FAS 115-a, FAS 124-a, and Emerging Issues Task Force (EITF) 99-20-b, “Recognition and Presentation of Other-Than-Temporary Impairments,” initially included both debt and equity securities. Based on the feedback received, the FASB decided the final FSP will apply only to debt securities.

One significant change to current practice relates to management’s assertion regarding recovery of fair value declines. Yesterday, the FASB affirmed its decision to move from an assertion about “intent and ability to hold to recovery” to a “do not intend to sell” or “it is more likely than not that it will not be required to sell” prior to recovery assertion. Currently, when determining whether the impairment is other-than-temporary, preparers must assess whether the entity has the intent and ability to hold a security until recovery of its cost basis.

Under the forthcoming FSP, preparers will assess whether the entity intends to sell the security or if it is more likely than not that it will be required to sell the security prior to recovery. If the entity does not intend to sell the security or if it is more likely than not that it will not be required to sell the security before its anticipated recovery, then all available evidence should be considered to estimate the anticipated period over which the cost basis of the security is expected to recover. If the entity does not anticipate recovery of its cost basis, an other-than-temporary impairment should be considered to have occurred and the credit loss component, as described below, should be recorded in the income statement.

Another change relates to measuring impairment in instances other than when an entity intends to sell or is more likely than not to be required to sell prior to recovery. Under the current practice, if an impairment is deemed to be other-than-temporary, the loss is recognized in earnings as the difference between the cost and fair value measured as of the balance-sheet date. This difference encompasses all declines in fair value, which would include not only credit but also such items as changes in interest rates and market liquidity.

The FASB affirmed its decision to bifurcate the components of fair value when an other-than-temporary impairment exists as follows: The credit loss component would be recognized in earnings, and the other components would be recognized in other comprehensive income in instances other than when an entity intends to sell or is more likely than not to be required to sell prior to recovery. Although the net charge to the income statement represents only the credit loss component, both the credit and noncredit components will be presented in the income statement. The total other-than-temporary impairment charge will be reduced by the amount recognized in other comprehensive income.

To recap, the FASB actions would result in the following.

If the entity intends to sell the security or it is more likely than not that the entity will be required to sell the security prior to recovery of its cost basis, the entire impairment would be recognized as an other-than-temporary impairment in earnings, which is consistent with existing rules.
If the entity does not intend to sell the security and it is more likely than not that the entity will not be required to sell the security prior to recovery of its cost basis, the entity should estimate the anticipated period over which the cost basis is expected to recover. If an other-than-temporary impairment exists, only the amount of the total impairment charge related to credit losses would be recognized in earnings. The final FSP will clarify that credit losses should be based on the estimate of the decrease in expected cash flows or on the best estimate of the amount of the other-than-temporary impairment that relates to credit deterioration. One way of estimating this amount would be to consider the measurement methodology described in FAS 114, “Accounting by Creditors for Impairment of a Loan.” The remainder of the impairment (those declines due to other factors such as liquidity and interest rates) would be recognized as part of other comprehensive income rather than as part of earnings. This is a significant change from current practice.

Several comment letters suggested that for held-to-maturity debt securities, only credit losses should be recognized in the income statement, and the fair value should be disclosed in the notes to the financial statements. However, the FASB decided to retain the requirement as proposed to recognize noncredit losses on held-to-maturity debt securities in other comprehensive income and amortize that amount over the remaining life of the security.

A number of other suggestions were made, including recommendations to address the prohibition against reversals of other-than-temporary impairment charges and equity securities that have debt-like characteristics. The FASB decided not to address these issues in the final FSP because of the existing broader project on its agenda to consider changes for all financial assets and liabilities.

FSP to Change FAS 107
On Jan. 30, 2009, the FASB issued proposed FSP FAS 107-b and Accounting Principles Board (APB) 28-a, “Interim Disclosures About Fair Value of Financial Instruments,” to require more frequent disclosures under FAS 107, “Disclosures About Fair Value of Financial Instruments.” The proposal is largely in response to concerns expressed about the lack of fair value disclosures – particularly for loans – in the interim financial statements. The FASB sought comment on the practicality of requiring these disclosures on an interim basis and the timing that would be necessary to create processes and controls in order to comply.

Yesterday, the FASB decided to proceed with issuing a final FSP to increase the frequency of disclosures about fair value of financial instruments. This FSP will require additional qualitative (that is, the methods and significant assumptions used to estimate fair value) and quantitative disclosures for interim periods in addition to the existing annual requirement. The FASB did agree that the final FSP will apply only to public companies.

Effective Dates and Transitions
The FASB decided that all three FSPs should be applied for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. Earlier application for periods ending before March 15, 2009, would not be permitted.

If an entity chooses early adoption of the FSP to amend FAS 157, then the FSP to amend FAS 115 and EITF 99-20 also must be adopted. Likewise, if an entity chooses early adoption of the FSP to amend FAS 115 and EITF 99-20, the FSP to amend FAS 157 also must be adopted. If an entity chooses early adoption of the FSP to amend FAS 107, all three FSPs also must be adopted.

For making the transition to the new rules, the FASB decided that an entity that does not intend to sell the security, and that is not more likely than not to be required to sell the security before recovery, should record a cumulative effect adjustment as of the beginning of the period of adoption to reclassify the noncredit component of a previously recognized other-than-temporary impairment from retained earnings to other comprehensive income. For entities that choose early adoption, the adjustment will be made as of Jan. 1, 2009.

Readers are encouraged to stay tuned for the issuance of the final FSPs. The FASB expects to post the final FSPs on either April 9 or April 10.

Read the FASB's summary.

Contact Information
If you have any questions about the FASB’s proposed changes, please contact Sydney Garmong with Crowe Horwath LLP at 202.333.0375 or sydney.garmong@crowehorwath.com.

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