BY duncan will
SFAS No. 157 provided guidance on how
relevance (“fair value”) would be determined
and disclosed. A few months later, FASB released SFAS 159, not to mandate the use of
fair value, but rather to give reporting entities
a “fair value option.” SFAS 159 allows companies to go not only line by line on financial
statements, but also “financial instrument
by financial instrument” within a financial
statement category.
The pronouncements permit treating some
financial instruments according to fair value,
while others still use historical cost accounting. The fair value option is elected when an
eligible item is first recognized, but the decision is irrevocable once the election has
been made.
FASB’s stated objective in offering the fair
value option was to improve financial reporting by giving entities the opportunity to
mitigate reported earnings volatility caused
by measuring related assets and liabilities
differently without having to apply hedge
accounting. However, this option provided
an incentive for some entities to use fair
value selectively. One unfortunate byprod-uct of the fair value option has been the lack
of comparability of financial reporting and
related analytics among otherwise comparable entities.
Both SFAS No. 157 and 159 took effect for
financial reporting periods beginning after
Nov. 15, 2007.
The FASB’s July 1 Codification of U.S. GAAP
has made references to SFAS obsolete. This
article addresses the risks associated with
U.S. GAAP Codification of Accounting Standards Topic 820, Fair Value Measurements
and Disclosures, and Topic 825, Financial Instruments (formerly SFAS Nos. 157 and 159,
respectively).
Topic 820 recognizes three valuation tech-
niques (the market, income and cost ap-
proaches) to measure the fair value of assets
and liabilities. These techniques represent
long-established approaches.
Topic 820 also prioritizes observable inputs
over unobservable inputs in determining the
fair value of an asset or liability. Observable
inputs represent the assumptions that market
participants would consider when pricing an
asset or liability based upon data obtained
from independent sources (not data provided
by the reporting entity). Unobservable inputs
are the reporting entity’s own assumptions
regarding what market participants would
consider in estimating the reporting entity’s
financial instruments.
Lastly, Topic 820 provides for a fair value
hierarchy to assess the significance of particular inputs. The fair value hierarchy is broken
into three input categories:
Level 1: Quoted prices in active markets
for identical assets or liabilities on a specific
date (e.g., the New York Stock Exchange,
NASDAQ).
Level 2: These inputs involve data other
than quoted prices and use comparables to
determine the value of an asset or liability
derived from prior transactions in similar assets or liabilities (e.g., Kelley Blue Book, real
estate comparables).
Level 3: These are unobservable inputs
and are based on management’s assumptions about what market participants would
consider to set fair value based on the best
available data (the income approach using
unobservable inputs).
close information about the impact of “
reasonably possible” alternative Level 3 inputs,
additional disclosures regarding Level 3 fair
value activity measurement, and additional
disclosures regarding transfers in or out of
Level 1 and 2 categories of inputs, as well as
other disclosures about inputs and valuation
techniques.
The risks in fair value
The Financial accounting Standards Board issued SFaS no. 157, Fair Value Measurements, in
September 2006, and SFaS no. 159, The Fair Value Option for Financial Assets and Financial
Liabilities, in February 2007. These pronouncements may appear old news, but they remain
fraught with risk for the unwary and are still being misunderstood and clarified.
Dangers lurk in fair value measurements and disclosures
assurancenews
COST IMPEDIMENTS
When it is not practicable (i.e., cost-prohibi-tive) for an entity to estimate the fair value
of a financial instrument, the entity should
disclose information pertinent to estimating
the financial instrument’s fair value and the
reasons why it is not practicable to estimate
its fair value.
Utilizing this exception to fair value reporting is a two-edged sword. While it is permissible to avoid the use of fair value in these
instances, doing so could be problematic.
SEC CHARGES FIRM
THAT FAKED KPMG AUDIT
CHICAGO — The Securities and Exchange
Commission has filed fraud charges
against a health care financial services
company after it allegedly provided
investors with forged financial statements
and audit reports to lure them into a $75
million investment scheme.
Officials of Canopy Financial Inc.
allegedy solicited investors by providing them with a falsified audit report
purportedly from KPMG, as well as bank
and financial statements with false and
misleading information. According to the
SEC, the fraud came to light when KPMG
discovered that Canopy had been claiming that its financial statements for 2007
and 2008 were audited by KPMG. In
fact, KPMG had never been retained by
Canopy to audit its financial statements
and had never opined on the financial
condition of the company, and the firm issued a cease-and-desist letter to Canopy.
OVERSTOCK CEO ESCALATES
BATTLE WITH GRANT THORNTON
SALT LAKE CITY — The dispute between
Overstock.com and its former auditor,
Grant Thornton, heated up after the
Internet retailer’s chief accused the firm
of “inconsistencies and inaccurate statements.” CEO Patrick Byrne released a
letter in response to an SEC filing from
Grant Thornton, in which the firm said
that it had determined that the company’s accounting treatment of an overpayment to a fulfillment partner was in error.
“This is a falsehood,” Byrne wrote, claiming that Grant Thornton had determined
that the treatment was “not unreasonable” — until it got a letter from the SEC
on Nov. 3 questioning the treatment.
Duncan Will, CPA/ABV/CFF, CFE, is a loss
prevention accounting and auditing specialist with Camico ( www.camico.com).
DISCLOSURES
When estimating the fair value of financial
instruments, an entity shall disclose: the
fair value of financial instruments for which
it is practicable to estimate value, and the
methods and significant assumptions used
to estimate the financial instruments’ fair
value. A current proposal under consideration would require reporting entities to dis-
BETWIXT AND BETWEEN
As a result of this complexity and confusion,
accountants find themselves caught between
lenders, the government, the rule-setters
and the courts. It’s not the first time we’ve
been here, but it does present an environment of greatly increased risk and ethical
murkiness.
CPAs performing audit, review or compilation services for clients with potentially
significant fair value reporting implications
should make certain that their clients are
aware of the GAAP reporting requirements,
and assess the fair value and historical cost
reporting differences. The differences could
be insignificant and merely require the
disclosure of a GAAP departure. However,
when potentially significant GAAP departures are apparent and when a client’s valuations appear materially inaccurate, it is
crucial to engage the services of a qualified
valuation expert.
The CPA most at risk is the one who fails
MADOFF TECHIES CHARGED
WASHINGTON, D.C. — The SEC has
charged two computer programmers,
Jerome O’Hara and George Perez, with
helping convicted Ponzi schemer Bernard
L. Madoff cover up fraud at his investment advisory firm for more than 15
years, providing the technical support
necessary to produce false documents
and trading records, and taking hush
money to help keep the scheme going.
