The Financial Institutions Accounting Committee, in a letter to the Financial Accounting Standards Board, has advised against an across-the-board adoption of market value accounting for investment portfolios. FIAC is composed of 16 senior bank and thrift executives and is affiliated with the Financial Managers Society. Other excerpts were carried in the Aug. 24 issue, page 4.
Primary Issue #6:
Should subsequent measurement of financial assets and liabilities be based on historical prices or current prices? Or should the basis depend on the type of instrument or other circumstances?
The subsequent measurement of financial assets and liabilities may be based on either historical or current prices depending upon business purpose and management intent that must be measured and proved within verifiable parameters. Identical financial assets and liabilities may necessitate different accounting treatment when the business purpose and management intent for those financial assets and liabilities differ. Consistent with our response to Primary Issue 5, financial assets and liabilities are initially recognized at their fair value and become their historical cost basis.
Existing accounting guidance requires subsequent remeasurement and adjustment in carrying value in specific instances, primarily when there has been a permanent impairment in the recorded value of the asset or liability, or when it is anticipated that the asset or liability will be liquidated within the accounting cycle at less than its initial recorded value. Securities trading accounts and securities held for sale are exceptions.
There have been abuses of existing accounting guidance, primarily in the area known as "gains trading." While current accounting guidance needs to be tightened to correct these deficiencies, we do not believe that these deficiencies are justification for measurement of all financial assets and liabilities at current market prices. It is important to remember that the business enterprise being measured is a going concern and liquidation values are inappropriate.
Additionally, recent SEC comments to certain registrants have assessed some of these "gain trading" issues.
We do not support subsequent measurement of financial assets and liabilities at current market prices for the following reasons:
Relevancy--The reported values of financial assets and liabilities when based upon current prices would be volatile and subject to significant fluctuations based upon external factors, many of which may be temporary in nature, which otherwise would have no effect on the business of the institutions. The resulting recorded amounts would be meaningful only when the amounts are determined and reported.
Any mismatch in the movement of market values of assets and liabilities as a result of changing interest rates is a matter of interest rate risk, which is separately measured and disclosed to investors and regulators on a regular basis.
Subjecting financial assets and liabilities to subsequent remeasurement at current market prices introduces volatility in the financial condition of a financial institution, which does not reflect either the fact that the institution is a going concern or the business purpose and intent of liabilities.
Subjecting financial assets and liabilities to remeasurement only because the market level of interest rates has changed from the inception of the contract results in financial condition volatility, which may never actually be realized, a condition that may ultimately prove to be confusing and misleading to financial statement users.
Business transactions should be recorded based upon the anticipated realization of cash flows in financial contracts. As we have previously discussed, market value information may be relevant to certain parties interested in financial institutions. However, such information is not relevant as a measure of an entity's ongoing operations and business purpose.
Reliability--Accurate information of current market prices of many financial assets and liabilities is not available and must be determined based upon analysis of the terms and risks of specific transactions. This process is extremely subjective and relies upon estimates and assumptions.
The resulting reliability of financial institution financial statement would be questionable and the ability of auditors to express an opinion of the reported results would be seriously impaired if a consistent source is not available to determine market values.
Under SFFAS 107, there are provisions for non-disclosure when market values are not available or estimable. Under such circumstances, the absence of market values in the financial statements would produce extremely confusing results.
Comparability--Due to the subjectiveness involved in the remeasurement of financial assets and liabilities at current market prices, comparability of financial statement of different institutions would be impaired since preparers may not rely upon identical assumptions when measuring ... similar assets and liabilities.
We believe that rather than pursuing an across-the-board conversion to an accounting model at current market value, the accounting, regulatory and investing community would be better served by the FASB's pursuing enhancements and significant revisions to existing accounting guidance.
It is with consideration of such further enhancements that we fully support the use of the current accounting model. We believe that this can be accomplished by the following:
* The development of more definitive guidance on management intent so that intent becomes more measurable, verifiable and realistic. In this regard, we recommend that intent be further defined to specifically identifiable events and that intent be measured based upon the one-year accounting cycle.
With this type of parameter around management intent, it will be relatively simple to determine whether management's statement of intent may be relied upon and used as a basis for historical cost accounting treatment of assets and liabilities.
* Revise the current historical accounting model to consistently report substance over form through evaluation of individual financial instruments based upon the nature, timing and amount of cash flows. The significant number of exception and special rules that apply to different forms of financial instruments ... should be eliminated and these instruments should be accounted for more consistently based upon substance. The existing rules confuse users of financial statements and masker understandability more difficult.
We believe that the disclosure requirements under SFAS 107 represent a substantial increase in the presentation of financial information at current market value and that this disclosure should satisfy the needs of the majority of constituencies when included as a supplement to the financial statements prepared based upon existing and further refined accounting guidance.
We also believe that the current projects under development at the FASB. together with the other changes discussed above, will substantially mitigate the need for and perceived benefit to be gained from current market value accounting on a broad scale.
Primary Issue #7:
Should subsequent measurement of financial assets and liabilities differ because of a hedging or other relationship between financial instruments?
Financial assets and liabilities should be measured differently because of a hedging relationship with other financial instruments.
Gains or losses on the principal instrument and the hedging instrument should be measured on the same basis, based upon the trading, held for sale or investment purpose of the principal asset. In addition, in determining which hedges should qualify for hedge accounting, we believe that risk exposure should be assessed on an enterprise basis since this approach more accurately reflects management of the enterprise. We urge the FASB to move expeditiously on a definitive hedging statement, which would reconcile the differences between SFAS 52 and SFAS 80 and provide more comprehensive guidance.
Primary Issue #8:
When should a financial asset that still exists be derecognized?
A financial asset should be derecognized when substantially all economic risks and rewards of ownership have been transferred. Derecognition cannot be considered in isolation. Derecognition of financial assets and liabilities must follow the same logic as recognition, which is based upon the continuance or discontinuance of rights and obligations.
Primary Issue #9:
When should a financial liability that still exists be derecognized?
A financial liability should be derecognized when the legal obligation has been assumed by another party or when the entity becomes secondarily liable and will only be obligated when a future event occurs that is deemed not probable. A financial liability may subsequently be re-recognized when the probability of liability occurs, as pursuant to SFAS No. 5.
Primary Issue #10:
How should realized gain or loss be reported?
When an exchange transaction occurs, the resulting financial assets and liabilities should be measured at fair value and any resulting gain or loss realized in the exchange reported in the income statement.
Finally, gaining the consensus of a committee on such an arduous and complex document as this has required us to learn a new technical language and set aside our individual prejudices. It has been a beneficial learning experience. We thank you for this opportunity and look forward to working with you to achieve a positive outcome.