U.S., Global Boards Are World Apart on Loans

They agreed in joint meetings to revisit the rules on accounting for financial instruments, and they will come together next month to host a series of public roundtables on the topic. With that kind of cooperation in place, how did U.S. rulemakers and their international counterparts arrive at such different views on valuing basic loans, which has emerged as a key issue in the debate over mark-to-market accounting?

The Financial Accounting Standards Board, which wants to broaden the use of mark-to-market accounting in the United States, is hashing out a proposal that would potentially force banks to mark all loans to market, even ones they plan to hold to maturity. A proposal from the International Accounting Standards Board, meanwhile, specifically preserves the option to value certain loans at their amortized cost.

In addition to inviting comparisons between the two approaches, the discrepancy raises questions about the viability of both boards' stated goal of converging their rules into a single, global standard that makes it easier for investors to compare the financial statements of companies in any country.

"Even though the principle should be that we have one answer on this, there are questions about sovereignty and the quality of the different standards," said H. David Sherman, an accounting professor at Northeastern University.

"That's one reason to think the idea that we're going to have total conversion even five years from now is not likely."

For years, the FASB and the IASB, a London group that supplies guidance to companies in more than 100 countries, have telegraphed their desire to fuse their standards. Their joint decision to re-examine financial instrument accounting dates to 2005. And while it is not uncommon for the boards to deliberate separately and then reconcile any differences later in the rulemaking process, the stance each board has taken toward loan valuations may represent a philosophical divide that could prove difficult to bridge.

The FASB views mark-to-market as a way of providing investors with a crisper snapshot of a company's financials. And by making it the sole valuation method for nearly every financial instrument, it would vastly reduce the complexity of the current system, which allows for a mix of amortized cost valuations and mark-to-market valuations — some of which are reflected only on the balance sheet, and some of which flow through to the income statement.

The IASB also has sought to reduce complexity. But its proposal would still leave two treatments for loans. Some might have to be valued on a mark-to-market basis, but others could still be valued at amortized cost.

Amortized cost is particularly important to community banks and others that do not engage much in trading and want to shield their financial statements from the vagaries of the market.

The IASB was out of the gate first on the issue, circulating its proposal last month for classifying and measuring financial instruments, and opening a public comment period that ends in mid-September.

Facing pressure from the Group of 20, a bloc of finance ministers and central bank governors from the world's largest national economies, the IASB is eager to adopt changes in time for companies to apply them to their year-end financial statements.

The board plans to issue follow-on proposals regarding impairment methodologies and hedge accounting, two other big issues in the valuation of financial instruments.

The FASB, meanwhile, aims to issue a single proposal covering all the major factors. It has yet to iron out how and where it wants mark-to-market values presented within a company's financial statements, and is still deciding on the feasibility of marking deposits and other liabilities to market.

FASB Chairman Robert Herz announced last week that it would be several more months before a formal proposal would be issued, and 2011 at the earliest before any rule changes would be adopted.

That potentially gives the boards time to reconcile the differences in their thinking, paving the way for an easier convergence down the line.

Joyce Joseph-Bell, a senior director and North American accounting team leader at Standard & Poor's, said she hopes the conflict is smoothed over soon.

"We believe a single set of global standards — instead of two, currently working in tandem, which converge only in part in some cases — will prove more effective in the long term," she said.

The idea of convergence already has its share of opponents, many of whom argue that the rules-based approach of the FASB has too little in common with the more principles-based approach of the IASB. But on the loan-valuation question, the two boards may wind up finding themselves more aligned than they might appear to be.

"Under the IASB proposal, on the face of the balance sheet you would have amortized cost, but I would expect that you would still disclose the fair value in footnotes," similar to current FASB requirements, said David Larsen, a managing director at Duff & Phelps.

"When you cut through everything, the information [the boards want] disclosed is the same. It's just that right now the FASB approach would put things in a different place than the IASB approach."

But to banks, which have seen investor and regulatory scrutiny reach new heights, even placement can be a crucial issue.