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The statement also outlines its scope. For example, it outlines that the rules governing the valuation of financial instruments are to be used, even with investment companies. Though investment companies are subject to other rules and guidelines, they must still use Statement No. 157 guidelines when preparing their financial statements, for the ease of comparability.
The fair value methods should be used quarterly, as per this statement. This is especially true for those items whose value is determined on the market by observable inputs. Even for unobservable inputs, however, it should be disclosed the impact that the assumptions used will have on the firm's earnings or assets. This is important because the assumptions, particularly for unobservable inputs, can have a significant influence on earnings or asset levels. These disclosures regarding the assumptions allow anybody examining the statements to understand the sensitivity of the results to changes in the assumptions.
Statement No. 157 also is to be used for derivative instruments. The main thrust of this statement is that it nullifies guidance that was previously issued and amends other previously issued guidance. This reflects the FASB's objective that Statement No. 157 begins to streamline the guidance with respect to fair value. Fair value guidance had been scattered throughout a number of different statements and 157 is intended to reduce the number of different statements containing fair value guidance.
The previously-issued statements also did not always adhere to the framework that the FASB uses when issuing its statements. That framework was created with consistency in mind, such that financial statements can different issuers can be easily compared with one another. The process of streamlining the guidance with respect to fair value is part of the move towards increased consistency, beginning with consistency at the philosophical level.
This statement has been ascribed by some as a cause of the current financial crisis. The case has been made before government, for example, that the markets for mortgage-backed securities and collateralized debt obligations were driven down by fear and speculation. The markets, therefore, were behaving irrationally, and irrational markets should not be used as the basis to value an asset (Gross, 2008).
For a couple of reasons, however, this argument does not hold water. The first is that financial institutions have long used mark-to-market accounting (Gelinas, 2008). Remember that Statement No. 157 did not introduce new fair value methods, it simply clarified existing practice and provided guidance with respect to technique and disclosure.
The second reason is that for the most part financial institutions' stock had been battered because nobody knew the real value of some of the so-called toxic assets. The mortgage-backed securities became unmarketable, and the value of the underlying assets indeterminate. Financial institutions wrote down some of these assets but the market suspected they did not write them down enough (Ibid). The statement 157 compelled the banks to provide disclosure about their assumptions, which investors were able to read, but the assumptions themselves did not change. Thus, the valuations and writedowns did not change. All that happened was that investors were better informed and able to make better decisions for themselves as a result of the disclosures.
We should not abandon fair market valuation simply because we do not like the results. This is especially the case in this situation, where the bank managers responsible for the crisis have been reticent to accept responsibility for their actions (Norris, 2009). In a time of crisis such as this, fair market valuation keeps financial statements honest (Johnson, 2008), which improves the robustness of the financial system as a whole. Even if you took as truth that the markets have behaved irrationally, irrational market behavior is temporary, and still impacts the ability of a firm to derive value from a sale. It is, after all, the sale by which worth can be extracted from a financial instrument.
FASB Statement No. 157. Retrieved May 17, 2009 from http://www.fasb.org/st/summary/stsum157.shtml
Gelinas, Nicole. (2008). 'Mark-to-Market' Isn't to Blame for Meltdown that Led to Crisis. Manhattan Institute. Retrieved May 18, 2009 from http://www.manhattan-institute.org/html/miarticle.htm?id=2928
Johnson, Sarah. (2008). The Fair-Value Blame Game. CFO Magazine. Retrieved May 18, 2009 from http://www.cfo.com/article.cfm/10902771?f=home_featured
Norris, Floyd. (2009). Blame the Accountants. New York Times. Retrieved May 18, 2009 from http://norris.blogs.nytimes.com/2009/03/12/blame-the-accountants/
Gross, Daniel. (2008). The Mark-to-Market Melee. Slate Magazine. Retrieved May 18,…[continue]
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