New additions to fair value accounting standards have been proposed by the Financial Accounting Standards Board (FASB) with the release of Exposure Draft 1830-100, Fair Value Measurements and Disclosures (Topic 820), on June 29, 2010. If approved, these standards will impact businesses and entities of all sizes. And while the changes will make reporting much more transparent for financial statement readers, it is significantly more work for financial statement preparers, says Daniel Figueredo, manager at Burr Pilger Mayer.
“The new standards in the exposure draft will help converge the U.S. generally accepted accounting principles (GAAP) with international financial reporting standards (IFRS),” says Figueredo. “It’s a pretty robust draft with many new disclosure requirements. If it’s issued as is, it will be challenging for businesses.”
Smart Business spoke with Figueredo about how the new standards will impact businesses and what you can do now to prepare for the changes.
How do the disclosure requirements in the exposure draft change how financials are reported?
One of the most significant disclosure requirements that could affect businesses is the need to disclose a sensitivity analysis that attempts to measure the uncertainty in your fair value measurements categorized as level 3, which are the items that require the most management judgment to value. What this requirement says is, ‘If you change one or more of the assumptions used in your fair value formula to a different amount that could have reasonably been used, what are the effects on fair value and how much would it have changed?’ You will have to disclose the range of that price change, thus giving a reader a sense of the degree of possible swings to your balance sheet for other likely fair values that one could have arrived to.
For example, say a company such as a bank has mortgage-backed securities in its portfolio. These instruments require a fair amount of judgment by management to value, and would likely be categorized as level 3. Factors considered in measuring the value of a mortgage-backed security could include pre-payment assumptions, default rates, loss severities and discount rates, to name a few.
Under the sensitivity analysis, management would need to determine which assumptions in the valuation are most significant and then come up with other likely amounts that could have been used for them to arrive at another theoretical fair value.
