FASB is circulating an Accounting Standards Update that would clarify required disclosures about fair values.  Particularly noteworthy is that the Update proposes a detailed “roll forward” of fair value measurements using significant unobservable inputs (“Level 3″), which would provide a clear breakdown of how the total level 3 measurements changed as a result of:

  • transfers in and out of level 3 (e.g., because a market dried up, there are no more prices to use for measurement, or alternatively, a market was created that provided observable prices)
  • realized and unrealized gains and losses
  • purchases
  • issuances
  • sales
  • settlements

These need to be reported separately for different classes of assets and liabilities.  The example in the pdf (see link above, page 13) includes separate columns for residential and commercial mortgage-backed securities), with 7 columns in all.

The Update also provides examples of how to report “reasonably possible alternative inputs for fair value measurements” for level 3 items.  The example (page 16) provides the effect of reasonably possible alternatives in the form of increases and decreases of fair value.  However, results from a field test with preparers found that “most volunteer participants expressed concerns about the operationality of the proposed requirement for a tabular quantitative disclosure of Level 2 and Level 3 fair value measurements disaggregated by types of significant inputs, such as broker quotes, yield curves, volatilities, housing prices and default rates.” This means, as far as I can tell, that you will be able to see a single range of reasonably possible values, but not be able to determine which assumptions are most important, what that value would be if housing prices fell by 10% but default rates rose by 5%, or whatever your own predictions might lead you to project.

I doubt this proposal will generate much controversy, because most people would rather fight over recognition than disclosure.   However, fans and foes of fair value should be paying close attention. Thorough footnote disclosure can be discipline management estimates, but might also prove that Level 3 measurement is a bad idea.  After all, the footnote to just one of the ‘reasonably possible alternatives’ to the recognized FV measurement is a full page long.  How many of those footnotes will a firm need in order to comply?

Codification and XBRL

It is worth looking through the update to see how the Accounting Standards Codification changes the standard-setting process.  This proposal doesn’t update FAS 157; instead, it updates Topic 820 of the codification, “Fair Value Measurements and Disclosures.”   I think this will make life much easier for all of us, but gives us a whole new set of numbers to memorize (like 820), and I will have to train myself to type ASU (Accounting Standards Update) instead of FAS.  The ASU also clarifies how the footnote disclosures should be coded for XBRL, which is interesting to see.