Will Ideological Purity Kill the FASB?

I’m no big fan of the Perlumtter amendment.  I see it as a naked power grab by the ABA and their ilk, who I don’t trust at all.

That being said.  I feel their pain.

One of the more painful lessons I learned from SOX was that AS2 wasn’t very good.  All due respect to Doug Carmichael, in retrospect AS2 was far too academic/theoretical and not practical enough.  This is coming from the guy who was (and still is) a big fan of  SOX 404 and who originally thought AS2 was great.

I got it.  I understood that the standard never envisioned people documenting every single control in the organization in a bottom-up approach.

It’s not that I’m smarter than the average auditor, it’s just that I sat in a room for four months and worked with the standard every day because I was writing a book on it.  Very few people have that luxury.  Standards setters (and I’m guilty of this, too) tend to think that everyone else out there has the same level of intimate knowledge of the standard that they do.  This is erroneous.

AS5 was much better because it was more practical.  People could actually apply it.

Which brings me to the accounting standards setters, the FASB.

I stopped writing about accounting standards 10 years ago because I wasn’t smart enough to figure them out.  But recently, I’ve been helping a client do create some content around fair value measurements.

The issue I was looking at this afternoon was establishing fair value for a liability.  FAS 157 sets up a definition for fair value based on an “exit price” and what the asset or liability would fetch in an open market.  Theoretically sound.  Makes sense.

Except when it comes to liabilities.  Liabilities aren’t transferred.  You can settle a liability, but your lender won’t let you transfer it to a third party, right?  Some liabilities, a corporate bond, may be traded in a market, but they’re traded as assets, not liabilities.  Is that okay?

So I’m looking at this stuff, and I stumble across an old article from CFO magazine.  The FASB discussed this issue in April 2008.  In an open Board meeting, FASB chairman Bob Herz had the temerity to suggest that the amount at which you could settle the liability was a good measure of fair value.

If I owe someone a million bucks, I’m not going to be able to transfer that obligation to someone else, there’s no way the lender will let me do that.  But the lender would be willing to settle the liability for $800k.  Isn’t that the de facto fair value of the liability?  Doesn’t using the settlement value more or less accomplish our overall financial reporting objective?

But here’s how it went down.

“I would have thought settlement value would be exit value,” Herz said at the meeting. “It’s the best measure of exit value in those circumstances.”

That line of thinking, however, seemed to exasperate Seidman, who thought Herz was suggesting a complete “overhaul” of 157 by changing the basic definition of fair value to include the concept of settlement. “If you say we should never have required fair value accounting,” she said to Herz at one point, “that water is under the bridge.”

For his part, the chairman suggested that he was only trying to make things easier for preparers and users. Referring to a shortcut permitted under 157 for Level 3 estimates, Herz sought a way out of the impasse. In using the shortcut, a corporation estimates what it would accept as payment for assuming its own liability.

But using such an estimate might violate the statement under 157 that fair value is “not the price that would be paid to … assume the liability.” That would be using an “entry price” rather than the “exit price.”

For that reason, Herz proposed labeling the shortcut as a “practical expedient” because it really doesn’t conform with the fair-value standard. “While it would help people get to a transfer notion, I don’t think it’s hypothetically correct,” he said.

Let’s get this straight.  The chairman proposes a practical expedient that gets shot down because it’s not hypothetically correct.

ARE YOU KIDDING ME?

Ms. Seidman, the fact is the existence of your entire organization is being threatened because you are perceived as being creating standards that are difficult if not impossible to understand and apply.  And your answer is to get into a snit because settlement value is an entry price not an exit price.  Really?

Outside of maybe the five FASB board members, who else on the entire planet would care?  At what price ideological purity?

It strikes me that taking a hardline stance is not as admirable as you might think.  I don’t see it as sticking up for a principle, I see it as lacking pragmatism and imagination.

Now, to their credit, the FASB eventually did issue guidance to address this issue.  But it took them over a year to get that out.  In the meantime the ABA is marshaling resources and planning to completely revise the standards setting infrastructure, and this esoteric sniping over exit vs. entry pricing and whether we are being hypothetically correct or incorrect…it’s just giving them more things to point to and say “those guys are out of touch, we need congressional intervention.”

Believe me, I am no fan of the ABA.  But I feel their frustration.

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