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Monday, August 7, 2006

Fair Value Now A Bit More Fair

FAS 159 allows companies to reduce volatility offerings

In February 2007 FAS 159, "The Fair Value Option of Financial Assets and Financial Liabilities" standard was released, and with it a way to account for financial instruments that have not historically been recorded in financial statements.

FAS 159 permits any entity, including not-for-profit organizations, that elects the fair value option (FVO), to choose to measure many financial instruments and certain other items at fair value; however, it does not require the entity to do so and it does not change any previous standards that require the use of fair value. Companies electing to use FVO can reduce the volatility of earnings by allowing a company to reflect the value of asset and liability hedge positions without using the complex hedge accounting rules of FAS 133.

The objective of FAS 159 is to reduce both the complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. Many times, assets are purchased to offset the impact of liabilities. Under prior rules, unless the transaction met the narrow definition for hedge accounting under FAS 133, the difference in the accounting rules for the assets and related liabilities often caused significant earnings volatility. The goal of FAS 159 is to allow entities to account for both the asset and liability at fair value. This in turn will eliminate the aforementioned volatility.

FAS 159 Benefits

Entities that use assets and liabilities as a hedge will benefit from the newest statement the most. Both the asset and related liability can now be marked to market, which in many cases means the gain in one will offset the loss in the other. Below are items that are eligible for the fair market accounting option which can be accounted for now under FAS 159.

Eligible items:

  • A recognized financial asset or liability (with certain exceptions)
  • An entity commitment that would otherwise not be recognized at inception and that involves only financial instruments
  • A written loan commitment
  • The rights and obligations under an insurance contract that is not a financial instrument but whose terms permit the insurer to settle by paying a third party to provide those goods and services
  • The rights and obligations under a warranty that is not a financial instrument but whose terms permit the warrantor to settle by paying a third party to provide those goods and services
  • A host of financial instruments resulting from the separation of an embedded non-financial derivative instrument from a non-financial hybrid instrument under Statement 133 (Statement 159, par. 7)

Note, however, that the fair value option can be elected for specific assets and liabilities and need not be elected for all assets and liabilities. This is a one-time election which is irrevocable and must be made at the initial recognition of the financial asset or liability.

The good news is that entities electing to use fair-value accounting can reduce the volatility of earnings caused by accounting requirements instead of those caused by the economic reality of the underlying transaction. In turn, FAS 159 will assist in providing additional information that is intended to help investors and other users of financial statements to more easily understand the effects on reported earnings of the company’s choice to use fair value. Before electing to capitalize on the benefits of FAS 159, it’s best to consult with your auditor(s) to analyze the impact of electing the fair value option and to understand the implications. While financial institutions have been quick to adopt FAS 159, it does provide non-financial institutions with an opportunity that should be considered.

How Armanino Can Help

Armanino is able to help by analyzing balance sheets for potential benefits of electing fair value accounting, ensuring management understands the rules and disclosure requirements and assisting in determining the fair value of elected assets and liabilities by using our proven valuation methods. To ensure you are receiving the most benefit from this statement, contact our Risk Department who can assess whether or not this is the right step for your company.


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