SFAS 159: Is the Fair Value Option Right for You?

By James M. Boak, CPA

Has Statement of Financial Accounting Standards No. (SFAS) 159, The Fair Value Option for Financial Assets and Financial Liabilities (as amended), been overshadowed by its much debated cousin, SFAS 157, Fair Value Measurement?  The answer seems to be “yes.”  Despite the fact that both standards were effective simultaneously (years beginning after Nov. 15, 2007), companies, politicians,  newspapers, and professional journals all have focused on SFAS 157, mark-to-market, banks, insurance companies, and the perceived effect on the down economy, to the exclusion of SFAS 159.

Purpose of SFAS 159

SFAS 159 allows a company to elect fair value accounting (the fair value option) in place of the traditional historical cost basis accounting for certain financial assets and liabilities not currently covered by other standards. The stated purpose of SFAS 159 is to reduce volatility in earnings, to expand fair value applicability, and to simplify the accounting for derivatives under hedge accounting rules. Additionally, this standard helps to move U.S. accounting towards more universal fair value measurement and increased conformity with international accounting standards.

General Application

SFAS 159 applies to all entities, including not-for-profits. Entities may elect fair value on an instrument-by-instrument basis or for an entire account. However, election on only a part of the instrument is not allowed.  In addition, the election can be made only when the financial instrument is acquired and such election, once made for an instrument, is irrevocable for its life. The general intent of the standard is to allow entities to make the fair value measurement a long-term attribute of a financial asset or liability class of accounts. A further purpose of this restriction on revocability is to prevent adoption to achieve a certain accounting outcome, e.g. to enhance earnings. Changes to fair value are recorded in earnings similar to trading securities under SFAS 115. Lastly, disclosure is significantly expanded to insure financial transparency. SFAS 159 disclosure is largely in addition to disclosure already required by SFAS 157.

Transaction Applicability

In the article, “The Finer Points of Fair Value,” (Journal of Accountancy, December 2007) Thomas Ratcliffe lists the following examples of transactions to which SFAS 159 applies:

Loans receivable and payable

• Investments in equity securities, including investments accounted for under the equity method
• Rights and obligations under insurance contracts
• Host financial instruments that are separated from embedded derivative instruments
• Firm commitments involving financial instruments
• Written loan commitments

Non-applicable Transactions

SFAS 159 also lists transactions to which fair value options do not apply:

• An investment in a subsidiary that the entity is required to consolidate
• An interest in a variable interest entity that the entity is required to consolidate
• Employers’ benefit plans and plans’ obligations
• Financial assets and financial liabilities recognized under leases as defined in FASB Statement No. 13, Accounting for Leases
• Deposit liabilities, withdrawable on demand, of banks, savings and loan associations, credit unions, and other similar depository institutions
• Financial instruments that are, in whole or in part, classified by the issuer as a component of shareholder’s equity (including "temporary equity") e.g. a convertible debt security with a noncontingent beneficial conversion feature

Controversy

Interestingly, five of the seven members of the Financial Accounting Standards Board approved the standard, and two dissented. Some reasons cited by the dissenters are:

The stated objectives (e.g. reduction of volatility) may not be achievable.
Applying fair value to only some items is a fragmented approach that may not portray financial position consistently and comparably.
The ostensible reduced volatility of earnings may not be justified by the increase in complexity and decrease in understandability by the financial statement reader.

From a practical standpoint, implementation of the fair value option also may complicate maintenance of sub-ledgers for financial instruments by introducing different methods of accounting for similar classes of instruments. Disclosure still must include all elements of SFAS 157 plus those required for SFAS 159. And, accounting for non-trading assets and liabilities, and for which inputs are not observable, is not made any easier to calculate by a company or to be audited.

Is the Fair Value Option Right for You?

That, of course, depends on the facts and circumstances. Remember, the standard only applies to certain financial assets and liabilities and not to items such as fixed assets. Record keeping and disclosure will be increased.  Ratcliffe also points out that there is a risk of “riling regulators.” For example, he indicates that the SEC staff in 2007 “issued a warning [against] structured transactions that are designed to trigger a particular accounting result.”

Summing It Up

According to Ratcliffe, “[The] key for auditors [and accountants] is to insure that the guidance is implemented in a manner that is consistent with the underlying objectives of Statement No. 159 and reflects substance over form…  Auditors [and accountants] need to exercise the appropriate level of professional skepticism when evaluating facts … related to using the fair value option. A heightened degree of awareness might be necessary to ensure that businesses are using the option to [best] reflect economic reality….”

James M. Boak, CPA, is an audit partner with Eide Bailly LLP, Denver. He is an active member of the CSCPA Public Company Forum. Contact him at jboak@eidebailly.com.

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