IASB amends fair-value disclosure

Under US Gaap, disclosures about the valuation process for the fair value of an instrument are made according to a three-tier hierarchy. Each level of the hierarchy reflects the inputs used in the valuation process. As these inputs may vary depending on the state of markets, the hierarchy informs investors of the relative accuracy of each valuation.

In level one - reflecting valuations in active markets - the inputs are prices quoted in the markets for identical assets or liabilities. Level two - which indicates valuation in less active markets - means the inputs can be observed in the market either directly, such as prices, or indirectly, such as derivations of prices. These inputs do not include quoted prices used within level one. Level three - which reflects illiquid markets - means unobservable inputs were used. In this latter tier, where the unobservable inputs are often generated using models, additional disclosure is required.

"The three-level hierarchy will help to increase the clarity of the information. The proposals build on the advice we have received from the IASB's expert advisory panel," said David Tweedie, chairman of the IASB, in a written statement.

"In our view, the additional requirements to disclose the breakdown of your assets and liabilities by fair value make a lot of sense," said Andrew Spooner, a financial instruments partner at Deloitte in London. "A lot of the larger financial institutions under IFRS were already doing this as their US competitors were obliged to under US Gaap."

The IASB has also clarified existing requirements surrounding disclosure of liquidity risk. In its financial statement, an institution must now provide information allowing investors to accurately determine the nature and extent of liquidity risk deriving from its assets, and how it intends to manage this risk. Both of these amendments to IFRS 7 apply for the annual period from January 1 onwards.

Fair-value accounting has come under fire since the beginning of the financial crisis. Its pro-cyclical nature has frustrated financial institutions, which blame the standard for exaggerating the frailty of their balance sheets. In illiquid markets, bankers argue that market prices for certain assets are simply not representative of their intrinsic value if the asset is held to maturity. Investors counter that market prices reflect the current value of assets and therefore fair value is a relevant piece of information they deserve to know.

A spokesperson for the IASB said the board continues to review IAS 39, the accounting rule that deals with the valuation of financial instruments. Meanwhile, a global expert advisory panel set up by the IASB and Financial Accounting Standards Board is investigating issues arising from the global financial crisis. The panel is expected to report back in the first half of 2009.

"I think the next stage has got to be what are we going to measure at fair value and what aren't we? Once you've answered that question, hopefully a lot of the problems that we've got with the current standard will disappear as it will become less complex. I expect the IASB will be looking at this over the next year, and we support that," said Spooner.

See also: SEC: fair value not to blame for financial crisis;
Fair enough?