Fair Value Fair Value
By Sam Gutterman
TORTOISE: That isn’t what I hear. If there
isn’t a proper (defined either as an active or
liquid) market, isn’t it just a guess, subject to
bias at best and manipulation at worst? It’s bad
enough for non-traded derivatives; it has to be
sheer nonsense for insurance contracts!
ACHILLES: But it’s gotta be better than historical cost! How relevant is that in today’s
financial statements? Although the market
isn’t always right, it’s better than the alternatives. For insurance, I defy anyone but an
actuary to understand current accounting values like retrospective adjustments. Only doors
should be locked, not assumptions! I can see
why smoothed income would be appealing—
but if you want to understand a company’s
prospects and risks, how can such results be
useful or timely?
TORTOISE: Since it’s so difficult to find reliable prices in an illiquid market, wouldn’t
it make sense to suspend their use in those
ACHILLES: If there was a temporary switch
away from fair values, even for a short period,
it would very likely throw a wrench into investor confidence. I doubt investors will feel any
better, and most users will probably ignore
the temporarily substituted values. And who
would dictate the timing of a suspension?
TORTOISE: These are tough questions!
Changes in fair value shouldn’t be recognized in income. If that happened, it would be
tough to figure out how a company performed
or what its likely prospects are. Instead, they
could be included in “other comprehensive income.” Although the IASB has indicated that
it won’t accept a deferred profit or smoothing
account, it’s now suggesting that revenue be
set at an entry price (customer consideration)
without subsequent measurement. Won’t this
encourage some to get around or take advantage of the rules?
ACHILLES: Maybe insurance will be exempted from that revenue standard. In any
event, although accounting standards are
often blamed for most financial crises or failures, at worst they facilitate reporting the
current status of the financial effect of past
events. They can’t make up for bad lending
practices, inadequate pricing, weak or nonexistent enterprise risk management or fraud!
Financial statements are meant to provide investors or regulators, depending on the type
of report, with useful and relevant information. How can companies and investors make
sound decisions without information based
on current expectations and price data?
TORTOISE: Even if I buy your no-fault argument, I’m still not convinced it’s a good idea. I
can sort of see the need for a current view of
performance and value and transparent information about risks. But while it makes sense
for something that is commonly traded, why
use a hypothetical market otherwise? Isn’t it
like marking to someone’s imagination? And
who are these participants in such a market?
How can reliable measures be developed or
verified for reasonableness if there’s nothing
8/14/09 2:11:43 PM