Yesterday, the Financial Accounting Standards Board (FASB) voted to adopt changes to its fair value accounting standard FAS 157 in response to over 600 “comment letters received on FSP FAS 157-e, Determining Whether a Market Is Not Active and a Transaction Is Not Distressed.” The new guidelines which will apply to the second quarter will now require companies to value their assets based on current market conditions. Last month, the FASB received immense pressure from Congress to provide revised guidance on its current mark-to-market accounting.

In its decision the Board decided that the final FSP will reflect the following changes:

  • Provide “that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions (that is, in the inactive market).”
  • Clarify and provide additional criteria “for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active.”
  • Require entities “to base its conclusion about whether a transaction was not orderly on the weight of the evidence” and eliminate the presumption that “all transactions are distressed.”
  • Include “an example that provides additional explanation on estimating fair value when the market activity for an asset has declined significantly.”
  • Require entities to disclose all changes in valuation techniques.
  • Require the application of “fair value measurements when appropriate.”  

In its decision regarding other-then-temporary impairments, the FASB decided that the final FSP will reflect the following changes:

  • The change to existing guidance for determining whether an impairment is other than temporary is limited to debt securities.
  • The existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery is replaced with a requirement that management assert that (a) it does not have the intent to sell the security and it is more likely than not it will not have to sell the security before recovery of its cost basis.  
  • When an entity does not intend to sell the security and it is more likely than not that the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income.  
  • Unless the security is subsequently sold or there are additional credit losses, noncredit losses on held-to-maturity debt securities will be recognized in other comprehensive income and amortized over the remaining life of the security.  
  • Credit losses should be measured on the basis of an entity’s estimate of the decrease in expected cash flows, including those resulting from an increase in expected prepayments.  
  • An entity will be required to present the total other-than-temporary impairment in the statement of earnings with an offset for the amount recognized in other comprehensive income, and to present (where the components of other comprehensive income are reported) amounts recognized in accumulated other comprehensive income related to the noncredit portion of other-than-temporary impairments recognized for available-for-sale and held-to-maturity debt securities.  
  • Entities will be required to disclose the cost basis of available-for-sale and held-to maturity debt securities by major security type, the methodology and key inputs ( such as performance indicators of the underlying assets in the security, loan to collateral value ratios, third-party guarantees, levels of subordination, and vintage) used to measure the portion of an other-than-temporary impairment related to credit losses by major security type, and a rollforward of amounts recognized in earnings for debt securities for which an other-than-temporary impairment has been recognized and the noncredit portion of the other-than-temporary impairment that has been recognized in other comprehensive income.