Fixing Financial Instrument Accounting

In response to the financial crisis, the IASB has speed-balled a proposal to rejigger the accounting for financial instruments. Issued in July, with the comment period ending yesterday, the proposed accounting would give investors a new prism through they can view financial statements.

Only two kinds of accounting would exist for financial instruments: amortized cost or fair value. But they can't look at the same financial instruments both ways - a batch of financial instruments would be classed one way or the other. You wouldn't see financial instruments reported at amortized cost, with a fair value for thesame holding reported at fair value.

It's a cloudy prism for investors. And the criteria for determining what gets amortized cost treatment and what gets fair value treatment is a dog's breakfast of rules and management intentions - something prone to require constant guidanceand interpretation in practice, as companies seek to maximize the amount of assets in the amortized cost category.

I've written a comment letter regarding the proposal, which is not yet on the IASB's website - but you can see it here.

This project may seem like an exercise in hair-splitting, but it isn't. Everyone wonders about the fate of IFRS convergence; this project may be pivotal in that quest.

The FASB has also undertaken a project to improve financial instrument reporting but has a much more investor-favorable approach, yet one that is fair to all. So far, it calls for the inclusion of fair values and amortized cost on a firm's balance sheet - at the same time. All of the information that any party would want is displayed right from the start. Changes in fair values of financial instruments that are currently carried at amortized cost would be shunted through the burial grounds known as "other comprehensive income."

One major improvement, however: the other comprehensive income statement would have to be displayed on the same page as the income statement. It couldn't just be a basement for hiding ugly economic activity: the statement of OCI would havenew prominence.

This is a very different path from where the IASB is heading, and a much better one, I think. It's possible the two standard setters will go their separate routes. If they do, convergence - in the short term, at least - will be stopped in its tracks. It's possible that the IASB will come around to the FASB's thinking, though there's no indication it's imminent.

It's also possible FASB will be coerced into coming around to the IASB's thinking: the G-20 meeting will be taking place in less than two weeks and you never know if the US delegates will use US accounting convergence as a means to getting something they want from the EU.

Let's hope not. The FASB's idea is too good to waste.

Comments

[Dialectical...:]

I have been saying this for a long time, and I am a rank amateur. If both numbers have something to say and either can be useful, then including them both is a no brainer. More importantly, if one number can hide ugliness inherent in the other number (or if using one number unfairly under values an asset), then again using both numbers seems obvious. And accounting should be obvious, or it is not really accounting in the original sense of the word is it?

Sep 15 04:03 PM

[Jeff332:]

Unless you take politics out of the equation (and that will never happen), any rules will be changed to benefit those in power (and friends of).

Sep 15 05:53 PM

[sethmcs:]

An accountant is asked in a job interview "what is 2+2 equal?" The accountant paused and said "What do you want it to be?" The interviewer said "your hired."

Disclosure: I am an accountant

Sep 15 11:53 PM

[Moon Kil Woong:]

This solution is great because it saves the accountant from having to be a judge and make arbitrary decisions that aren't so arbitrary since the guy wanting to water down any negatives is usually the guy paying. Bank accounting should also be made clear including full disclosure off off balance sheet items. Such disclosure is scary but useful. It lets everyone know the FDIC and all others should be focused on the too big to fails still because their numbers still look the worst even though they are raking in the dough from paying depositors almost nothing and then service feeing them to death.

So much for customer first. The customer is first to pay for their failures.

Sep 16 02:04 AM