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New accounting rules for financial instruments under U.S. GAAP likely will have a greater focus on amortized cost and less on fair value accounting than what is presently proposed, according to Moody’s.

This spring the FASB issued an exposure draft proposing changes that would require banks, insurers, and other financial institutions to carry significantly more financial assets at fair value on the balance sheet, rather than at amortized cost.

The largely negative response from constituents, however, means that the board will probably move closer to the approach of the International Accounting Standards Board, which emphasizes amortized cost basis reporting.

Respondents’ main objections were that the use of fair value in determining the carrying value of illiquid assets and liabilities on financial statements does not reflect the true economic value of such instruments and can be pro-cyclical, forcing firms to sell assets in illiquid markets, and further depressing prices.

Whatever the form of the final rules, Moody’s will continue to consider both fair value and amortized cost in its analysis of financial institutions’ creditworthiness.

“Fair value is relevant in assessing a firm’s liquidity position and provides an indication of the market’s view of the quality of an asset,” says analyst Wallace Enman. “Conversely, amortized cost less impairment speaks to expected losses on a security, which is a better indication of the economic value of an asset. Amortized cost is therefore a useful indicator of a firm’s long-term capital adequacy.”

If the final rules do favor amortized cost as the appropriate measure for loans and debt instruments, Moody’s believes that full disclosure of the fair value of such instruments should nonetheless be included in an institution’s financial statements to facilitate investor access to such information, and to ensure that such values are subject to a similar level of audit rigor.

Source: FASB Likely to Heed Market Concerns on Fair Value