As part of an organized global effort to reduce the inconsistent measurement of fair value and the application of impairment guidance for financial assets, FASB has taken swift action with rapid expansion of fair value accounting guidance intended to provide relevant and transparent information to users of financial statements. Similarly, IASB has developed a timeframe for increasing guidance pertaining to recognition and measurement of financial instruments. FASB and IASB collaboration on these projects is paramount due to the impending convergence towards a common, international standard of financial reporting.
While the markets decline appear to have leveled off through the first half of 2009, establishing fair value for certain investments and assessing asset impairment will continue to be challenging aspects of the 2009 financial statement reporting process due to new and developing pronouncements from domestic and international standard setting organizations.
The Evolution of Investment Accounting for Insurance Enterprises
In 1982, FASB issued SFAS 60, Accounting for Insurance Enterprises, which established accounting guidance specific in nature to insurance companies. SFAS 60 required that insurance companies carry fixed maturity securities at amortized cost and equity securities at fair value. Fluctuations in fair value were reflected as unrealized gains and losses within the equity component of the balance sheet, and gains and losses realized upon disposal were recognized within earnings.SFAS 60 introduced the concept of other than temporary decline in fair value, but merely mandated that such declines be recognized as if a sale had occurred.
More than a decade later in 1993, SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, superseded the investment accounting guidance offered by SFAS 60 and established a new, categorical method for investment accounting with the introduction of the categories trading securities, available-for-sale securities and held-to-maturity securities.A major development surfaced by SFAS 115 was the need to recognize market value fluctuations as a component of earnings for securities classified in the trading category.SFAS 115 retained the other than temporary decline concept introduced in SFAS 60, and brought greater prominence to the concept of intent to hold as a means of justifying the classification of fixed maturity securities in the held-to-maturity category.
There were several shortcomings of SFAS 60 and SFAS 115 that were not fully exposed until the bull market, which began in the 90’s, was abruptly shifted into reverse during 2008. Specifically, the need for meticulous impairment analysis and the consideration of valuation when confronted with inactive markets were not exceedingly germane. The generally long-running bull market created an environment in which the concepts of other than temporary and intent ability to hold did not require extensive analysis; bright line tests such as the 20% / 6-months approach successfully weeded out the truly poor performing assets. Further, functional markets with high volumes of activity and pervasive asset inflation did not leave many people questioning the significance of a fair value methodology.
While the economic crisis of 2008 lead to the recent barrage of accounting guidance, there existed a severe, but relatively short-lived market slide subsequent to the dot-com bust and 9/11 that sparked dialogue regarding the matters raised in the preceding paragraph. In 2005, FASB issued a Staff Position (FSP), FSP 115-1, which established a framework to evaluate impairment on a security-by-security basis, the severity of the impairment, and the likelihood of recovery prior to an anticipated disposal. Unfortunately, the guidance offered in FSP 115-1 was subjective and created significant inconsistency in evaluating other than temporary impairment (OTTI), which surfaced in the insurance industry during the 2008 financial statement reporting process, when comparing the aggressiveness (or lack thereof) of impairment charges taken by one carrier to the next. While it isn’t extraordinary for two companies to reach different conclusions regarding OTTI for a particular security, due to differing conclusions about intent & ability to hold and assumptions about recoverability of the security valuation, the difficulty that exists for users of financial statements when attempting to compare one company’s performance to another is great. Continue reading ‘Standard Setters on Record-Setting Pace For Issuance of Fair Value Accounting Guidance’ »