IASB and FASB convergence project

IASB and FASB convergence project

Introduction

The implementation of standards requiring the use of fair-value measures have been one of the most challenging accounting issues facing the Financial Accounting Standards Board (FASB) in recent history. Some argue that fair-value accounting may introduce excessive financial statement volatility which may drive companies' reported balance sheet values to be lower than their economic value (e.g. present value of expected future cash flows). These critics claim that this leads to premature needs for additional capital, premature violation of debt covenants, and even premature liquidations. At the core of the debate is the issue of whether quoted market values are reliable representations of fair-value during periods when orderly markets do not exist. Therefore, all the issues and aspects related to IASB and FASB convergence project will be discussed in detail.

Discussion

The Securities and Exchange Commission (SEC) noted that the key issue associated with a continued expansion of the use of fair-value accounting lies in the importance of financial instruments. Many researchers analytically show that quoted prices from illiquid markets have biases relative to prices that would prevail in normal markets. Further, several researchers analytically show that market values in periods of illiquidity can create distortions and contagions effects. They conclude that the effects are severe enough to result in premature liquidation of financial institutions. The issuance of Statement of Financial Accounting Standard (SFAS) 157 has provided guidance on the matter (Moussa, 2010). SFAS 157 requires the classification and disclosure of fair-values under a hierarchy of three levels. Considering that both the FASB and the International Accounting Standards Board (IASB) have expressed interest in expanding the use of fair-value accounting, it is possible, if not likely, that the use of Level 3 valuation techniques will become even more pervasive. The use of Level 3 valuations is of such contemporaneous importance that the FASB recently issued an Exposure Draft on a proposed Accounting Standards Update to SFAS 157 to improve disclosures about fair-value measurements that use significant unobservable inputs (Abarbanell, 1997).

The use of fair-value accounting has been a controversial issue since the implementation of the first standards requiring the use of fair-values. Some early issues rose related to a lack of clear definition for "fair-value". For example, should the definition of fair-value be based on entry value, exit value, or value-in-use? Other issues raised included the increase in volatility in earnings arising from the constant revaluation of investment securities at fair-value. Despite these arguments, a vast number of studies have shown that reported fair-values are value relevant to investors. The recent economic crisis has put fair-value accounting at the forefront of many debates once again. Critics argue that fair-value accounting introduces excessive financial statement volatility which may lead to contagion effects such as premature needs for additional capital, premature violation of debt covenants, and even premature liquidations. Further, they find that the magnitude of the price reactions around these events was positively related to banks being less than well capitalized and having assets ...