Early Adoption of FASB Statement Number 159 Looks Like a Good Move, but Careful Consideration is Well-Advised
By Frank Gonzalez, CPA

Many companies and not-for-profit corporations are currently considering early adoption of Financial Accounting Standards Board Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (FAS 159). While FAS 159 certainly offers opportunities for some entities to restructure their investments, an understanding of the statement’s purpose is vital when assessing whether adoption, or early adoption, is right for your organization.

FAS 159’s transition provisions clearly present an opportunity for some entities, but this opportunity is perceived to be much wider than it actually is. The opportunity in question is based on the belief that entities are able to “reclassify” held to maturity (HTM) or available for sale (AFS) investments that are currently valued at less than their cost basis (or “underwater”) to the trading category -- and then to sell such securities without recording a loss in the income statement. In some cases, the next step in this strategy would be to repurchase securities that are identical or very similar to those sold but with a higher yield. Current market conditions appear to make early adoption of FAS 159 even more advantageous.

There are several reasons why this perceived opportunity is not as clear as it first appears, and why FAS 159 is not right for every entity:

• The principle objective of FAS 159 is very specific, and not designed for the goal of reclassification;
• Early adoption requirements of FAS 159, including concurrent required early adoption of Financial Accounting Standards Board Statement No. 157, Fair Value Measurements (FAS 157), are strict; and
• Previous assertions made by entities as to their intent and ability to hold underwater HTM and AFS securities to maturity or recovery can be a barrier.

FAS 159 allows entities to account for most financial instruments at fair value rather than under other applicable generally accepted accounting principles (GAAP), such as historical cost. The result of this approach is that the instrument is marked to fair value every reporting period, with the gain/loss from a change in fair value recorded in the income statement. This accounting treatment is an election made by the entity, on an instrument-by-instrument basis, when the financial instrument first becomes eligible for the election (generally upon entering such instrument, but see paragraph 9 of FAS 159 for further details). However, once the election is made, it is irrevocable.

FAS 159 is part of the current trend toward the issuance of principles-based standards. In a principles-based standard, all provisions within the Statement must be considered in the context of the Statement’s objective. Therefore, understanding the objective of FAS 159 is crucial when considering its adoption.

Paragraph 1 of FAS 159 states, “The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.” To appropriately apply this principles-based standard, it is therefore expected that entities applying the fair value option are doing so to take advantage of obtaining accounting in their financial statements that corresponds to economic hedges in their activities.

The fair value option, therefore, should not be elected merely to achieve a specific accounting result. Instead, an entity must consider whether the election is being made to meet the objective of FAS 159. This consideration requires professional judgment by various key decision-makers, including management and members of the board of directors responsible for monitoring the entity’s investment policies and strategies. In addition, there may be governance issues that would require an entity to modify its asset/liability management policies in order to execute this opportunity.

The effective date of FAS 159 is for fiscal years beginning after November 15, 2007. There is an opportunity to early adopt FAS 159 as of the beginning of a fiscal year that begins on or before November 15, 2007, however it comes with conditions in addition to the others required at the stated adoption date. These include:

• The choice to adopt early must be made within 120 days of the beginning of the fiscal year of adoption, so for calendar-year end entities, this would be prior to April 30, 2007.
• An entity must also early adopt all of the requirements of FAS 157 as of the early adoption date.
• An entity cannot have issued any financial statements that include required notes for any interim period within the year of early adoption.
• The choice to apply the fair value option to eligible items existing at the early adoption date is retroactive to the early adoption date.
• The choice to apply the fair value option to items that became eligible during the period is retroactive to the date they became eligible.

Early adoption of FAS 159 should be made only after a thorough consideration of how the adoption achieves the objectives of FAS 159 and FAS 157. In addition, the Securities and Exchange Commission is taking early implementation under investigation in determining if a Registrant’s adoption is for the right reasons, as intended by the Statement. At MBAF, we are currently providing clients with guidance on the pros and cons of early adoption, and we recommend a thorough review for any interested entities.