For only the second time in its four-year history, the Public Company Accounting Oversight Board (PCAOB) issued an "audit alert" in December, telling auditors to be on guard for the double whammy of Financial Accounting Standard (FAS) 157--the so-called fair value rule--and the collapse of the subprime mortgage market, which when absorbed together may generate new worries for those companies with the biggest exposures to each. "When the credit markets headed south, the investment companies and commercial banks became the ones that will be most affected by FAS 157," notes Barry E. Smith, a managing director at Smart Business Advisory and Consulting LLC of Devon, Pa.
Many companies were hoping for--and even banking on--a delay in 157's implementation. These new guidelines, issued by the Financial Accounting Standards Board (FASB), call for measuring and disclosing assets and liabilities at values markets would currently assign. In November, however, FASB agreed only to a one-year deferral for nonfinancial assets and liabilities and refused a postponement for others. So, for filers with fiscal years beginning after Nov. 15, FAS 157 is already a reality.
The FAS 157 controversy involves the three levels of valuations it establishes for determining asset and liability values--the most problematic, less liquid Level 3 inputs that don't have quotable or observable pricing mechanisms like many of today's subprime-related holdings and derivatives. "One or two years ago you were dealing with Level 1 assets that have now dropped to Level 3. That creates real challenges for the preparer and the auditor," says Greg Scates, PCAOB deputy chief auditor. "An auditor may not agree with a preparer's assumptions."
Level 3 estimates could cause many companies problems. "Companies are taking a hard look at how they made these estimates and it wouldn't be surprising if they change how they estimate and, before the end of the year, make adjustments up or down," says Dennis Beresford, professor of accounting at the Terry College of Business at the University of Georgia. "For many, it will probably be down."