After Sarbox

Yesterday’s sit-down with Chuck Mulford adds to our suspicion that that the FASB’s embrace of fair value accounting will ultimately prove more controversial than it has so far.

This approach, which is the basis of a number of individual items on the accounting board’s agenda as well as its so-called conceptual framework, requires that assets and liabilities be marked to market instead of allowing them to be carried at historical cost.

The idea has generated some criticism but nowhere near the firestrom fueled by Sarbox. But that’s likely to change once the FASB’s emphasis on it is better understood.

Chuck’s fundamental objection is that marking assets to market makes it harder to figure out what is driving a company’s earnings. Under fair value, for example, an increase in its earnings may reflect nothing more than the appreciation of its real estate, yet that may not be apparent without a lot of analysis.

Mulford isn’t alone in worrying about this possibility. As Jack T. Ciesielski put it in the cover letter for the April 3 edition of The Analyst’s Accounting Observer, „fair value was one of the ingredients in the witches brew that Enron’s managers concocted; it enabled them to recognize profits years earlier than they should have, if they they should have recognized any at all.“

Ciesielski went on to liken fair value to strong medicine that kills if used improperly. On the other hand, he understands why Chairman Bob is such a big fan of the stuff. Used properly, wrote Jack, it can be downright indispensable–when it’s telling investors and analysts more about the true state of a firm’s financial condition than does comparable historical cost-based accounting.

This is no doubt just the beginning of what promises to be the next big debate in financial reporting. And if as Tim reported way back when, corporate finance bigs like GE’s Phil Ameen have anything to say about it, the debate will not ensue without a certain amount of fireworks. Look for the financial reporting package we’re starting to put together for the magazine to delve further into all of this.

Posted by Ronald Fink | April 21, 2006 01:30pm

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