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Critics Cry Foul on New FASB Rule

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By: Riley McDermid | May 27, 2009

A new rule from the Financial Accounting Standards Board that would require banks and other financial firms to move certain losses from their income statements to their balance sheets is “inconsistent” with fair value accounting and “delays the inevitable,” Rick Martin, vice president and head of technical accounting at Pluris Valuation Advisors, told Markets Media Thursday.

FAS 115-2 would cover other-than-temporary impairments on debt securities that are held by a company as an investment until they either mature or are sold. Under its terms companies would have to “dissect” such losses between their credit and non-credit components, said Martin.

“Fair value accounting says that losses of this nature should be measured as the entire difference between fair value and book value,” he said. “The new rule adds an extra step, to reduce the loss by amounts that don't relate to credit deterioration, i.e. liquidity.”

Martin added that the rule also makes it easier for companies to avoid losses altogether, because the previous standard said that in addition to other criteria in evaluating a loss, a company had to assert its ability and intent to hold the security.

“The new rule says all companies have to do is say they don't plan on selling it, which is a lower threshold than promising to hold the investment,” said Martin, a crucial distinction.

He asserted that FAS 115-2 is also in conflict with a “fundamental accounting principle” called the matching principle that “forms the cornerstone of all accounting theory.”

“It basically says that income and expenses should be recognized in the period in which they occur,” he said. “This new accounting rule inappropriately postpones the recognition of impairment losses in the income statement into an unknown period in the future.”

In addition, the new rule will also be very difficult to implement and audit.

“Separating credit and non-credit losses can, for many companies, be analogized to an insurance adjuster in south Florida staring at a house that has just been flattened by a hurricane,” said Martin. “The adjuster's job is to differentiate between wind damage and water damage. It will be challenging to implement the new rule in a consistent manner.”