Sample Accounting Research Paper on Suitability of the Proposed Changes to the Disclosure Requirements of Fair Value Measurements

Suitability of the Proposed Changes to the

Disclosure Requirements of Fair Value Measurements

Introduction

The debate surrounding the recently proposed update to adjust disclosure requirements for fair value measurements has attracted varied reactions from affected stakeholders. The Financial Accounting Standards Board (FASB) has invested in a disclosure framework project in an attempt to provide better parameters for institutions and organizations to quantify their materiality. The suggested move that provided a limited timeframe for comments would involve elimination, modification, and the addition of several disclosures. The proposed changes to eliminate disclosure requirements that do not offer decision-useful information is a welcome move. The suggested modification on disclosures that guide in quantifying investments regarding net assets would be useful in the formulation of financial statements. Moreover, the changes suggested concerning the measurement of uncertainty or sensitivity are a good move especially in establishing the actual value of an asset. The proposed changes are operable within the right timeframe with no cases of elements that have auditability issues. Nevertheless, the subject of uncertainty should be communicated effectively for clarity. On another perspective, the proposed changes that involve unrealized gains and losses have lesser benefits relative to the costs incurred in tracking such information. A better approach should feature entities that allow disclosure of related in entirety at all levels while Level 3 is approached separately. While the move to require disclosure of range and a weighted average of all relevant unobservable inputs is vital, disclosure about the timeframe of establishing such values would not benefit an enterprise. On another perspective, the idea of establishing materiality needs improvement as it affects how fair value measures are reported in the event of quantifying uncertainty. Some of the proposed changes should be adopted to enhance the effectiveness of such disclosures in shaping the nature of financial statements for meaningfulness to users while others should be improved to expand the benefits accrued relative to the costs incurred in tracking all the required information.

Background Information

            The proposed changes are bound to affect firms that have to comply with the US GAAP. They cut across elements that define recurring or nonrecurring fair value measurements. FASB proposes the elimination of such aspects as closes that demand amount and reasons in the event of a transfer from one fair value hierarchy to another (FASB, 2015). This affects any transfers between Level 1 and 2 of the already established hierarchy. The policy regarding timeframe feature in the measurement of materiality would be removed. Moreover, some policies used in valuation in Level 3 hierarchy as they do not provide decision-useful information. Private companies will not have to feature unrealized gains and losses at the end of the reporting period. The suggested modifications that affect private businesses removes the need to reconcile closing and opening balances, but demands disclosure of any transfers cross fair value hierarchy Level 3 communication on purchases and issues of liabilities and assets at the same level (FASB, 2015). The amount of time used for the liquidation of an asset has been modified with many finding this requirement non-beneficial. An additional modification demands clarity in the measurement of uncertainty based on the date of reporting rather than having to focus such aspects as sensitivity to future transitions. Moreover, FASB has proposed additional of closes regarding disaggregation of unrealized gains and losses an element affects private firms that may lack ledger data that is established in line with FASB structured hierarchies. The additional aspect involving disclosure of weighted averages will find many private institutions prepared but the factor regarding periods for liquidation will prove a challenge.

Rationale

Interpretations of the proposed disclosure requirements reveal the reliability of the suggested standards, and how they would affect various stakeholders in the society. Some of the suggested changes are encouraging while others call for improvement to enhance meaningfulness. Examination of such proposed changes will reveal this in depth.

Elimination of Irrelevant Disclosure requirements

The proposed amendment to remove some disclosure requirements due to their irrelevance will help organizations establish consistent decisions, and have a chance to exercise some discretion in the event of having to make reports with relevant authorities. It has been clear from FASB notices that some requirements are not consistent with other structured provisions, and do not necessarily assist in the decision-making process. Affected stakeholders have been keen to express satisfaction in this proposal particularly on the issue of having to disclose the policies and procedures adhered to in determining fair value measurements for Level 3.  Responses, comments, and feedbacks from various institutions in the like of State Street Financial Center find this amendment diligent especially at a time the amount of time featured in making a decision is cited (Newth, 2016). There would be no need to create time for evaluation of parameters, techniques, and inputs that are employed in arriving at the final decision. This amendment should be adopted as it eliminates abstract factors as level of required details that could vary with an item, the degree of emphasis to term a measurement as fair, and the required extent of aggregation or disaggregation in the valuation process.

Measurement Uncertainty

            While FASB was keen to eliminate some requirements, it proposed a move to structure the nature of disclosure as inspired by its “uncertainty” without much emphasis on its sensitivity. This marks an improvement of this section as the diction used suggests basing a measurement on the date of valuation rather than having to consider variation that would come in future. FASB suggests the use of qualitative signals in the measure of uncertainty. Such parameters help in making investment decisions in various sectors of the economy (Christensen, Glover, & Wolfe, 2012). But this aspect demands improvement as qualitative tools are not enough in establishing the degree of uncertainty pertaining an asset or liability. The inputs applied in the line of use affect the value of an asset. There could be the need to communicate how the value of an item varies in the event of exposure to other factors. Making such establishments is easier and less difficult in the long run. While quantitative analysis of uncertainty may be costly, the act is operable as long as the relevant information is provided to the preparers. In fact, firms have been providing such disclosures without any challenges.

Proposed Disaggregation of Unrealized Gains and Losses

As uncertainty and sensitivity concern investors, the proposal to have unrealized gains and losses disaggregated is a move that would insensitively affect such industries as banking. FASB imagines that such disclosures for level 3 hierarchy would be relevant for users who would want to analyze the possible implications of fair value measurements that are categorized as unobservable. But such a benefit is restricted to only Level 3 position. It is not applicable in Level 1 and level 2. Moreover, many stakeholders have expressed concern over the approach used in auditing for net income does not factor unrealized gains and losses (Newth, 2016). A requirement to disaggregate would have financial sectors perform significant changes to their subsidiary ledger data a sentiment shared by American Bankers Association (Gullette, 2016). In this light, banks use a different approach other than hierarchies in tracking down the value of their assets. Their value portfolios do not create distinctive segments for unrealized or realized gains or losses. Assets are tied economically to others and creating hierarchical categories would yield confusion in the measurement of fair value. Moreover, such information would not prove relevant to users. It would be an additional cost to the investors despite their irrelevance.

Weighted Averages and Time Periods

            The proposal regarding the disclosure of weighted averages will be useful in complementing the already available data regarding observable inputs. Such information will provide some back up for estimating the level of involved uncertainty. The weighted averages are a better reflection of the reliability of the range used unlike the midpoint of the range, which offers a rough estimate of the weighted averages. A weighted-average of the input is the most consistent tool for measuring uncertainty (Jennings, Bratten, & Schwab). Nevertheless, some organizations have opposed the disclosure of weighted averages as they become irrelevant with time an item that can mislead the client (Newth, 2016). They might be forced to establish fair measurement based on historical inputs while the actual and most appropriate information should the one given at the reporting date. Moreover, the tools used to measure such elements are unique for all reporting entities. As such, there would be a lack of uniformity, an aspect that eliminates the chance for comparison. For an industry that has been not concerned about such data, there would be cases of incremental costs yet the information would not be useful in the decision-making process. There would be no meaningful tools that would assist in measuring the weighted averages of derivative portfolios (Gullette, 2016). The approaches used can be contentious in the event of items that call for counterparty netting, and those received in a given period. On the other hand, the proposal to disclose the timeframe for the development of unobservable inputs is a questionable idea. It will leave an open door for use of times featured in historical context an element that would allow reporting entities to make adjustments to enhance relevance. Such changes can eliminate aspects that might be meaningful to the user. As such, this aspect should not be included in the final update.

Materiality

            With the proposed amendments touching on various issues, the concept of materiality as suggested by FASB has raised some critical arguments. The definition has eliminated some aspects of materiality as only the management can deem an item as material. The proposal does not provide enough information on the connection between materiality and measurement uncertainty. There are no suggested tools on how preparers can quantify materiality of fair value disclosures when the dynamics of uncertainty are put into perspective. In some cases, uncertainty may prove larger than the evaluated materiality and thus a proposal that brings confusion. In some incidences, the uncertainty may affect net income an element that is used in the evaluation of materiality. It can further affect earnings per share thus calling for better instruments of measurement and interpretation of the factors that define materiality. In the event of planning and performing an audit, such aspects as omissions and misstatements can be proved to have the ability to affect economic decisions made by users. As such, materiality is affected by the nature of the included misstatements, and circumstances featured in the event of establishing fair value measurement. Ideally, the parameters used in measuring materiality are inspired by the commonness of the needs of the users (IFAC, 2009). The information they desire to know provides light on what to include and omit. In this aspect, individual users may be forced to forego some aspects of the information an element brought about by misstatements. With the suggested proposal at hand, does not explain the role of materiality in significant measurement uncertainty, and its application in deducing the latter.

Operability and Auditability of the Proposed Disclosure Requirements

            While proposing new requirements is one thing, fair value auditing is a factor of consideration. Various stakeholders have not identified significant aspects that would prove difficult in operability and auditability. The benchmarks used as parameters tend to test on the fairness of any stated financial statements on the dynamics of materiality. Some researchers have investigated how auditability of fair values relates to measurement uncertainty. Proportion as much as 70% of such measurements tends to feature measurement uncertainty with a significant range of values that could be equal or surpass the quantitative audit materiality (Cannon &Bedard, 2015). It has been noted that the currently provided standards for auditability of fair measurements make the operation difficult (Bratten, gaynor, McDaniel, Montague, & Siera, 2013). This is attributed to the presence of financial statements that have varied points estimates and affect such measurements as net income.

Suggested Alternatives and Changes to Improve Proposed Requirements

            With the above examination of the suggested amendments, FASB should be encouraged to improve and offer better requirements that are useful in the decision-making process. An area of interest is the valuation model of significant inputs whether they are observable or unobservable. The quantitative disclosure requirement should be expanded to include inputs that are on both extremes; observable and unobservable. While FASB expresses desire to avail information regarding such aspects as conclusions and rationales used by the managements, it should define the limits of such applications as Level 2 items would attract such attention. While the FASB defines the suitable range of disclosure, it should be inspired by the suggestions offered by experts. This would bring about consistency and create room for comparison of shared information. A narrower range is more reliable to users unlike an expounded one (Davis-Friday, Liu, &&Mittelstaedt, 2004).

The issue of auditability calls for well-established parameters that address challenges associated with a measurement of uncertainty that exceeds the stated materiality. This can be achieved by giving the auditors the freedom of looking beyond the single point estimate (Bartov, Mohanram, &Nissim, 2007). They should consider the elements surrounding the reasonable range of uncertainty related to the single point estimate. As such, FASB should see that preparers engage in quantitative measurement uncertainty analysis that shed light on all range of outcomes. A requirement structured in this manner would enhance transparency in the provided financial statements, and underscore any possible challenges associated with fair value measurement. Collaboration with The Public Company Oversight Board would help FASB establish informed auditing standards.

As much as quantitative measurements may provide a wide range of values, arguing that decision-making process becomes complicated is a deliberate intention to ignore the degree of risks that are inherent in the transfer of property. FASB should see the need to disclose all fair value ranges based on quantitative measurements as even organizations earn a consistent culture in making and reporting their decisions (Majors, 2015). Such findings guide the firms in identifying risks, and mitigating them (Cannon, 2015). Apparently, the effect of trend tells the possible outcome on the level of income in a firm. As such, it goes beyond the aspect of establishing the value of an asset. It communicates about possible risks allowing firms to make appropriate decisions. In such a case, a measure of sensitivity should be used as an indicator of the implications of future variations in net income. Moreover, the reporting behavior among firms in the society is enhanced increasing transparency and honesty in fair value measurement. Nevertheless, as equally suggested by FASB, quantitative disclosure should not affect the interrelationships between inputs. This would otherwise create a bulk of information that would overwhelm users. In this light, the proposal on uncertainty would be encouraging.

Moreover, the FASB disclosure framework should spend more time to address the issues surrounding materiality. In the subject of significant measurement uncertainty, FASB should guide the preparers on how to establish fair value disclosures. It should eliminate the confusion that comes in the event of uncertainty exceeding materiality. The fact that uncertainty can flow to other aspects as earning per share and net income should underscore the need to address this issue. As such suitable valuation mechanisms would come in handy for truer and fairer view of the experienced risks and gains during a financial cycle. A suggested approach is having firms set valuation reserves for products that could be categorized as mark-to-model (Vinals, 2008). The reserves would help establish the uncertainty that comes with the valuation of fair value in a given situation. Ideally, the challenges that come with uncertainty are attributed to the complexity of a given product, and the pace of transformation of market conditions. With reserves at hand, stress tests related to different scenarios can be tested revealing the magnitude of uncertainty associated with the valuation of a given item at a particular time.

Conclusion

Concisely, the FASB proposed changes are solely meant to improve and better the parameters of fair value measurement, and identify relevant items for disclosure to interested entities. The proposed idea to eliminate some of the disclosure requirements is a remarkable decision. Uncertainty has been considered a far better item than sensitivity in the case of disclosures, making the suggested changes more appealing. Disclosure of weighted averages is encouraging as they can reveal the degree of uncertainty. However, some areas need improvement and clarification. Disclosure of periods is irrelevant to the users. The measure of materiality calls for clarification and better framing to help users make informed decisions. The suggested proposals are operable and auditable. An overall improvement of the requirements would address the fundamental tools for fair value measurement. All inputs should be clearly categorized for clarity. Firms can set in place valuation reserves that can serve to reveal the degree of uncertainty in a given period.

References

Bartov, E., Mohanram, P., & Nissim, D. (2007). Managerial discretions and the economic determinants of the disclosed volatility parameter for valuing ESOs. Review of Accounting Studies, 12(1): 155-179.

Bratten, B., Jennings, R., & Schwab, C. (Forthcoming). The accuracy of disclosures for complex estimates: Evidence from reported stock option fair values. Accounting, Organizations and Society.

Bratten, gaynor, McDaniel, Montague, & Siera. (2013). The audit of fair values and other estimates: The effects of underlying environmental, task, and auditor-specific factors. Auditing: A Journal of Practice & Theory, 32:7-44.

Cannon, N. (2015). Fair value measurement under high uncertainty: The effects of disclosure format and management aggresiveness on user’s risk assessments. . Retrieved from http://ssrn.com/abstract=2731367

Cannon, N., & Bedard, C. (2015). Auditing challenging fair value measurements. Evidence from the field. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2220445

Christensen, Glover, & Wolfe. (2012). Extreme estimation uncertainty in fair value estimates. A Journal of Practice & Theory, 31(1), 127-146. .

Davis-Friday, P. Y., Liu, C. S., && Mittelstaedt, H. F. (2004). Recognition and disclosure reliability: Evidence from SFAS No. 106. Contemporary Accounting Research , 21(2):399-429.

FASB. (2015). Disclosure framework—Changes to the disclosure requirements for fair value measurement. Retrieved from Financial Accounting Standards Board: https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=3&cad=rja&uact=8&ved=0ahUKEwiko6CNgr3LAhVEAZoKHbhqB7gQFggrMAI&url=http%3A%2F%2Fwww.fasb.org%2Fcs%2FContentServer%3Fc%3DDocument_C%26pagename%3DFASB%252FDocument_C%252FDocumentPage%26cid%3D11761

Gullette, M. L. (2016). Disclosure framework- Changes to the disclosure requirements for fair value measurement. Retrieved from FASB: http://www.fasb.org/cs/BlobServer?blobkey=id&blobnocache=true&blobwhere=1175832771772&blobheader=application%2Fpdf&blobheadername2=Content-Length&blobheadername1=Content-Disposition&blobheadervalue2=1269118&blobheadervalue1=filename%3DDISFR-FVM.ED.0001.AM

IFAC. (2009). Materiality in planning and performing an audit. Retrieved from IFAC: http://www.ifac.org/system/files/downloads/a018-2010-iaasb-handbook-isa-320.pdf

Majors, T. (2015). The interaction of communicating measurement uncertainty and the dark triad on managers reporting their decisions. The Accounting Review.

Newth, S. P. (2016). Fair value measurement (Topic 820)- disclosure framework- Changes to disclosure requirements for fair value measurement. Retrieved from FASB: http://www.fasb.org/cs/BlobServer?blobkey=id&blobnocache=true&blobwhere=1175832847774&blobheader=application%2Fpdf&blobheadername2=Content-Length&blobheadername1=Content-Disposition&blobheadervalue2=1398606&blobheadervalue1=filename%3DDISFR-FVM.ED.0004.ST

Vinals, J. (2008). Improving fair value accounting. Financial Stability Review, 12; 127-129.