One of Canada’s accounting bodies has jumped into the fair value debate, stressing that different standards related to fair value measurements lead to uncertainty and skepticism and, of perhaps greater significance, reduce comparability between financial statements.

Fair Value Accounting: The Road to be Most Travelled, a paper issued by the Certified General Accountants Association of Canada (CGA-Canada) in late January, also notes —  as U.S. Financial Accounting Standards Board (FASB) chair Robert Herz recently stressed — that confusion arises when financial reporting information is extended to purposes for which it was not intended, such as evaluating the capitalization of financial institutions.

According to CGA-Canada president and CEO Anthony Ariganello, the two key accounting standard-setting bodies in the world — the International Accounting Standards Board (IASB) and the FASB — have significantly different standards on the use of fair value for financial instruments. “This matter is especially important in Canada, where we will transition to international financial reporting standards (IFRS) in 2011, yet our economy is heavily integrated with that of the United States, which relies on standards set by the FASB.”

Rock Lefebvre, the association’s vice-president of research and standards and a co-author of the fair value paper, points out that fair value accounting standards are not new. Essentially, they are used to value a firm’s assets and liabilities based on market value rather than historical cost. But their application to the valuation of financial instruments has been debated heatedly since the onset of the financial crisis in 2007. He reiterates a key point in the paper, that fair value accounting was not a cause of the crisis, “but the crisis did illustrate several legitimate concerns — namely, that fair value accounting exacerbates procyclicality and increases volatility of financial statements.”

Some continue to lambaste fair value accounting for the financial crisis, he says. “But we have to appreciate that the volatility on balance sheets is primarily caused by the risk management framework and investment decision protocols employed, rather than the fair value accounting framework itself.”

Perhaps more important for Canadians, Lefebvre says, “Is that the Canadian economy is very closely linked to that of the U.S. In the absence of the convergence of the standards, the financial statements of domestic Canadian companies and U.S. companies are not easily comparable. This scenario creates difficulties for providers of capital and other economic decision makers on both the sides of the border. In the recent past, the efforts of Canada’s Accounting Standards Board and its Emerging Issues Committee were geared to harmonizing Canadian GAAP with U.S. GAAP, but this has naturally changed with the impending transition to IFRS in 2011.”

That, he adds, leads to the challenge of reconciling the different approaches to financial instruments on different sides of the border, “leaving Canada in an uneasy position with its most important trade partner.”

Lefebvre says concerns about fair value measurement are best addressed by converging and simplifying standards rather than resorting to inferior forms of financial measurement, such as historical cost. But he acknowledges that this might be difficult.

“The FASB approach can conceptually be more attractive due to its purity in applying fair value contrary to the IASB approach, which enables the blending of two different measurement basis — historical cost and fair value — in financial statements. For some, the IASB approach is nevertheless defendable on the basis that it sought to balance the conflicting influences of preparers, auditors, investors and regulators.”

Nevertheless, some sort of commonality needs to be achieved, Lefebvre says. “As difficult as it is, we can appreciate that it is the financial instruments themselves that are complex and risky and that the accounting rules should seek to report fairly the character of the underlying financial instruments.”

Today’s reality, he explains, “is that financial instruments, in fact all asset and liability items, require a responsive and informative reporting convention that accurately satisfies the needs of financial statement users. There is common recognition that fair value accounting has a legitimate role to play and that a level playing field is likewise beneficial — and that the opportunities lie in convergence and in simplification.”

Lefebvre also notes that financial reporting and prudential reporting have different purposes. But confusion between the two has led national governments and special interest groups to apply heavy pressure on the independent accounting standard setters.

“If accounting standards are going to effectively meet their intended purpose, the standard-setting process must be transparent, independent and free of pressure from political or special interests,” he says.

In any case, Lefebvre concludes, “shifting to a single, high-quality global standard ensures more uniform application, promotes accountability and credibility, and strengthens efficiency of the standard-setting process.”
Adds Ariganello, to that end, “a recent recommitment by the two standard-setters to remove differences between their respective interpretations of fair value accounting is a positive and welcome development.”

Peter Martin, director of accounting standards at the Canadian Institute of Chartered Accountants, says that, “for a practitioner who wants some insights to what is going on, (the paper) lays out some important points.” And it should elicit some response from readers, who will either agree or disagree with the basic position taken, adding to the debate on this highly contentious issue.