FASB 157 clarified asset valuation practices for publicly traded companies in the US, requiring assets to be divided into three categories based on reliability of fair value estimates. Tier-three assets, such as mortgage-backed securities, were difficult to value and led to significant write-downs for companies. The publication was necessary to provide investors with a more accurate picture of company value, and the global financial crisis that followed was not caused by the change in accounting practices.
FASB 157 was a publication issued by the Financial Accounting Standards Board (FASB) in 2006 to clarify accounting practices for valuing assets at publicly traded companies in the United States. This publication is designed to create greater accuracy when it comes to asset valuation statements by providing investors with an idea of the true fair value of assets listed in public disclosures. An immediate result of FASB 157 was a significant write-down of some major companies. Changes in accounting practices are dictated by the FASB in response to changing trends in the accounting and finance community.
According to FASB 157, when a company values assets, it must divide them into three different categories based on the reliability of their fair value estimates. Tier-1 assets can be valued with mark-to-market accounting and have the most accurate value estimates because they are pegged to identical assets valued on the open market. Bonds, for example, are easy to value because their fair market value is known.
Tier two assets are a little more difficult to value and must be valued using a pricing model. This is known as mark-to-model accounting. No equivalent assets are sold on the open market, providing a price, but assets similar enough for valuation to be possible are traded or sold, allowing companies to make a reasonable estimate of value. Finally, level three assets such as mortgage-backed securities cannot be valued accurately and in most cases are highly illiquid in nature.
Companies with a lot of value in level three assets were forced to write down their total value after FASB 157, reflecting the uncertainty of their stated asset valuation. Since a number of companies had invested heavily in the 2000s in precisely this type of business, the effective date of FASB 157 marked a dramatic shift in the value of many companies’ reported assets. This could be used as evidence to suggest that the publication was necessary, to give investors a more accurate picture of the value of the companies they are interested in.
Shortly after FASB 157 went into effect in 2007, a global financial crisis hit and much of it revolved around level three assets. Several factors have contributed to this crisis and the tightening of accounting standards certainly cannot be attributed to the fall in value of many large companies; the change in accounting practices did not cause a material change in value, but only made the true value of many publicly traded companies more apparent.
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