Fair value overkill



Last week, Warren Buffet made an announcement that sent shockwaves through the capital markets. “Based in part on the recent decision by Initrobe to classify the fair value of its debt as level 1, Berkshire Hathaway today purchased all of the outstanding common stock of Initrobe (ticket symbol IN). We were also impressed by the company’s Level 3 rollforward, which gave me invaluable insights into the company’s cash flows and operations."


Mr. Buffet then paused. “On a different note, Berkshire Hathaway today sold 10% of its stake in Palmetto Industries, due to the fact that its pension plan’s assets added a level 3 investment to the plan’s portfolio this year. Clearly the company should not have settled for a level 3 investment, but instead should have purchased a level 2, or even a level 1, investment, just like the good FASB intended. I also don’t like that some of the company’s investments were level 1 last year, but are level 2 this year. Really shows a lack of investment discipline by that company’s management team.”


As ridiculous as such an announcement would be, one wonders if the FASB somehow believes that users of financial statements analyze the fair value disclosures way more than they do. No person in her right mind would base an investment or lending decision, even a little bit, on a company’s fair value disclosures. To my knowledge, the SEC hasn’t issued very many comment letters on the finer points of fair value disclosure (I could see it now: “Please explain why your debt is level 2.”). In part because the existing fair value disclosures waste precious time and resources of users, companies and auditors, the FASB has stepped in. The FASB recently proposed changes to fair value disclosures required by ASC 820, most notably recommending the following changes:

1) The new standard states that “an entity should provide disclosures if they are material.” The fact that the FASB feels the need to clarify this means that they went a bit overboard in the first place when SFAS 157 (and subsequent updates) were issued. After all, isn’t it obvious that immaterial disclosures are not required to be made?


2) “Eliminates phrases like ‘an entity shall disclose at a minimum,’ which make it difficult to justify omitting immaterial disclosures.” As stated in the bullet above, this should have been a fairly obvious point.


3) The elimination of required disclosures that “are not consistent with the concepts in the proposed Concepts Statement or because they are no longer deemed to provide useful information.” The third bullet above is where financial statement preparers, users, auditors, and the financial markets as a whole will see the biggest value, as the world will no longer have to tolerate the following drivel: The amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy.


4) The policy for timing of transfers between level 3 financial instruments· The valuation policies and procedures for Level 3 fair value measurements.


5) For private companies, the change in unrealized gains and losses for the period included in earnings (or changes in net assets) on recurring Level 3 fair value measurements held at the end of the reporting period.

All good changes that are desperately needed, although I wonder why #4 above doesn’t apply to all companies (and not just private ones). Just one more example the FASB pretending to make GAAP less messy, but actually adding to its complexity (with different GAAP for public and private companies).


Be honest: have you ever known of any financial statement user, under any circumstances, to have changed an investment decision based, even in part, on the leveling mix of a company’s pension assets and liabilities? I research numerous public company filings for my own personal investments, and never even look at the fair value footnotes. Like most investors, I focus on whether the company has a clean audit opinion the strength of the company’s cash flow (especially free cash flow) and balance sheet the quantity and type of off-balance sheet transactions the company has whether the company can afford to pay me a dividend and other items. Fair value disclosures, though, aren’t anywhere near that list. So long as a reputable audit firm has vouched for the accuracy of the numbers, then I don’t care if an asset is classified as a level 1 or a level 2.


Of course, I shouldn’t complain too loud. The FASB’s eagerness to overwhelm financial statement users with mounds of meaningless disclosure has kept me employed for many years now. The CPA profession is booming, in part because the FASB’s mission is to make sure that investors can’t understand what is important and what (like fair value disclosures) is unimportant.Do you agree that fair value disclosures are useless? Or do you think they provide valuable insights into a company? Or are you somewhere in the middle? I’d love to hear your comments, either below or by tweeting me @shafercpa.