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Gains and Losses on Equity Holdings May Be Marked at Fair Value

The FASB wants publicly traded companies to fair value most gains and losses on equity securities and include them in net income. The board made an exception for equity shares that amount to 20 percent or more of another company that the owner doesn’t control.

The FASB voted 5-2 at its July 30, 2014, meeting to require publicly traded companies to fair value most gains and losses on equity securities and include them in net income.

The board made an exception for equity shares that amount to 20 percent or more of another company that the owner doesn’t control, or those of private companies.

The decision stemmed from the February 2013 Proposed Accounting Standards Update (ASU) No. 2013-220, Financial Instruments—Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities. The decision is subject to the board’s final approval at the end of August. The FASB has determined that companies would no longer classify the securities as for trading purposes or available for sale. Instruments in the trading portfolio will be recognized at their fair value, with gains and losses recorded in net income. Instruments classified as available for sale will also be priced at fair value, with changes in value recorded in other comprehensive income (OCI). The decision left in place the existing such treatment of debt securities.

FASB Chairman Russell Golden and Vice Chairman James Kroeker dissented from the decision. They preferred that the changes in value on the securities in question go to other comprehensive income, and limit the changes’ immediate effect on companies’ earnings. Golden also expressed a preference for an alternative not suggested by the staff: Fixing what he described as FASB’s “broken” impairment model.

Even a supporter of the decision, board member Harold Schroeder, said he would have preferred yet another alternative not proposed by the staff: Acceleration of the FASB’s longstanding financial presentation project, which is designed to help investors distinguish between operating performance and one-time items.

Some observers suggested that ridding GAAP of the distinction between trading and available-for-sale equity securities and including in net income fair value changes in them would be an improvement. They said it would give companies less opportunities to manage their earnings to meet Wall Street’s per-share earnings estimates and boost their stock prices.

“The [other comprehensive income] treatment allows more information to be buried in ‘management’s holding tank for things we’d rather not discuss,’ ” said Jack Ciesielski, a principal in the Baltimore investment advisory firm, R.G. Associates, and publisher of the newsletter, “The Analyst’s Accounting Observer,” in an email. “The income statement is supposed to show everything that happened in a timeframe and not ‘clean it up.’ “

Other comprehensive income has long been a sore point for some analysts and fund managers because U.S. GAAP has no clear definition for it, and there’s a great deal of inconsistency in how it’s applied. Other comprehensive income is a prominent part of the financial instruments proposal and has been a focal point of debate for as long as the FASB has been working on the planned standard.

Charles Mulford, an accounting professor at the Georgia Institute of Technology, suggested that Wednesday’s decision was in line with an apparent trend at the board to downplay other comprehensive income, as it recently decided to allow companies to include actuarial gains and losses on pensions in net income, whereas the changes used to have to be in other comprehensive income. Mulford asked rhetorically, “Might gains and losses on cash flow hedges and foreign currency translation gains and losses be next?”

Much of the board’s discussion about where to include changes in equity holdings’ value had to do with the extent to which investors were likely to understand how they relate to operating results. Golden argued that gains should be included in comprehensive income, because net income would then be freer of one-time items. Others on the board said it would make little difference to include them in net income because analysts would find it easy enough to determine operating income. Some board members seemed to agree with a staff member who noted that the market was more or less efficient when it came assessing the effect of one-time items. But Thomas Linsmeier said he was skeptical about most investors’ ability to focus on much besides earnings per share.

Under the exceptions the board carved out of the proposed guidance, holders of 20 percent or more of a company’s equity, who aren’t deemed in control of the company, would continue to account for them under the so-called equity method. A proportionate share of the profits and losses of the company in which it holds that equity would be included in net income, while owners of shares of private companies would hold them at historical cost and include any observable changes in value in other comprehensive income.

Separately, the board also voted to require banks to disclose the amount and average weighted life of their core deposit liabilities and explain the considerations that went into the estimates.

For more analysis of Proposed ASU No. 2013-220, please see the Accounting and Auditing Update Service [AAUS No. 2013-09] and the SEC Accounting and Reporting Update Service [SARU No. 2013-09] (February 2013): Accounting For Financial Assets And Financial Liabilities.

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