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SEC Market Value Conference: experts urge mark-to-market.

Leaders from business, government, the accounting profession and academia argued the merits of fundamentally revising the traditional American basis of accounting and financial reporting at the Securities and Exchange Commission's groundbreaking Market Value Conference, held last November in Washington, D.C.

The conference, whose theme could be described as why the historical cost basis of accounting is no longer a relevant or reliable means of valuing a company's assets and liabilities, encouraged a shift to valuation based on current market value (a method also referred to as mark-to-market).

Market value accounting is championed by SEC Chairman Richard Breeden, who has encouraged accounting standard setters to begin moving toward the market value method. In brief remarks opening the conference, Breeden called the continuing relevance of cost accounting "one of the most significant accounting issues as we look forward to the future."

George Diacont, acting chief accountant at the SEC, warned, "Nothing does more to destroy the credibility of the financial reporting process, or the confidence of the investing public, than financial statements that create the impression all is well when in fact all is not well."

Diacont expressed concern that financial statements prepared using generally accepted accounting principles do not always contain the most relevant financial information. "You only have to look at the thrift industry disaster to know what can happen when you travel too far down a path that ignores economic reality," he stressed, adding that historical cost financial statements prepared in the early 1980s would have shown a savings and loan industry that was solvent; on the other hand, the same statements prepared using a market-value basis would have shown an insolvent industry.

"Some have warned that the problems of moving toward a market-based system of accounting are too great," he said. "I think the much greater risk is that we will allow the development of accounting standards to stagnate and become mired in maintaining a status quo that, in a rapidly changing economy and a shrinking world, will result in the dissemination of financial information to investors that is increasingly irrelevant."

U.S. Comptroller General Charles A. Bowsher, Jr., said, "When historical cost does not reflect true or current value, you have a set of financial statements that doesn't tell the real story." He pointed to a General Accounting Office study of 39 banks that failed over a two-year period, saying about $7 billion in assets "melted right off the balance sheets" once the government took the banks over and determined the real worth of their assets.

"More and more people are questioning whether they are really getting the right information when they read financial reports," Bowsher said. He suggested a mix of historical cost and market value models could produce statements reflecting the current value of assets and liabilities, "so people making decisions, including managements, boards of directors and regulators, are not looking at financial reports that don't hold up."

Comprehensive application. Market value accounting also was strongly supported by Leland C. Brendsel, chairman of the Federal Home Loan Mortgage Corporation (Freddie Mac). "To be effective, market value accounting must be comprehensively applied to all assets and to all liabilities," he said, "rather than to only a select group of items, which is typically reflected in many of the proposals" concerning market value accounting.

Brendsel described how Freddie Mac uses market value information, rather than GAAP, in making day-to-day management and investment decisions and called market-based data "critical for a comprehensive analysis of financial strength," a finding not readily determinable from historical cost statements.

"Many of our shareholders, creditors and regulators, want market value information to help them better understand us and to make better decisions," he said.

Brendsel also asserted that measuring market values for Freddie Mac's assets and liabilities was practical and inexpensive, despite the fact that it holds loans on millions of homes along with a variety of other investments.

Moreover, market value reporting provides better information about interest-rate risk management, he said, since it incorporates current interest rates into the measurement of values of all financial assets and liabilities, thereby reflecting the sensitivity of future earnings to movements in interest rates.

Finally, responding to critics who say market value reporting will result in volatile financial performance, Brendsel countered, "Financial performance will be volatile only if an institution is exposed to excessive interest rate risk." If such was the case, "you certainly would want that reflected in the financial statements."

Support from business. Bernard G. Ragland, CPA, assistant controller and chief accountant for the AT&T Corporation, proposed setting as an objective the development of a comprehensive current value model "as a complete overlay to the historical cost model." Ragland said in addition to the increased relevance to all decision makers already referred to, "the fundamental justification for this proposal is one of consistency. No longer would we swear allegiance to a historical cost model, even as we move away from it."

Ragland said by focusing on the economic significance of events and transactions, "optimal business decisions will be encouraged and industry will produce improved real financial results." Perhaps most important, he said, using market value as a basis, "the accounting model and financial reporting will have an intuitive appeal, making it more meaningful and more approachable by a wider audience."

Academic attack. A stinging critique of GAAP accounting was delivered by Lawrence J. White, the Arthur E. Imperatore Professor of Economics at New York University Stern School of Business and a former member of the Federal Home Loan Bank Board (FHLBB).

Describing himself up front as a "fierce advocate" of market value accounting, White asserted that "all too often balance sheets are frauds; balance sheets are cheats." Noting the dismal banking situation, White said changing to market value accounting would be "the most important banking regulations reform for the 1990s; all else pales in comparison."

He added, "We've got to get away from the myth that GAAP is perfect or precise. It is neither. We are all better off with a market value accounting system aiming at the correct target rather than with a GAAP system looking backward and focusing on the wrong one."

Accountants' views. In somewhat more subdued tones, the increasing relevancy of market value measurements over the historical cost model was echoed by prominent representatives of the accounting profession. Edmund L. Jenkins, managing director of accounting principles for Arthur Andersen & Co. and chairman of the American Institute of CPAs special committee on financial reporting, lent his support to the market value model.

Saying current accounting in "replete with problems that arise as a result of trying to force economic transactions or economic activity into a historical cost framework," Jenkins argued that "the use of market value, or as I prefer, fair value, for accounting purposes would resolve many of the accounting controversies we now face." He added, "I'm not thinking only about, or even primarily about, financial institutions."

Among the controversies that would be lessened or removed by moving to fair value accounting, Jenkins said, are accounting for business combinations, nonmonetary exchanges, involuntary conversions, formation of joint ventures and hedge accounting.

"Financial statements would be much more understandable, much more credible and much simpler if we had fair value accounting for these transactions," he remarked. "Some recapitalizations and restructurings might not be necessary, some transactions with respect to debt extinguishment, hedge accounting and so forth might not need to take place at all. And if they do take place, they certainly could be much more simply crafted."

In addition, Jenkins said the Financial Accounting Standards Board's agenda items on impairment and present value would largely be resolved or would not be relevant, since the assets would already be reflected at fair values.

Finally, Raymond C. Lauver, a former chairman of the AICPA accounting standards executive committee, former FASB member and former national director of accounting service for Price Waterhouse, presented his view. "Additional disclosures of market values during recent years have demonstrated that those measures constitute relevant information," he offered. Reiterating the day's theme, he then asked, "Why is relevant information not being recognized?"

He said much of the accounting debate about greater recognition of market values during the last 20 years had looked at the interests of equity security holders. But market value accounting also would aid creditors, he said.

"The buffer between losses to an enterprise and losses to a creditor depends on the measure of capital," he continued. "Which measure of capital, historical cost or market value, tells unsecured creditors more effectively what they need to know about the extent of risk? I believe it's clear the more relevant capital amount is measured using market value."

He added, "Without reporting assets and liabilities at market value, neither creditors nor regulators know how many enterprises are operating with understated, overstated or nonexistent capital."

His conclusion: "Accountants now have the opportunity to advance the state of their art, to enhance the value of their services if they will only do what they hold themselves out to do--to measure more items, more frequently and more accurately."
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Title Annotation:conference on the proposed shift to corporate valuation based on current market value
Author:Miller, Stephen H.
Publication:Journal of Accountancy
Date:Jan 1, 1992
Words:1507
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