Accounting Alert 07-6

April 18, 2007

The AICPA’s Center for Audit Quality (CAQ) has just issued an open letter (CAQ Alert #2007-14) to its members. The letter, which can be obtained on the CAQ’s Web site, warns of financial reporting pitfalls in certain strategies involving the adoption of FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities.

In Accounting Alert 07-5 we highlighted accounting and disclosure issues surrounding certain strategies whose goal of taking advantage of the transition provisions of Statement 159 and avoiding recognizing unrealized losses in income rather than measuring financial assets or financial liabilities at fair value in future periods appears to be inconsistent with the objectives and spirit of Statement 159.

The CAQ letter was based on discussions with member firms and the SEC staff and includes the following statements:

If an entity proposes to adopt the fair value option merely to achieve an accounting result that is contrary to the principles and objectives in FAS 159 (i.e., the recording unrealized losses directly in retained earnings coupled with little or no intent to apply the fair value option as a measurement attribute with respect to these classes of financial assets and liabilities on a go forward basis), the auditor should reach a conclusion that the entity’s proposed accounting departs from generally accepted accounting principles.

In those situations where early adoption of FAS 159 is deemed appropriate, and where unrealized losses are being recorded directly in retained earnings in connection with the early adoption of FAS 159, entities should provide clear and transparent disclosures of the reasons for electing the fair value option for specific eligible items and for not electing the fair value option for other eligible items within a group of similar items, including a discussion of any accounting motivations of such elections, with the other required disclosures of FAS 159.

An entity’s management should consider having discussions with its audit committee and consulting with its independent auditor if it plans to employ a strategy in connection with the adoption of Statement 159 that may not be consistent with the principles or objectives of the Statement.