Seeking harmony

GPs and LPs may have hoped that they were finished dealing with the various “clarifications” to accounting and valuation standards last year, but unfortunately this year could bring a new batch of changes, as the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) work to achieve a common set of financial accounting standards, including a common fair value standard, in 2010.

While the current working draft being uses the same definition of fair value as FAS 157 (now known as ASC 820), the two sides are still far apart on key issues, said David Larsen, a managing director at Duff & Phelps, during one of the firm's roundtable discussions on valuation on Thursday. Larsen is a member of FASB's valuation resource group, as well as a member of the International Private Equity and Venture Capital Valuation (IPEV) board, and so he has participated in discussions on accounting harmonisation. Finding common ground on these issues could ultimately lead to another reexamination of ASC 820 in the US, he said.

“What we are going to see from the macro perspective is that the IASB is going to conclude how they should go forward, and that will likely trigger a deliberation on ASC 820 or certain aspects of it in the US,” Larsen said. “So when we thought things were settling down, because of that desire to converge from an international perspective we have the potential to reopen [some of these issues].”

For one, there is a divide between how FASB and IASB think financial instruments such as bank loans should be valued, with FASB taking the position that such instruments should be recorded at fair value rather than valued at amortised cost. The IASB also adheres to the premise that there should be no special accounting standards for special industries, while in the US investment companies have a separate and distinct set of accounting rules.

“Under international standards, if you own control of an investment, you have to consolidate [your holdings],” Larsen said. “Under US standards, if you are a large private equity fund and you own control of an investment, you report it at fair value. What that says for investors in alternative assets is that international accounting standards are arguably irrelevant, because they don’t provide investors with the information they need.”

That’s why very few private equity funds follow international accounting standards, he said. In a world with one common set of accounting standards, the consolidation issue would be “problematic” for the alternative asset industry.

Other issues that will have to be harmonised are the use of blockage factors and disclosures about fair value measurements. In particular, the issue of sensitivity testing for valuations of Level 3 assets differs in IFRS and GAAP. In January, FASB released Accounting Standards Update 2010-6, which explicitly stated the sensistivity testing is not required. Under IFRS, sensitivity testing is still required, though Larsen noted that outside of the US, auditors don't have to report to a government entity as they do in the US, and thus sensitivity testing is likely to be less rigorously executed.

“It became a huge discussion point during the drafting stage because many people said [sensitivity testing] is not relevant, it is hard to do, it will just confuse things,” Larsen said. “So FASB decided not to include sensitivity disclosures in their new guidance.”

This once again puts FASB and IASB at odds, and may change again as they two sides seek common ground. All of which means that GPs and LPs shouldn’t expect to take a break from valuation issues anytime soon.