The Valuation Resource Group formed by the Financial Accounting Standards Board is lobbying the board to give new guidance on how fair value should be measured when markets are inactive.

The group met with members of the board in an open forum last week, making their case that the market could use some more direction on how to apply Financial Accounting Standard No. 157, Fair Value Measurements. The group told FASB preparers and auditors are confused and conflicted about how to determine for FAS 157 purposes whether markets are active or inactive, when it’s appropriate to move away from quoted market prices and rely on models to establish values, and how to factor illiquidity into fair-value measurements.

In discussing the issues, said VRG member Don Charles, a partner at Ernst & Young, “The general consensus is they’re all interconnected. Further guidance would be appreciated.” In defining active vs. inactive markets, FASB could rely on factors such as the amount of time it takes for an entity to make a sale or the ability of an entity to execute a transaction at a given price, for example.

Charles told FASB the group sees “significant variability” around when entities rely on quoted market prices to establish fair value, as well as when and to what extent they instead rely on other less observable data. The group also sees differing views on whether transactions are characterized as distressed, a key point in the valuation process because FAS 157 says prices in distressed transactions do not reflect fair value. “The question people are dealing with is when does a distressed market become distressed transactions?” Charles said.

At the same time, the VRG cautioned FASB to steer clear of requests to come up with accounting workarounds that try to segregate the effects of liquidity from credit in the stated financial results. “The consensus is that segregating elements of value between liquidity and credit would be complicated and costly,” said Charles. Instead, “think about presentation and location. Geography might be another way of handling the issue.”

VRG member Michael Mard, managing director at the Financial Valuation Group, said inactive markets have morphed into inefficient markets, further complicating the valuation process. “The efficient market theory says reasonable people will do reasonable transactions given reasonable information,” he said. “If you have inactive markets, you have something that’s unreasonable.”

FASB member Tom Linsmeier asked VRG members if the current tension is caused by auditors insisting on use of market prices when preparers and valuation experts would prefer to rely more on other market data. “We all responded resoundingly yes,” said Mard. Auditors in particular are “glomming on to market transactions because they believe they are not challengeable,” he said. “Regardless of whether it’s reasonable or not, regardless of how stale or how non-sensical, that becomes the driving indicator of value.”