Documenting Fair Value Determinations in an Uncertain Economy

While the changes made to fair value accounting may seem like yesterday’s news, it is still important to maintain a strong control environment and robust documentation over the valuation of financial instruments in order to ensure reliable and transparent accounting. It is critical to remember that the valuation of financial instruments is the responsibility of management and that management must be prepared to support the reasonableness of these values. This is increasingly true as the normalization of some markets may require the use of different valuation inputs than those previously used and as proposed accounting guidance may expand the scope of financial instruments presented at fair value on the balance sheet.

Unfortunately, fair value measurements are seldom as simple as drawing a number from a broker statement or obtaining a pricing service mark. In markets with reduced activity, such as with some corporate bonds, real estate loans, asset-backed and mortgage-backed securities, it is frequently necessary to scrutinize the methodology and inputs used by valuation sources. While it seems that the values provided by respected financial institutions or service providers should be reliable sources of fair value, management must still understand and accept responsibility for the methodologies and inputs used by these parties. In markets with limited activity, these institutions and services providers frequently utilize significant judgment and unobservable inputs in the determination of fair values.