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Called "tricky" by at least one industry observer, a new accounting standard that's already caused problems in the investment-banking business kicked in officially on Thursday.
The Financial Accounting Standards Board, an audit rulemaking group, voted against deferring Statement 157, which requires companies to come up with a fair value for assets using market-based approaches. It also promotes greater disclosure about those fair-value measurements.
The rule applies to financial assets and liabilities for fiscal years starting after Nov. 15. But FASB said it deferred the rule for non-financial assets, such as plants, equipment and property.
Big banks and brokers have already begun changing their accounting to adjust for the new rule. They now identify assets that trade infrequently and are the most difficult to value as Level 3 assets.
By comparison, Level 2 assets are those that may not trade much but that can be valued by checking market prices of similar securities and making assumptions about variables such as interest rates. Level 1 assets are easy to value, such as stocks.
In theory, this gives investors more information about how much of an investment bank's value is based on hard-to-value assets.
The new approach has come along at a tough time for investment banks, many of which have been struggling as the implied market value of some subprime mortgage-related assets such as collateralized debt obligations, or CDOs, has slumped. That's highlighted how difficult some of these assets are to value and in turn has undermined investor confidence.
One accounting expert said on Thursday that financial institutions would have probably wanted Statement 157 deferred but were still preparing for the change just in case. For investors, the change is essential, he added.
"I'm glad they didn't defer it," said Charles Mulford, an accounting professor at the Georgia Institute of Technology. "We desperately need disclosures of CDO and subprime mortgage securities that aren't actively traded, so we can understand how these assets have been valued."
Financial institutions "asked for a deferral but didn't get it," he added. "But they were braced for the change anyway."
Indeed, the latest disclosures from investment banks on their CDO and subprime mortgage exposures have been "reasonably good," Mulford noted.
"We've been able to calculate what percentage of a company's earnings was coming from Level 3 valuations," he said. "It's a tricky rule, but needed."
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