The Financial Accounting Standards Board (FASB) has come out with a new rule with is a doozy. FASB is one of the entities that create what is called Generally Accepted Accounting Principles (GAAP).
In the May 12th , 2017 New York Times article in the Street Scene section talks about a change. A Little-Known Accounting Change Could Have a Big Impact talks about a rule change in the recording of small investments in other companies.
Current FASB Rule
Currently, under FASB and GAAP, investment in less than 20% of a company’s equity are recorded at cost. Should the investment not do well, then the company (we will call the company that made the investment, “ACME“) can write down the investment and take the associated cost. Again, for clarity, the company that ACME invested in, we will call “Road Runner.”
If the Road Runner does well, there is no rule that says the company needs to write-up the investment. The disservice to the investors of the ACME is they never know that the investments like Road Runner are doing well. Therefore, FASB decided to address that issue. In so doing they have created, some major [un-] intended consequences.
The FASB Change
Under the new rules, ACME would now have to show on their balance sheet the market value of Road Runner. In many companies that are small, it is quite difficult to determine its true market value. It actually can get quite expensive to have that study done. Most companies will not have the accounting bench with the prerequisite skill sets to complete proper valuations. So this rule is a boon to public CPA firms and specialty houses that do valuations.
But wait; I left out the best part. The rules state that this is not done on an annual basis. No, that would be a disservice. Companies need to record this valuation on a QUARTERLY basis. Can you imagine the stress and strain on companies? Let’s not even talk about the cost.
So you’re thinking, one company investment, not that big a deal. Many companies invest in multiple, scores, even hundreds of small companies. Now multiple the effect. Horrendous!
Our graphic of the ACME Atom Re-Arranger is extremely apt. If the rule stands, investments by all types of companies into other companies might just stop. I know from companies I’ve been associated with that this rule with be a game changer and game stopper. Those companies would not have the resources to pay a firm to do valuations of several investments – quarterly. The costs in hard dollars and time would just weigh in favor of not investing.
What was the makers of the FASB’s thinking? Or were they just thinking of the ultimate flow of cash into the public (sic larger) CPA firms and specialty houses? I’m sure we’ll never know, but this is another rule that makes zero sense.
If you took this rule to its logical extreme, why not use market valuations for buildings and land. How about every non-current balance sheet asset? And while we’re at it, how about the true value on some of the liabilities (like amounts that are in dispute that don’t make it to notes on the financial statements).
And the silly changes keep trucking on…..