FAS 107: What It Was and What Replaced the Standard
Examine the historical role of FAS 107 in financial instrument disclosure and how its foundational principles evolved into current accounting standards.
Statement of Financial Accounting Standards No. 107 (FAS 107) was issued by the Financial Accounting Standards Board (FASB) to increase financial reporting transparency. The standard’s primary objective was to mandate that entities disclose the fair value of their financial instruments within the footnotes of their financial statements. FAS 107 was strictly a disclosure standard; it did not alter the measurement basis of financial instruments on the balance sheet, where most items were carried at historical cost. Instead, it offered supplementary information about an instrument’s current market value. The standard was first effective for fiscal years ending after December 15, 1992.
Core Disclosure Requirements
FAS 107 established a broad definition for “financial instrument,” encompassing cash, any evidence of an ownership interest in an entity, and contractual rights or obligations to either receive or deliver cash or another financial instrument. This comprehensive definition ensured the standard captured not only traditional financial assets like stocks and bonds but also various off-balance-sheet instruments.
The central mandate of the standard was the disclosure of the fair value for these instruments, presented alongside their corresponding carrying, or book, values. This side-by-side presentation was designed to illuminate the difference between what an asset or liability was worth on the company’s books versus what it could be exchanged for in a current transaction. By revealing the fair values, the standard allowed financial statement users to assess the potential impact of market fluctuations on a company’s financial health.
If it was not practicable to estimate the fair value of an instrument without incurring excessive costs, the standard required a different disclosure. In these situations, an entity had to provide descriptive information pertinent to estimating the instrument’s value, including details about its terms, market risk, and credit risk.
Methods for Estimating Fair Value
FAS 107 guided how entities should determine the fair value of their financial instruments for disclosure purposes. The standard expressed a preference for using quoted market prices from active markets for identical instruments, as this method is based on observable data from actual market transactions.
When quoted market prices were not available, the standard permitted looking at the market prices of similar financial instruments. For instance, if a company held a bond that was not actively traded, it could look to the market price of a similar bond from a different issuer with a comparable credit rating and maturity date.
In the absence of any comparable market data, entities could turn to valuation techniques like the discounted cash flow method. This technique involves estimating the future cash flows that an instrument is expected to generate and then discounting them back to their present value using an appropriate interest rate. The standard allowed for flexibility, recognizing that the most suitable valuation method could vary depending on the instrument.
Scope and Applicability of the Standard
FAS 107 was designed to have a broad reach, applying to all entities that prepare financial statements in accordance with generally accepted accounting principles. This included not only financial institutions like banks and insurance companies but also commercial and industrial companies.
Despite its wide scope, the standard included several specific exemptions for certain types of financial instruments where fair value disclosure was not required. A primary exemption was for employers’ and plans’ obligations related to pension benefits and other post-retirement benefit plans. These obligations were covered by other specific accounting standards, and the FASB decided that separate fair value disclosures under FAS 107 would be redundant.
Other notable exemptions included obligations and rights under insurance contracts, lease contracts, and warranty obligations. Employee stock option plans and similar arrangements were also excluded from the scope of FAS 107, as they too were addressed by separate, more specific accounting guidance. The focus of the standard was on more traditional financial assets and liabilities, such as investments, receivables, payables, and derivatives.
Supersession and Current Guidance
The accounting landscape has evolved, and FAS 107 is no longer the primary source of guidance. The standard has been superseded, and its requirements have been absorbed and expanded upon within the FASB’s Accounting Standards Codification (ASC). Today, the principal guidance for disclosures about financial instruments is located in ASC 825, “Financial Instruments.”
This topic carries forward the core principle of disclosing fair value information, but its application has been refined. For financial instruments not already measured at fair value on the balance sheet, the mandate to disclose their fair values now primarily applies to public business entities.
The methods for determining fair value have been formalized and detailed in ASC 820, “Fair Value Measurement.” This standard establishes a comprehensive framework for measuring fair value and introduced the three-level fair value hierarchy. This hierarchy categorizes the inputs used in valuation techniques into three levels: Level 1 (quoted prices in active markets), Level 2 (observable inputs other than quoted prices), and Level 3 (unobservable inputs). This provides much greater transparency into how fair value is calculated than what was required under the original FAS 107.