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Accounting Discretion and Fair Value Reporting: A Study of US Banks’ Fair Value Reporting of Mortgage-Backed-Securities


  • Kang Cheng

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    • The author is from Morgan State University. He thanks Krishna Kumar, Alex Tang, Huey-Lian Sun, Yu Cong, Audrey Hsu, Weimin Wong, Ben Usher, Barnie May, Jon Keeton, Martin Walker (editor), an anonymous referee, and seminar participants at the 2010 AAA annual conference, and 2011 CAAA annual conference for their valuable comments. Special appreciation also goes to Chong-Rong Chong and Vanthuan Nguyen for their help on technical issues.

Kang Cheng, Department of Accounting and Finance, Earl G. Graves School of Business and Management, Morgan State University, 1700 E. Cold Spring Lane, Baltimore, MD 21251, USA. e-mail:


Abstract:  This study looks at US banks’ fair value reporting of mortgage-backed-securities (MBS) before and after a new accounting rule, FSP 157–3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, initially issued by the US Financial Accounting Standard Board (FASB) and later adopted by the International Accounting Standard Board (IASB) into IFRS No. 13 Fair Value Measurement. FSP 157–3 allows for additional accounting discretion in fair value reporting when the market for a financial asset is inactive and significant adjustment needs to be exercised in estimating fair value. By evaluating MBS’ fair value reporting against observable economic factors, firm-specific reporting incentives, and the reporting entity's mortgage-banking activities, this study makes inference on the relationship between accounting discretion exercised under FSP 157–3 and any unobservable, private information conveyed in the MBS’ fair value reporting. Empirical results indicate that additional accounting discretion has been exercised in MBS’ fair value reporting under FSP 157–3. While MBS’ fair value reporting is less associated with economic factors and firm-specific characters under the new rule, it is reflective of the reporting entity's mortgage-banking activities.