To achieve these goals, we strongly recommend that fair value balance sheets be accompanied by, indeed be derived from, cost-based statements. Costs represent the true basis for the creation of an asset. Value exists relative to the cost of creation.

While derivatives and hedges could appear anywhere on the balance sheet, even as a separate category, we believe it makes the most sense to associate hedges with assets so as to minimize fair value volatility of the combined asset and hedge. When a firm issues short-term debt and swaps to a longer maturity, it is currently often shown as a liability hedge. We would favor showing that hedge relative to the fixed assets that have greater price volatility rather than the short-term liabilities that have little price risk.

The source of fair values should be clearly delineated. Values based on live liquid markets should be separated from those derived by management based on models of future cash flows. Where models are used, assumptions should be provided in sufficient detail for investors to assess their reasonableness. Separating fact from forecast will further enable investors to understand the degree of certainty in the fair value statements.

Income statements should clearly distinguish traditional cost-based income measures and gains in fair value. True revenue reduced by current costs and amortization of prior investment represents an important measure of income. Changes in value of existing positions, or the estimated creation of value from R&D or other activities, should be clearly segregated in a fair value income statement. With such segregation, an income statement becomes merely management's forecasted value without any anchor in current performance.

For financial instruments, firms should provide an estimate of the net yield of assets, liabilities and hedges on a cost basis as well as at the fair value mark. One shortcoming of fair value accounting is that if a firm's assets fall in value relative to its liabilities on a mark to market basis, this will be reflected as a decline in fair value. The inclusion of a net yield measure will show the increase in future earnings from these value changes. Likewise, an increase in asset values relative to liabilities may boost current period values, but may be reflected in lower future spreads.

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