Accounting fair value measurement and the recent financial crisis

Abstract

Fair value accounting measurement is the oldest and most reliable tools for reporting the assets and liabilities in financial statement at their fair value. However, in the recent period several researchers have raised the question over the integrity of this tool and have associated it with the financial crises. Meanwhile, other researchers have dismissed raised speculation over this traditional and reliable method by expressing it as the lack of knowledge and understanding over financial concept. In this report writer has provided a brief illustration of the relationship between fair accounting measurement and recent financial crises. The second section of this report provides detailed analyzes of bank of America financial statement before and after the financial crises and lastly the writer has suggested steps through which they can prevent the occurrence of similar crises in the near future

Accounting fair value measurement and the recent financial crisis

Introduction

Financial crisis can be defined as a condition when money requirement rapidly increases as compared to the money supply. A few decades before, a financial crisis was equal to a banking crisis, but today it can also take the shape of a currency crisis. Currently the world is facing a global recession that is causing businesses to close down, unemployment to rise constantly, and government revenues to shrink (Badertscher et al, 2011). Recent happenings suggest that big developed economies may have touched the bottom and have started to recover but still unemployment level is hiking. Various banks and household consumers are facing serious difficulty in maintaining their bank balances, and since people are unemployed, they are forced to leave the houses they have acquired through sub-prime loans. This paper will discuss the impact of the recent financial crisis on the financial statement of the company along with relationship between the fair value measurement and these financial crises.

Discussion

Guidelines and conceptual framework presented in FASB standard No. 157

The implementation of standards requiring the use of fair-value measures have been one of the most challenging accounting issues facing the Financial Accounting Standards Board (FASB) in recent history (FASB, 2006). Some argue that fair-value accounting may introduce excessive financial statement volatility, which may drive companies', reported balance sheet values to be lower than their economic value (e.g. present value of expected future cash flows). These critics claim that this leads to premature needs for additional capital, premature violation of debt covenants, and even premature liquidations. At the core of the debate is the issue of whether quoted market values are reliable representations of fair-value during periods when orderly markets do not exist.

Further, several researchers analytically show that market values in periods of illiquidity can create distortions and contagions effects. They conclude that the effects are severe enough to result in premature liquidation of financial institutions. The issuance of Statement of Financial Accounting Standard (SFAS) 157 has provided guidance on the matter.

SFAS 157 requires the classification and disclosure of fair-values under a hierarchy of three levels. Considering that both the FASB and the International ...