Debate on Fair Value Accounting

Abstract

Numerous critics have argued and debated on the strong underlying realtion between the recent global economic crisis and the fair value accounting method. The fair value approach to evaluation of financial data was introduced under FAS 147 in the year 2006. The method required companies to value tradable assets like mortgage securities as per their existing value in the market rather than the estimated future value or historic cost. However, upon the collapse of the global markets during the devastating economic crisis, the consequrent loss in the value of tradable assets had a crucial impact on the holding institutions. This highlighted major weakpoints in the fair value accounting method. Some of the most important and valid concerns voiced by critics are regarding certain accounting standards defined under FAS 157. Some critics argue that the loses reported under this method are temporary as well as misleading since they will inevitably be reversed when the market condition normalizes. Other critics point out how the estimation of fair value is a tedious task that often yields unreliable results. This paper examines available literature on the subject of fair value accounting to determine how exactly the method has contributed towards the economic crisis.

Debate on Fair Value Accounting

Introduction

The accounting concept of fair value has faced a lot of flak over the years for a number of reasons. These debates began mainly after the cataclysmic events of Sept 12, 2008, when the implosion of the US market sent shockwaves across major markets of the world (Escaffre et al., 2008). Among other things, the crash of the global financial market helped to highlight the fact that the fair value method was not an objective measurement attribute for the position of financial statements. Fair value accounting is a financial reporting approach, also known as the accounting practice of marking to market, according to generally accepted accounting principles (GAAP). Using fair value accounting, companies measure and report the value of certain assets and liabilities based on their actual or estimated fair market prices (Laux & Leuz, 2009). Changes in the values ??of assets or liabilities over time generate gains or losses for assets and liabilities held in circulation, increasing or decreasing net income as well as equity in the balance sheet.

Part A

The advent of the criteria for fair value measurement is controversial and divides specialists. If, on one hand, the fair value method is more relevant, the estimates that it underlines are more subjective while the account balances contained in the financial statements are more volatile. Proponents of fair value accounting argue that knowledge of the fair value of an asset is often more relevant than its historical cost. For example, Laux & Leuz (2009) explain that it is much more reliable than other methods since it is based on an actual transaction entity which allows access to accurate data. Another aspect to be considered is the fact that the fair value really illustrates the exhibits an entity in real time, but companies only disclose the ...