The current global financial crisis has led to trillions of dollars written down from the global financial market books of accounts especially balance sheets as values of assets experience huge declines. Some commentators have pointed the blame for the level of write down directly to the use of Fair Value accounting. Fair value of an asset is the expected inflows of cash in the future adjusted to take care of the risks involved in the trading of the assets and the arrived value is discounted to reflect its value at the present. The most recent edition of the International Valuing Standards (IVS 2007 creates a clear distinction between Fair- Value, and Market Value (Hitz, 2007).
It needs the examination of the price which is likely to be fair between specific parties considering the respective merits or demerits that each one of them will benefit from such a transaction. Market Value can meet or beat these criteria.However, it may not necessarily always be the case.FV is commonly used when carrying out due diligence especially in corporate transactions, where certain synergies between affected parties may indicate that the price which is fair to the two of them is more than the price likely to be obtainable in entire market. Meaning that Special Value may have been generated. Market Value calls for the element of Specific Value not to be regarded, but it is part of the examination of the Fair Value (Glautier, 1986).
The argument that follows is meant to justify the above claims.
The IASB arguments prefer fair value reporting and measurement, especially when dealing with Relevance. Recent financial instruments standards certain non-financial Assets accept the new measurement criterion. In my view, the current problem brought about by fair value accounting, one of the reasons is that, It is at the moment being used in valuing mortgage-related stocks which experience unexpected and unforeseen differences between their price and value. These discrepancies are not as a result of real credit losses incurred by investors at the security markets but by the entire industry and regulators adoption of making use of the ABX index, that tracks the credit price default changes rather than real mortgage-made securities.
Since traders of credit -default swaps are no longer expected to have ownership of mortgage-made stocks swaps were made for protection, the so called ABX -index price shows the extend of speculation in most of the mortgage-backed stocks credit, and is not related in any way to the performance of the securities (credit performance). If you disagree with this premise, try to see if you are able find enough realized losses, not reduction in their market value, but real suffered losses related to the recently written-down securities related to mortgage. Any real realized losses found is going to be approximately 95% below the amount written down by each investor (Deegan, 2006).
Therefore , if the majority of available, rated, mortgage related stocks are cash-flowing (monthly distributed principal amount and its interest distributed to the investors) then their “fair value” should be arrived at by present valuing the forecasted cash flow attributed to their mortgage-backed stocks by use of a discounting factor arrived at by looking at the quality of their mortgage security, the lender, lender, the mortgage conditions, performance as well as the rate.
Sadly, the markets and their regulators want one, there exist no objective ways of valuing most of the securities. A value can’t be arrived at by simply looking at an index, a rating, or any other unprofessional way. Mortgage-backed securities (and many others) can not be fungible and as long as human beings still have unlimited will to come up with idiosyncratic methods of financing, can not be.
Lack of willing bidders is in itself an indication of the market not interested investments the type. Price and value are not the same concepts the underlying differences between them is how many of us create our money.
This paper discusses the idea of decision importance of a reporting system which is based on fair-value from a theoretical point of view.
It emphases on evaluation theoretically on the logical soundness arguments brought on the table by regulating bodies and standard setting ones. It is conducted as economic analysis. Two approaches, the measurement and the information perspective or valuation perspective are adopted.
Findings show that the decision- relevance of measurement using fair value are capable of being justified from both points of view, However, the case based on concept is never strong. The information cumulating notion underlying standard setters’ agreement with fair-value measurement remains theoretical.
Constrained by its applicability and validity. Furthermore, comparative analysis of accounting based on fair value against that based on historical cost does not yield uniform results.
The FASB and IASB have substituted systematically measures based on market for those based on cost. The use of fair value was started to make sure that securities at the stock markets are being valued uniformly worldwide valuing them at the price which is being considered as the price at which they can be sold regardless of the current prevailing market conditions and none of them should feel cheated. In December the year 2003, AASB 139 was given out together with AASB 132, which dealt with Disclosure of ‘Financial Instruments’ and Presentation. They aimed to assist in ensuring that the use of fair value succeeded (Alfredson, 2004).
After the impact of the financial crisis was heavily felt on most developed economies some companies like Deloitte issued reports whose recommendations are as follows; FV principles of accounting and standards have to be reevaluated to develop guidelines which are more realistic when it comes to dealing with more illiquid instruments and pressurized markets.
The tension existing between the business’s purpose attended to by controlled financial organizations which intermediate credit as well as liquidity risk and also the interests of shareholders and creditors must be solved by developing standards based on principles which reflect better the business pattern of these organization apply required rigor to valuation of intent, and calls for improved disclosure and openness. The standards should at the same time be reviewed by, and co-coordinated with, regulators who are more prudent to ensure implementation in manner consistent with sound and safe operation of those institutions. Principles of accounting should also be made more flexible to maintain enough protection against expected losses due to loss of asset value especially liquid assets like stock.
The economy carries the value creation, and there exists finance only to support the economy (which originally was so). The principal for improving community is supposed to play more substantial role which is the initial best way of having scholarship consequently leading to the power of wisdom.
According to the joint statement by the Barclays investment group, Stopping fair-value method of accounting at the current challenging economic period would deny investors critical, required financial information at the time it is needed most. The reviewed financial market- bailout proposed gives the SEC authority to terminate usage of the Financial-Accounting- Standards Board’s (FASB) Statement -157, which gives a framework for valuing measurement at times of active market in existence. Even though the investment is falling below past or expected expectations in the future, the said suspension is not necessary and counter-productive. It would not assist to solve the present economic crisis (Scott, 2005).
FASB further proposed giving out additional guidance to interpreter fair-value valuation within the rule’s aim of getting better consistency. The board released a public statement in period through October 2008 about the proposals. Among further points of clarifying, the SEC and FASB report said, “The consequent of non organized transactions can not be determined not when appropriating fair value. The principle of a fair-value valuation assumes an organized transaction among market participants. Forced liquidation auctions are not organized transactions, and therefore the truth that a transaction may be or is distressed should be taken care of when comparing the evidence available.
Determining whether a certain transaction is forced disorderly or distressed needs a verdict (Godfrey, 2006). Conceptual- framework of bookkeeping seek to recognize the nature, subject matter, reason and wide substance of general-purpose financial exposure and the qualitative distinctiveness that financial information must have decision usefulness model helps to provide information required by management to enable them value accurately the company’s assets. The two theories helped reduce the impact of the economic crisis.
In my view, the fair Value principle of accounting helped to reduce the impact of the crisis because if the market value was to be used, investors would have incurred larger losses because their assets value would have fallen below their intrinsic value at the stock markets. This would be so because of the increased supply of stocks at the market due to panic selling by investors who were fearing a further decline of the value of the share (share’s selling price). Therefore the use of fair value accounting in valuation and presentation of financial assets and liabilities served its purpose of preventing erosion of share value at times of fluctuating prices.
Hitz, Joerg-Markus. (2007). ‘The Decision Usefulness of Fair Value Accounting – A Theoretical Perspective‘, European Accounting Review,16:2, 323 — 362. Web.
Deegan, Craig. (2006). Financial Accounting Theory. New Jersey: McGraw- hill higher education. Web.
Godfrey, J. (2006). Modern Accounting theories. New York: John Wiley and Sons.
Alfredson, K. (2004). Accounting Standards in Australia. Mel borne: John Wiley and Sons.
Scott, W. (2005). Financial accounting, theory, 4th ed. Canada: Prentice Hall.
Glautier, M. (1986). Accounting theories, 2nd ed. London: Pitman.