Is Fair Value Accounting “fair”?

The press has been very vocal about the impact of fair value accounting also called “mark-to-market accounting” following the global economic meltdown. Is fair value accounting responsible? How could a reporting change affect the financial markets? Is fair value accounting”a good thing”? Not since current cost accounting was discussed in the 1970s has there been so much written about a change in accounting standards. As we know, current cost accounting did not succeed past the discussion stage in gaining acceptance. Fair value accounting on the other hand has been implemented internationally. The US has been the primary proponent of this change in accounting standards. Fair value accounting was adopted in the US in 2006 following the financial accounting standards Board's adoption of Financial Accounting Standard (FAS) 157. Fair value accounting involves revaluing financial assets and liabilities to their market values rather than retaining them in the balance sheet at historical cost. The impact has been most widely felt in the banking and financial sector where balance sheets contain assets not usually found in other industry sectors. These financial assets can fluctuate wildly depending on the financial markets. The question arises whether the standard should be applied to all assets and liabilities where market volatility can affect the balance sheet fairly dramatically. As an accountant I feel strongly about applying a standard in some instances and not in others. Plantin, Sapraand Shin (2004) who examined the impact of mark to market reporting developed the hypothesis that the longer the duration of an asset and more illiquid the asset, the more vulnerable it is to artificial volatility. They recommend only using mark to market reporting for short-lived assets. This would be a difficult application of the standard and would leave management exposed to the risk of purchasing an asset, describing it as a short-lived asset, reporting it to shareholders as such and then due to market conditions not being able to dispose of it. This would result in having to restate audited financial statements. Banks and financial institutions have commented that fair value reporting has introduced artificial volatility into financial statements and that fair value reporting should not apply to financial instruments. For accountants it means that we would be expected to interpret the standards to apply to the types of financial instruments used in banking and financial sectors and possibly some other sectors. It would also create difficulty in comparing corporation’s financial statements which is really the basis of developing an international set of standards. The actual reason for the crisis in the banking and financial sector is not reporting standards but a failure of adequate credit analysis. Subprime mortgages were extended to clients who could not possibly afford them. In this case mark to market accounting accurately reported the true value of those assets in the bank's financial statements. The International Accounting Standards Board has been under pressure to change the International Financial Reporting Standards to allow banks and financial institutions to report certain assets at historical cost. While this issue hasn't been resolved at the IASB they appear to be swayed by government influence and intervention.

In Canada as we move to the implementation of IFRS in 2011 this issue will become critically important. Our banks and financial institutions have not had the same experience with the subprime mortgage assets that were prevalent in the US and their exposure was limited. We would hope that the IASB heeds the advice of its member bodies and maintains the original standard without succumbing to political pressure to change the rules.

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