Corporate Accounting: Applicability of Fair Value Accounting and its Influence in Financial Crisis

Running head: CORPORATE ACCOUNTING
Corporate Accounting
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

1CORPORATE ACCOUNTING
Table of Contents
Part A: Essay....................................................................................................................................2
Part B: Case Study...........................................................................................................................5
References:......................................................................................................................................9

2CORPORATE ACCOUNTING
Part A: Essay
Introduction
Fair value accounting is considered as the accounting process where the assets and
liabilities are measured based on their current market price1. Over the years, an argument has
occurred related to the use and usefulness of fair value accounting for the private as well as
public companies. This essay sheds light on the applicability of fair value accounting and the
influence of the same in the financial crisis in the contemporary world.
Discussion
The main use of fair value accounting is the reporting of the useful information about the
assets and liabilities of the companies to the users of the financial statements. However, the
presence of major arguments can be seen in the use of fair value accounting in the public and
private companies. It needs to be mentioned that fair value accounting assists in providing more
transparency than the historical cost accounting. The relevance and reliability of fair value
accounting can be proved by criticising the historical cost accounting as it is considered that
historical cost if reliable and relevant only on the day they are recorded. The presence of both
reliability and relevance is there in the fair value measurement as the users can get the most
recent information of the assets and liabilities from fair value accounting2.
The income statements of the private and public companies under fair value accounting
also deliver the economic income of those companies as it reflects the change in the firms’
1 Lu, Hung-Yuan (Richard) and Vivek Mande, "Does Disaggregation Of Fair Value Information Increase The Value
Relevance Of The Fair Value Hierarchy?" (2014) 26(1) Research in Accounting Regulation
2 Siekkinen, Jimi, "Value Relevance Of Fair Values In Different Investor Protection Environments" (2016)
40(1) Accounting Forum

3CORPORATE ACCOUNTING
values over the time. This is because fair value accounting helps in producing more relevant as
well as comprehensible financial information about the company’s assets and liabilities which is
supportive to the shareholders and other stakeholders for making effective decisions about the
assets, liabilities and income of the firms. For this reason, it can be said that the fair value
accounting in the corporate accounting of the private and public companies provides efficient
values of the assets and liabilities; and the performance of the management and risk exposure can
be gained from the income statement under fair value measurement. However, as per many of
the critics, the use of fair value accounting in the private and public companies provides the
managements with the scope of manipulation so that they can show the result that the
management would like to show3.
According to many critics of fair value accounting, this valuation technique was majorly
responsible for the world financial crisis due to the fact that the fair value accounting contributed
towards the difficulties in the measurement of the value of the subprime positions4. As per their
claims, fair value accounting led to extreme leverage used by the banks at the time of boom and
contributed towards the downward spiral during the period of recession, creating pressure on the
banks to value the assets at fire-sale prices. This aspect created an extremely lower valuation of
the assets which created danger for the lending. At the same time, many opponents of fair value
accounting believed that the fair value accounting damaged the critical basis of financial
reporting that includes verifiability, reliability and traditionalism. It implies that the presence of
these attributes influenced the subprime crisis5.
3 Du, Hui, Sherry Fang Li and Randall Zhaohui Xu, "Adjustment Of Valuation Inputs And Its Effect On Value
Relevance Of Fair Value Measurement" (2014) 26(1) Research in Accounting Regulation
4 Song, Xiaofei, "Value Relevance Of Fair Values-Empirical Evidence Of The Impact Of Market Volatility" (2015)
14(2) Accounting Perspectives