Fair Value Accounting: Pros and Cons

Running head: CORPORATE ACCOUNTING
Corporate accounting
Name of the student
Name of the university
Student ID
Author note

1CORPORATE ACCOUNTING
Part A
In accordance with fair value accounting (FVA) approach, the present market values are
used as a basis to identify the value of certain assets as well as liabilities. It is the price that is
estimated for which the asset is capable to be sold or at which the liability can be settled for an
orderly transaction to the 3rd party under the present market scenario. It includes various concepts
like – (i) present market scenario – deviation in fair value shall be made on the basis of market
situation on the date of measurement rather than the transaction date that took place at earlier
times (ii) orderly transaction – intention of the liability or asset’s holder to continue holding it is
irrelevant with the fair value measurement (iii) orderly transaction – FV shall be generated based
on the orderly transaction that infers the transaction where no undue pressure is there for selling
in case of corporate liquidation and (iv) 3rd party – to derive FV on the basis of assumed sale to
any organization that is not the corporate insider or not related to the seller in any way (Magnan,
Menini and Parbonetti 2015).
As per the FVA it is assumed that the market is comparatively complete and perfect and
under such scenario the financial reports shall also comply with monitoring requirements of the
existing shareholders through reporting the past transactions as well as events by utilising the
measurements that is entity specific and will reflect opportunities those are actually available
with the reporting firm. As per the arguments presented by Laux and Leuz (2009), under IFRS as
well as GAAP both the FVA is mostly used for valuation of financial liabilities and assets (Laux
and Leuz 2009). However, even for the financial assets as well as liabilities mixed attribute
model is there with the multiple rules that stipulate that some of the items are reported at the fair
values whereas others are reported at the historical costs. Further, the losses and gains those are
unrealized from the items those are reported at the fair values based on their classification may

2CORPORATE ACCOUNTING
not or may impact the net income. People who are in favour of this argument further argue that
the FVA for the liabilities as well as assets represents the present market scenario and hence
offers timely information which in turn increase transparency and encourages in taking
corrective actions promptly (Audytax.mx 2019). However, the main controversy is regarding the
fact that whether FVA is helpful in enhancing transparency and whether the same can lead to the
undesirable actions on part of the firms and banks. Regarding this, the opponents claimed that
the FV is irrelevant and is considered as misleading for the assets for the assets those are held
over the long term period where the values can be distorted by the market inefficiencies, liquidity
issues and investor’s irrationality that makes the FVA approach unreliable and lead to
procyclicality of financial system (Hodder, Hopkins and Schipper 2014).
FVA and application of FVA through business the cycle is exposed to considerable level
of debate. Major concern is that FVA is procyclical that is it intensifies the swings of financial
system that may even lead to downward spiral under financial market. 2 arguments are there
regarding why FVA approach can contribute to the procyclicality – one under booms and one
under busts. 1st argument is that during the booms FVA and the write-ups for assets allows the
banks to enhance their leverage that in turn makes financial crises more severe and financial
system more vulnerable (Lodh 2018). On the contrary, HCA (historical cost accounting) does not
allow write-ups of the assets under boom and generate hidden reserves that can be used under the
crises times. However, this argument does not takes into account the fact that FVA offers early
signal as warning for impending crises and therefore force the banks taking proper measures on
earlier basis. Hence, FVA approach actually may reduce severity of the crises and further the key
question is that why the bank will hold the hidden reserves in accordance with the HCA