Advantages and Disadvantages of Fair Value Accounting

This article analyzes the concept of fair value accounting and its impact on the accounting process. It discusses the advantages and disadvantages of fair value accounting, including the three-tier process, qualitative characteristics of financial information, and more.

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Table of Contents
Introduction......................................................................................................................................2
Advantages and Disadvantages of Fair Value Accounting (FVA)..................................................2
Three Tier Process...........................................................................................................................4
Qualitative Characteristics of Financial Information......................................................................5
Conclusion.......................................................................................................................................7
Reference.........................................................................................................................................8

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Introduction
The main purpose of this assessment is to analyze the concept of fair value accounting
and how the same has affect the overall accounting process. The concept of fair value has an
important significance in accounting and is used for measuring the assets and liabilities of the
business. The fair value accounting principle requires businesses to value their assets and
liabilities at current values rather than historical values (Christensen and Nikolaev 2013).
However, there are certain debates and discussions which are associated with this concept which
can affect the investment choices and management decisions. This assessment aims to reveal
different aspects of fair value accounting and analyze academic journals for identifying the
importance of fair value accounting.
Advantages and Disadvantages of Fair Value Accounting (FVA)
FVA can be defined as an accounting process which allows the management of a
company to report the assets and liabilities of the business at such prices which are similar to the
fair values of the same. The advantages which can be identified for FVA are listed below in
details:
 Accurate Valuation: The method of accounting is known to provide more accuracy in terms
of financial reporting and valuation of assets and liabilities of the business. In case, the prices
are anticipated to increase or decrease the valuation of assets and liabilities of the business
would be showing such a fluctuation (Marra 2016). The company which applies FVA in
reporting enables them to present accurate financial statement. In such a case, the
management needs to prepare appropriate notes to account. Therefore, in other words, FVA
allows businesses to present a realistic position of the assets and liabilities of the business.

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 Measurement of True Income: The method also facilitates accurate and true measurement of
the financial information in the annual reports of the business. In such an accounting practice,
there is less opportunity for any manipulation of accounting data. The changes which takes
place in the assets or liabilities of the business are also reflected in the income of the business
and therefore the financial statements show appropriate view of the income and earnings of
the business.
 Benefits to the Investors: The method of FVA allows the management of a business to
appropriately reflect the assets and liabilities of the business at real values which in turn
helps and guides the investors to assess the financial health of the business appropriately
(Blankespoor et al. 2013). The benefit to the investor in such a case is that they are able to
take sound decisions on the basis of the financial statements which is prepared under FVA
method.
There are also certain disadvantages which are associated with the concept of FVA and the
same are discussed below in details:
 Regular Fluctuation in Values: The major disadvantage of this method of reporting is that
the fluctuation in assets of the business happen on regular basis throughout the year and
therefore the asset which is reported in the financial statement might not be showing
appropriate value and are highly volatile (Magnan, Menini and Parbonetti 2015). These
assets also affect the revenue of the business and in some cases also show misleading gains
or losses considering the short-term position.
 Reduces Investors Satisfaction: In general cases, most of the business value their assets
and liabilities on the basis of historical costs and therefore investors do not notice that a
company has followed fair value accounting, any reduction in income of the business result

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in dissatisfaction of the investors of the business. This affects the business as potential
investors refrain themselves from investing in such a company.
 Affects Historical Perspective: In case of Historical valuation, the changes in book value of
the asset takes place when the business is purchasing or selling new or old assets. In similar
case, the Valuation under Fair value changes on arbitrary issues and therefore, it can be said
that the book value of the assets is affected on short term basis.
Three Tier Process
As per the journal of Marra (2016), the process of Fair value estimation follows a three-
tier process and the same is shown below for every level:
Level 1 Input
The inputs which are covered in this level are cited prices of active markets for different
assets or liabilities which are judged. As these prices are available in active market, the same are
used by businesses for the purpose of measuring the fair value of assets or liabilities of a
business. Therefore, the business needs to access the market when measuring the assets or
liabilities of the business under fair value (Lachmann, Stefani and Wöhrmann 2015). The active
market which is considered should have adequate volume and frequency for providing necessary
pricing information. There can also arise a situation where in the active market is not showing
accurate price and is not consistent with the fair value of measurement.
Level 2 Input
These are the inputs which are different from level 1 inputs and the same can be observed
for assets and liabilities of a business. The inputs in this level can be described as quoted assets

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and liabilities of similar items in active market and the data which is available from the market is
presentable in credit spreads, yield curves, interest rates. The fair value needs to categorized in
level 3 form in case the inputs are of significant nature.
Level 3 Input:
The inputs under this level are observed to a minimum level and in this situation the
evaluation of the new inputs is not feasible and therefore the same are taken on assumption basis
estimating the market prices for the assets or liabilities of the business. The business is required
to enhance its utilization of pertinent observable inputs along with diminish the overall
utilization of unobservable inputs. An instance can be provided where cash flow estimation is
used by a business for appropriate valuation of an unlisted organization (Demerjian, Donovan
and Larson 2016). In such a case, all valuation in terms of fair value is done on the basis of
lowest level inputs which carries more significance.
Qualitative Characteristics of Financial Information
A business which is following fair value accounting process in the reporting framework
of the business must consider the qualitative characteristics of the financial statements of the
business. The qualitative characteristics are classified into two major heads which are
fundamental qualitative characteristics and enhancing qualitative characteristics (Barth 2013).
One of the characteristics is relevance of the information which is presented in the financial
statement which requires that information which are of significance and can affect the business
in one or the other should be included in the financial statements of the business. Another
element is materiality of the information which demands such information should be contained
in the annual reports which can influence the decision-making process of the investors. Another

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characteristic states that the information should be represented faithfully and should be free from
any material misstatements. One of the enhancing characteristic is that the information which is
presented in the financial statements should be comparable in nature so that distinction between
the performance of the business in industry and across periods can be made (Kim, Kraft and
Ryan 2013). Verifiability is another characteristic which allows verification in the performance
of the business on the basis of the annual reports of the business. Another characteristic is
timeliness which requires businesses to report crucial financial information within the stipulated
time period (Wang 2014). The last characteristic is understandability which requires the business
to present the financial information of the business in such a manner that the information is
easily interpreted and understood by the users of the annual reports.
The qualitative characteristics which are discussed above are all related to fair value
accounting techniques. The prices which are considered under this method needs to be relevant
with the market rates and the method also reveal material information in the annual reports.
Moreover, the information needs to be disclosed with in a specified period therefore the element
of timeliness is followed. Therefore, it can be said that fair value accounting is consistent with all
the qualitative characteristics of a financial statement and can be used by businesses for
measuring assets, liabilities and equity of the business.
Conclusion
The above discussion shows that fair value accounting process can be used by companies
for the purpose of reporting considering the benefits and limitation which are associated with the
process. The above discussion points out both benefits and limitations which needs to be
considered. The above discussion also identifies three- tier levels of fair value accounting which

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includes both observable and unobservable inputs. The assessment also shows the relation of
qualitative characteristics of a financial statement with the method of fair value accounting and
how the same can impact the users of the financial statement of a business.

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Reference
Barth, M.E., 2013. Measurement in financial reporting: The need for concepts. Accounting
Horizons, 28(2), pp.331-352.
Blankespoor, E., Linsmeier, T.J., Petroni, K.R. and Shakespeare, C., 2013. Fair value accounting
for financial instruments: Does it improve the association between bank leverage and credit
risk?. The Accounting Review, 88(4), pp.1143-1177.
Christensen, H.B. and Nikolaev, V.V., 2013. Does fair value accounting for non-financial assets
pass the market test?. Review of Accounting Studies, 18(3), pp.734-775.
Demerjian, P.R., Donovan, J. and Larson, C.R., 2016. Fair value accounting and debt
contracting: Evidence from adoption of SFAS 159. Journal of Accounting Research, 54(4),
pp.1041-107
Kim, S., Kraft, P. and Ryan, S.G., 2013. Financial statement comparability and credit
risk. Review of Accounting Studies, 18(3), pp.783-823.
Lachmann, M., Stefani, U. and Wöhrmann, A., 2015. Fair value accounting for liabilities:
Presentation format of credit risk changes and individual information processing. Accounting,
Organizations and Society, 41, pp.21-38.
Magnan, M., Menini, A. and Parbonetti, A., 2015. Fair value accounting: information or
confusion for financial markets?. Review of Accounting Studies, 20(1), pp.559-591.
Marra, A., 2016. The Pros and Cons of Fair Value Accounting in a Globalized Economy: A
Never Ending Debate. Journal of Accounting, Auditing & Finance, 31(4), pp.582-591.

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Wang, C., 2014. Accounting standards harmonization and financial statement comparability:
Evidence from transnational information transfer. Journal of Accounting Research, 52(4),
pp.955-992.