Effects of Fair Value Accounting on Financial Reporting

This research discusses the effects of fair value accounting on financial reporting, including pros and cons, the three-tier process, and qualitative characteristics of financial information. It also includes a literature review and emphasizes the importance of fair value with the introduction of the International Accounting Standards.

Running head: FAIR VALUE ACCOUNTING
Fair value accounting
Name of the student:
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Table of Contents
Introduction:...............................................................................................................................2
Literature Review:......................................................................................................................2
Pros and cons of the Fair Value:................................................................................................3
Three-tier process:......................................................................................................................3
Qualitative Characteristics of the financial information:...........................................................4
Conclusions:...............................................................................................................................6
Reference:..................................................................................................................................7

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Introduction:
This research will consist of the study about the effects of the fair value accounting. A
literature review is to be performed on the topic. This study will also have comprised about
the pros and cons of the fair value accounting. The three-tier process in the fair value will be
discussed. The qualitative characteristics of the financial information is also included. It is
considered during the utilisation of FV method in the financial reporting. More emphasis is
efforted on the fair value with the introduction of the IAS that is the International Accounting
Standards.
Literature Review:
It has been established that due the hazards that was experienced because of the historical
cost, the implementation of the fair value accounting has been performed. In USA, in the year
1980, the Savings and the Loan crisis shifted the historical cost accounting towards fair value
accounting which occasioned in major delayed write-offs (Marra, 2016). This went
inadequate for the financial status of the companies as the status could not be identified
properly. Thus, an outline was created for the development of the accounting standards by the
IASC that is the International Accounting Standards Committee. This also guided in
resolving the issues related to accounting. This frame work is termed as the Fair Value. The
resources of the entity were to be valued by the fair value as well as it appears to be useful for
the investors also. The fair value mentions the risks which is not to be specified by the
historical cost. The fair value is used for the prevention of the future account related
problems. As per the IASB the fair value is defined as an amount through which an exchange
of an asset can be done, and liability is to be established among the knowledgeable willing
parties in the length transaction of an arm (Zhang & Andrew, 2016). As per the FASB the fair
value is defined as an exchange price among the market participants for selling the assets and

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for transferring the liability in the market which is the principal and most advantageous
market.
Pros and cons of the Fair Value:
The pros and cons of the fair value accounting is compared with the historical cost
accounting. The riskiness of the business is visualised by the investors on the balance sheets
beneath the fair value. The value of the of the company’s is dependent on the condition of the
market. This value is majorly dependent on the assets’ value which is to be influenced by the
condition of the market in the case of the production companies (Balanchandran et al., 2014).
The compatibility of the financial statements is reduced among the companies by the
visualisation of the companies’ unwillingness about the utilisation of the models as well as
the assumptions which they used. The fair value has a pro-clinical effect which identifies that
during the economic growth, the assets are to be overstated and at the time of recession the
assets are to be understand. Thus, realized gains and losses are not led by the revaluations.
Under the fair value accounting, the cash flow operations seem to be more important. Fair
value accounting effects the amount which a bank can loan, which influences the bank.
Three-tier process:
Under the idealized conditions the fair value is regarded as the specific hypothetical market
price by the IASB as well as the FASB (Jones, 2015). As per the result of the efficient market
condition, the fair value is considered as the exit market price which is a transaction among
the independent, knowledgeable as well as the economical rational parties which is interacted
on the ground of complete information set. A three-tier hierarchy is used with the
implementation of this concept. In the measure which is grounded on the market, the
governing principle is the prevalence. Thus, the internal estimates appear to be more reliable
as the data and the market prices imitates the personal information of the market participants
(Macye, 2015). The best estimation of the fair value is performed by the market prices as the

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information is generally aggregated efficiently with these prices. Grounded on the active
criterion of the market, the applicable quality of information is imitated in the prices of
market. There is a requirement of daily trading of the objects on an appropriately liquid
market for the estimation of the fair value. When sufficient quality is not exhibited by the
market prices or unavailable, then in that case the next standard of estimation regards the
modified market prices of the items that are comparable (Fulbier & Klein, 2015). In this
scenario, the profile of the cash flow is referred generally with comparability. The mark-to-
mark approach is failed as well as the fair value is mandated at the time when the prices are
not utilised. The fair value is estimated with the utilisation of the internal estimates as well as
the calculations. The SFAC that is the Statement of Financial Accounting Concept no.7, the
SFAS that is the Statements of Financial Accounting Standards 157, as well as with the
alteration of the IAS that is the International Accounting Standard 37 has developed the
procedures as well as the principles for all these measurements (Durocher & Gendron, 2014).
In the modern neo-classical finance theory, the economic view of measurement which
appears as the lead for valuation is based. The fair value is the specific current value which
appears as the exit current value below the idealized conditions. Thus, a three-tier process is
trailed with the strict measures which are based on the market.
Qualitative Characteristics of the financial information:
According to the IASB, there are four qualitative characteristics which creates the financial
information more significant which are the comparability, understandability, reliability and
relevance. Information should be accessible in a comprehensible way for the operators who
have sensible information about the business as well as the economic actions and accounting.
This also regards the individuals those are eager to learn the information meticulously (Sikka,
2017). The relevance characteristic defines that the information must chance the decision-
making requirements of the operators. Relevant information effects the economic results of

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operators by serving them with the evaluation of the events of past, present and future as well
as by settling or amending their past assessments. Timeliness also plays a significant role as
the information is counted relevant when the users gains the information within a limited
period. This affects the decision of the users.
If no material errors as well as bias, then the information is counted as reliable. The multiple
characteristics comprising which the information is created are the faithful representation,
neutrality, substance over form, prudence as well as completeness (Bracci et al., 2015). The
transactions are faithfully represented in the information. The reflection of the economic
transactions over the information is known as the substance over form which is not the legal
form of the contract. The information should always be neutral according to the users’
decision as the users’ decision id influenced by the neutrality (Palea, 2015). Prudence is
mentioning a caution degree that is work out in the judgments exercise with orientation to
some indeterminate areas. Comparability is described as the financial statements are
compared by the users who can do this for a company, over time, so that they can classify
tendencies in the financial place as well as on the performance of the company.
The measurement of the fair value is relied on a specific asset as well as on the liability.
Thus, during the measurement of the fair value, the features of the asset as well as the
liability is granted in the account. On the measurement date, the market participants will
count those features into the account during the pricing of the asset as well as the liability.
These liabilities include the assets’ location as well as the condition and, on any restriction,
which is performed during any sale or during the utilisation of the asset (Gong & Cortese,
2017). This asset or liabilities are to be of two types that is the stand-alone asset as well as
liability and the group asset as well as group liability, also group liabilities and assets. The
asset or the liability is swapped in an orderly transaction among the participants of the market

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for selling the asset or for the transfer of the liabilities. This is performed as per the condition
of the present market on the date of the measurement (Hooper et al., 2017).
Conclusions:
The application of fair value has remained a trade-off among the relevance as well as the
reliability. The segment of relevance was regarded more significant by the controllers
because of the huge difficulties that was happened during the historical cost accounting for
instance the crisis which happened in the Savings and Loan. The revelation of historical costs
within the financial statements during the time when the values of the assets as well as the
liabilities have got reduced to major write downs. Then the companies have misled the
investors. These difficulties should have been evaded by fair value accounting, nevertheless
this gave birth to diverse difficulties. Fair values are firm to control in some conditions and in
a recession the instant gratitude of losses primes to an erroneously working valuing
mechanism.

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Ultimate

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