Pros & Cons of Fair Value Accounting in Financial Accounting Theory and Practice

FINANCIAL ACCOUNTING THEORY AND PRACTICE 1
Financial Accounting Theory and Practice
Student’s Name
Institution Affiliate
Date
Financial Accounting Theory and Practice

FINANCIAL ACCOUNTING THEORY AND PRACTICE 2
Pros and Cons of Fair Value Accounting
The fair value accounting is considered as one of the financial reporting technique which
is also referred to as the mark to market accounting practice and this is under the generally
accepted accounting principles. The assets and liabilities are reported by different companies
based on the actual fair market prices according to the fair value accounting approach. The use of
fair value accounting technique often results in the generation of unrealized losses or gain for
liabilities and assets outstanding, increase or decrease in net income. There are certain
advantages and disadvantages associated with the fair value accounting and theses are as
indicated below in the paper.
Pros
Displays True Income of Company
The ability of any particular company to manipulate its net income reported in the
financial reports can be limited by the fair value accounting.A key example occurs when a
particular firm intends to use the gains or losses obtained from the sale of a particular asset to
raise or lower the net income in the financial report as they desire (Sellhorn & Stier, 2018).
However, with the use of the fair value accounting, the losses and gains will only be reported in
the particular period in which they occur and hence there will be no manipulation of the net
income in the financial report.
It Provides Accurate Valuation
According to Lilien, Sarath & Yan (2018), the other key advantage of the fair value
accounting is based on its role of offering certain accurate valuation. Such a valuation is on the
liability and assets which is often a requirement by the users of financial information of any
particular company. For example, the price of an asset or liability may increase in the future,

FINANCIAL ACCOUNTING THEORY AND PRACTICE 3
during which a particular company will typically mark up the value to the current market price
with the aim of providing a true reflection of the price it would be sold to avoid any particular
liability. The same scenario also happens when the market price of a particular asset is expected
to decrease and therefore the value will be marked down to reflect the amount it will be sold at in
the market.
Cons
Results in Market Effects
One key disadvantage of the fair value accounting is in relation to its effect on the market
such that it may affect the market negatively. A key example is seen when there is a revalue
downwards of the asset resulting in a decrease in the existing market trading prices (Trajkovska,
Temjanovski & Koleva, 2016). When the value of an asset is decreased, there will be an increase
in sales volume by a company at very low prices and this is often the negative effect on the
market of the fair value accounting.
Leads to Reversal of Value
There are often times in which the market conditions in which the trade of both liabilities
and assets occurs may change over time and this could be volatile at times. Such a fluctuation
typically poses certain challenges to both the users of financial information and the company
itself (Marra, 2016). When the fair value accounting is applied by a particular company by
reevaluating the existing value of assets and liabilities in such a volatile market condition, there
will be large swings in regards to the value of such assets and liabilities. However, after the
stabilization of the markets, the value of assets and liabilities will become normal and this,
therefore, implies that the fair value accounting often offers certain misleading information.