Pros and Cons of Fair Value Accounting

This article discusses the concept of fair value accounting and its pros and cons. Fair value accounting is a method of valuing assets and liabilities at their current market prices. The pros include accuracy in valuation, measurement of true income, and adherence to accounting standards. However, there are also cons such as volatility in value changes and potential investor dissatisfaction. The article also explains the 3-tier process of fair value measurement and the characteristics of fair value accounting.

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ACCOUNTING

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The concept of fair value accounting refers to the method in which an asset or a liability or
any other thing for that matter is reported at the value which it would fetch in the open market
when sold. These have to be reported at their respective fair values in the financial
statements.
Pros of the method:
 It is more accurate. This is the method which helps in gaining an accuracy when it
comes to the valuation of the assets and the liabilities. In case, the prices of these
assets or the liabilities increase or decrease, then the fair value accounting could help
in the same. In case, there is an occurrence of sales, then any sort of a discrepancy
would change in case, there is a change in the transaction. When these are reported at
their respective current prices, then this allows the individuals or the businesses to
understand as to where they stand.
 It helps in the measurement of true income that the company earns. There is a lesser
chances of manipulation any data when it comes to the valuation of these assets and
the liabilities at their respective fair values. In fact, the fair value method helps in the
tracking of the actual or the estimated values. The changes to this income takes place
when there is a change in the value of an asset which are then reported in the financial
statements.
 It is in line with the standard of accounting. When the company uses the historical
approach for the purposes of valuing the assets or the liabilities, then it may not
always show the true and fair picture. The fact that this method is more reliable when
it comes to the valuing of the assets and the liabilities reported in the Annual Reports.
For example, $100 would not be worth $100, 5 years from now on (Marra, 2016).

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 This method also serves as a method in the difficult economy. When the historical
method if followed, then the value of the asset changes each and every year. When
there is a recession in the economy, then the changes in the historical prices somewhat
is difficult for the company. The method of fair value accounting helps in the
reduction of the prices of the assets within the market so that the business has a
chance of survival (Gaille, 2019).
Cons of the method:
 It leads to changes in the value that could happen many times. There are many of the
businesses that do not derive any advantage when it comes to using the stated method.
This is mainly due to the reason that their assets undergo a lot of change in their
values throughout the year. When there is a volatility in the value of the assets, then
the same could be reported in the statement of income that shows an accurate picture
of the company in long term. This could be misleading in the shorter period of time.
 In case, one business indicates a decrease in the net income, then this trend would
create a pattern which would indicate fall in the amount of the net income always.
Whenever there is a downward valuation, then that is somewhat contagious and leads
to selling which is due to volatility in the market. The not following of this concept
would then decrease in values do not take place and hence, there is more stability of
the investors. This would in turn keep the economy more stable.
 It loses the investors satisfaction. There are many investors that do not always notice
that the company has been using the fair value accounting concept and hence, it leads
to dis satisfaction for the investors since it means loss of income for them. Also, there
are many investors that trade in commodities when they should use these for
investment. It leads to the creation of a tough hit for their portfolio.

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 Following of historical costs. The current system of accounting is very much
important and also, there is a sense of historical valuations as well when it comes to
the tracking of these results. The net profits of the company could become low, when
the assets have had experienced lower success for the business (Trajkovska et al,
2019).
3 tier process:
The price any asset or a liability would fetch in the market when sold or purchased is the
quoted market price. In case, the company holds any position with respect of an asset or a
liability and the same is capable of being traded in the market, then the fair value of that asset
or the liability would be measured within Level 1 since that product would be quoted in the
market, even if the trading volume of the company is not able to absorb the quantity that it
holds and sell that product which may affect the quoted price of that asset (IAS plus, 2019).
Level 2 inputs are the inputs which are other than the Level 1 inputs. The level 2 inputs
include the prices of the assets that are quoted in the market for the same assets or the
liabilities that exists in the markets which may or may not be active. These inputs also
include the quoted prices which are capable of being observed for an asset or a liability,
implied volatilities and the credit spreads. These inputs also include the market data by
correlation which is observable. The Level 3 inputs are the inputs that are not capable of
being observed for any asset or a liability. These inputs are not capable of measuring the fair
value of an asset to a liability since there are no relevant inputs that could be considered
(ACCA global, 2019). The main reason behind this reason is the different data and the
information available for the purposes of allocating the fair values of the assets or the
liabilities.
Characteristics of Fair value accounting:

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The following of this method equips the investors with an intense understanding of the
financial facts contained in the annual reports of the companies. And also, helps them in
better understanding of the subjectivity of the measurement of the assets and the liabilities
that have been reported in the financial statements (Hodder & Hobkins, 2019). The adoption
of the fair value accounting indicates the latest financial performance of any company and
this also adopts in the use of the financial statements being the best next step. The IASB has
laid down 3 different levels for the purposes of facilitation of the appraisal of the fair value
concept under the assumption that it includes the process which mainly depends upon
judgment along with various other characteristics with relevance or the representational
faithfulness. There have been many studies that helps in the calculation of the market values
of the assets that are available for sale and which are the financial assets from the point of
view of the decision makers. The studies have shown that there exists a relationship between
the relevance and the representational faithfulness of the fair value accounting. These facts of
relevance and representational faithfulness helps the users in making the sound decisions
(Sergej & Orlovskih, 2017).
Also, the fair value accounting is logical. This is in the sense that if an asset or a liability for
that matter is reported in the financial statements at their respective historical costs, then that
would not be relevance. If that asset is worth $100 million on the historical basis but as per
the fair value accounting, method, it is of $10 million and at the same time, the company
requires cash, then if it goes into the market and sells this asset, then it would be not be worth
of more than $10 million. So, this would be a big hit for the company. This method makes
sure that the financial statements in which the financial facts are stated are useful and
relevance. This forms the part of the qualitative characteristics of these financial statements.
Hence, the adoption of this method serves the purpose of relevance, understand ability since

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it helps in a better understanding of the facts and the figures in respect of each asset and
liability which are disclosed in the Annual reports of the various companies (Aryan, 2016).
If the financial facts reported in the financial statements of the company are prepared
following the same set of principles, facts, then it would be easier for all the companies to
benchmark their financial result. This would mean comparison of the companies could be
done on a global basis. This helps in comparability and would show the correct and the
accurate picture of the financial position of the company in the financial statements. This is
somewhat logical.
The core principle of the application of this concept is the fact that they give more clarity to
the investors. And also, helps them in better understanding of the subjectivity of the
measurement of the assets and the liabilities that have been reported in the financial
statements. This indicates the application of fair value accounting when it comes to the
preparation of the financial statements.

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References:
Aryan, L. (2016). The Quality of Fair Value Measurements for NonFinancial Assets Article
(PDF Available) · January 2016 with 397 Reads. [online] www.researchgate.net.
Available at:
https://www.researchgate.net/publication/296334043_The_Quality_of_Fair_Value_M
easurements_for_NonFinancial_Assets [Accessed 19 Apr. 2019].
Gaille, B. (2019). 8 Fair Value Accounting Pros and Cons. [online] BrandonGaille.com.
Available at: https://brandongaille.com/8-fair-value-accounting-pros-and-cons/
[Accessed 19 Apr. 2019].
Hodder, L. and Hopkins, P. (2019). Fair Value Measurement in Financial Reporting. [online]
Nowpublishers.com. Available at:
https://www.nowpublishers.com/article/DownloadSummary/ACC-030 [Accessed 19
Apr. 2019].
ACCA Global (2019), IFRS 13, Fair Value Measurement [online] Accaglobal.com. Available
at: https://www.accaglobal.com/hk/en/student/exam-support-resources/professional-
exams-study-resources/strategic-business-reporting/technical-articles/ifrs-13.html
[Accessed 19 Apr. 2019].
IAS Plus (2019). IFRS 13 — Fair Value Measurement. [online] Available at:
https://www.iasplus.com/en/standards/ifrs/ifrs13 [Accessed 19 Apr. 2019].
Marra, A. (2016). The Pros and Cons of Fair Value Accounting in a Globalized Economy.
[online] SAGE Journals. Available at:
https://journals.sagepub.com/doi/abs/10.1177/0148558X16667316?journalCode=jafa
[Accessed 19 Apr. 2019].

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Sapkauskiene and Orlovskih, (2017). The usefulness of fair value estimates for financial
decision making – a literature review. [online] Cejsh.icm.edu.pl. Available at:
http://cejsh.icm.edu.pl/cejsh/element/bwmeta1.element.desklight-cc6b53c1-b64a-
4f7c-87d3-f3b1ad0f2b99/c/12_B5_Sapkauskiene.pdf [Accessed 19 Apr. 2019].
Trajkovska, O. (2019). FAIR VALUE ACCOUNTING – Pros and Cons. [online]
Eprints.ugd.edu.mk. Available at: http://eprints.ugd.edu.mk/16917/1/Fair%20value
%20accounting-pros%20and%20cons.pdf [Accessed 19 Apr. 2019].