Pros and Cons of Fair Value Accounting

This article analyzes the pros and cons of fair value accounting (FVA) and its impact on financial statements. It discusses the advantages of FVA, such as minimized net profit and realistic financial statements, as well as the disadvantages, including frequent changes and lower reliability. The article also explores the three-tier process of FVA and the qualitative characteristics of financial information. Overall, it provides a comprehensive understanding of FVA and its implications.

Running head: FINANCIAL ACCOUNTING THEORY AND PRACTICE
Financial Accounting Theory and Practice
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

1FINANCIAL ACCOUNTING THEORY AND PRACTICE
Table of Contents
Introduction:...............................................................................................................................2
a. Pros and cons of fair value accounting (FVA):......................................................................2
b. The three-tier process:............................................................................................................4
c. Qualitative characteristics of financial information:..............................................................5
Conclusion:................................................................................................................................6
References:.................................................................................................................................8

2FINANCIAL ACCOUNTING THEORY AND PRACTICE
Introduction:
Theory of "fair value accounting" is being practiced for over the last two decades. The
conception of this process is to evaluate "assets and liabilities" at its present price. It is a
notable drift away from the reality, that the balance sheets are required to be examined at its
real cost and not at the " present price". Furthermore, this theory leads into an argument, as
specific elements are required to be considered for venturing into investment preferences and
management decisions. This project would be aiming at analysing the factors regarding "fair
value accounting (FVA)" by typically evaluating this given scholastic piece.
a. Advantages (pros) and disadvantages (cons) of fair value accounting (FVA):
As stated by Ayres, Huang & Myring (2017), "FVA" is a sort of book-keeping
concept where the corporations quantify as well as report their "assets and liabilities" at
values that are analogous to the flow amounts. The gains from "FVA" are depicted below-
Minimised net profit:
During the utilisation of "FVA", when the value of an asset declines, net profit of the
corporation also falls. Although, a hike in value of liabilities, the estimated net income of the
company also reduces. Net income marks the sum on that the business acquires tax. It is
acknowledged to be a gain for the organisation, as lower net income points to lesser tax
disbursements. Identically, rise in "assets and liabilities" contributes to reduction of "business
equity". When there is lesser "equity", a company suffers from lower sum of cash to decide
for its business functionalities. This results a reduction in the payment of bonuses to the
employees and allows the company to preserve more cash (Bewley, Graham & Peng, 2018).
Realistic financial statement:
The utilisation of FVA provides the organisations with a precise "operating
statement" contrary to those not applying the system. Concurrently, the "assets and liabilities"

3FINANCIAL ACCOUNTING THEORY AND PRACTICE
are reported for their authentic values, it helps in preparing a practical operating statements.
The corporations applying the system are needed to disclose information regarding variances
in the "operating statement" by means of "financial notes". The users of operating statements
get an opportunity to investigate the same with the actual fair values, which guides them to
take the right decisions regarding forthcoming organisational activities.
Investor benefit:
FVA is involved in listing "assets and liabilities" for its actual costs, while the
"operating statement" serves a better overview of the financial standing of an organisation.
As a result, the shareholders could make wise commitments regarding their investment
options with the company (Barker & Schulte, 2017). The required footnote publications guide
the shareholders in inspecting the effects of the changes in the statement because of equitable
prices of "assets and liabilities".
The disadvantages of FVA are depicted below-
Frequent changes:
Price of any commodity would vary repeatedly in unstable markets. As a result, there
could be notable changes in the cost and incomes of a business. The accountants cross-out the
losses on commodities in contrast to the incomes of a company. The government enlisted
companies find it difficult, as the shareholders could experience some obstacles in evaluating
the quality of the company with these variations occurring frequently. However, the
probability for wrong evaluations could create problems during audit.
Lower reliability:
Book-keepers search the market during the period of gaining information regarding
"relevant" prices for "investments" or "assets". When the cost of a commodity varies from
market to market, the accountant then depends on intuition for valuing book commodities. If
an organisation with indistinguishable "investments" or "assets" evaluates commodities

4FINANCIAL ACCOUNTING THEORY AND PRACTICE
differently in contrast to another, problems could arise owing to the evaluation process of the
book-keeper.
Minimised book value:
From the classical viewpoint, the net asset value of an organisation could vary during
the period it buys new "assets" or "sells" an aged one (Shipman et al., 2017). However, FVA
varies the "net asset value" of a business for irrational problems. Suppose, if an investment
faces a crucial decline in cost for "short-term", it is required for the company to make book-
keeping adjustments. when the cost raises, the adjustments did not conduct anything; rather,
the "net asset value" of the company declines to a limited "time-frame".
b. The three-tier process:
After critical evaluation of the journal article by Marra (2016), it is identified that fair
price assessment utilises a "three-tier process" having a inflexible choice for "market-based
measures". The chain is represented as follows-
Level 1 Input:
The inputs of level 1 could be defined as uninfluenced quoted prices in the
progressive markets regarding the elements that are indistinguishable to the "asset or
liability" gauged. In case of citation of price in a progressive market, the value is used by the
corporation without changes when fair price is measured (Chung Lobo & Yong, 2017).
Therefore, the business has to enter the market during the valuation period. In case of
progressive markets, negotiations take place with enough volume and the prevalence for
declaring cost related information. If required, a different approach would be applied and the
standard enacts the norm, in which it could be implied. For example, there could be a
condition, in which the cost cited in a progressive market does not portray actual price during

5FINANCIAL ACCOUNTING THEORY AND PRACTICE
the assessment period. This condition could happen when a noteworthy matter like "business
combination" or restructuring happens after the market closure (Haswell & Evans, 2018).
Level 2 Inputs:
They are the inputs excluding the cited costs in level 1, which could be witnessed for
that "asset or liability". It is defined as cited "assets or liabilities" for equivalent items in
progressive markets or market information backs them such as- "credit spreads", "rates of
interest" and "yield curves". These inputs might require changes, if deemed to be necessary.
The fair price has to be categorised in the form of level 3.
Level 3 inputs:
Level 3 inputs might be noticed and they are required to be utilised as a minimal. In
some conditions when it is not feasible to notice the significant absorptions, they are required
to be generated for mirroring the hypothesis that the "market participants" would use during
the period of confirming an impactful cost for "asset or liability" (Kane, 2016). The
organisation is required to expand its usage of relevant noteworthy absorptions apace-with
declining the application of unnoticeable absorptions. Suppose, capital assessments would be
applicable for an unlisted business. All the analysis of fair price are restricted based on
minimum level absorptions, which conveys more noteworthiness.
c. Qualitative characteristics of financial information:
Every company needs to recognise specific qualitative features of "financial" data
when "fair value accounting" is utilised. The first feature is "relevance", which mandates the
need of appropriate financial information in order to aid the end-users of the "operating
statements" in making accurate commitments (Khan, 2018). The next feature is materiality, in
which the book-keepers and "auditors" are needed to focus on "financial" data expected to
affect the process of undertaking decisions of the end-users. The "3rd", feature is "faithful

6FINANCIAL ACCOUNTING THEORY AND PRACTICE
representation” ensuring right and actual presentation of the "financial" data, precisely; it
needs to be without any sort of distortions. The "4th" characteristic is "comparability”
needing the "financial" information to be notable throughout the firms and timeframes
(Magnan, Menini & Parbonetti, 2015). The "5th" characteristic is "verifiability" incorporating
the presence of crucial economic information of the business activities of a corporation. The
"6th" attribute is "timeliness", which requires revelation of financial information within the
set time by reducing any delays. The last attribute is "understand-ability", which requires the
end-users in having a complete insight of financial information coupled with reasonable
knowledge of economic and company functionalities.
All the attributes are believed to be maintaining linkages with the "fair value
accounting" system. In this system, the prices of all elements need to be pertinent and fair for
depicting their fair prices. However, it is required to give such revelations in a timely way to
the various end-users of the operating statement (Xie, 2016). Furthermore, in "FVA", it is
important that the operating statements do not consist of "materiality" difficulties so that the
right information would be conveyed to the users of the "operating statements". Along-side
this, it is noteworthy to indicate that the application of "FVA" is made precisely for "assets
and liabilities", as the elements of precise attributes. According to the propositions of "FVA"
method, the "market participants" utilise a particular system concerning the negotiations of
"assets and liabilities" with the intent of imparting or "selling the assets" (Zhang & Andrew,
2016).
Conclusion:
Its quite obvious from this project, that the analysis of "FVA" method has some
specific gains such as- "investor benefit, realistic assumptions and minimised net income".
Moreover, it also possesses some drawbacks such as- "frequent modifications, lower

7FINANCIAL ACCOUNTING THEORY AND PRACTICE
reliability and minimised book values of assets and liabilities". However, it has been
observed that this system utilises a "three-tier" hierarchy in order to have "strict choice for
market-based assessments". Hence, "three levels of inputs" have been analysed in this paper,
which associates both noteworthy and unwanted absorptions. "Lastly", it has been evaluated
that the "FVA" method uses all the important "qualitative features" of financial information
so that precise and timely data could be given to the different users of the "operating
statements" of the companies.

8FINANCIAL ACCOUNTING THEORY AND PRACTICE
References:
Ayres, D., Huang, X. S., & Myring, M. (2017). Fair value accounting and analyst forecast
accuracy. Advances in accounting, 37, 58-70.
Barker, R., & Schulte, S. (2017). Representing the market perspective: Fair value
measurement for non-financial assets. Accounting, Organizations and Society, 56, 55-
67.
Bewley, K., Graham, C., & Peng, S. (2018). The winding road to fair value accounting in
China: a social movement analysis. Accounting, Auditing & Accountability
Journal, 31(4), 1257-1285.
Carcello, J. V., Neal, T. L., Reid, L. C., & Shipman, J. E. (2017). Auditor Independence and
Fair Value Accounting: An Examination of Non-Audit Fees and Goodwill
Impairments.
Chung, S. G., Lobo, G. J., & Yong, K. O. (2017). Valuation implications of FAS 159
reported gains and losses from fair value accounting for liabilities.
Haswell, S., & Evans, E. (2018). Enron, fair value accounting, and financial crises: a concise
history. Accounting, Auditing & Accountability Journal, 31(1), 25-50.
Kane, N. M. (2016). Fair value accounting: Impact on organisational performance
reporting. Journal of Health Care Finance, 43(2).
Khan, U. (2018). Does Fair Value Accounting Contribute to Systemic Risk in the Banking
Sector?. Contemporary Accounting Research, Forthcoming.
Magnan, M., Menini, A., & Parbonetti, A. (2015). Fair value accounting: information or
confusion for financial markets?. Review of Accounting Studies, 20(1), 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), 582-591.

9FINANCIAL ACCOUNTING THEORY AND PRACTICE
Xie, B. (2016). Does fair value accounting exacerbate the procyclicality of bank
lending?. Journal of Accounting Research, 54(1), 235-274.
Zhang, E., & Andrew, J. (2016). Rethinking China: Discourse, convergence and fair value
accounting. Critical Perspectives on Accounting, 36, 1-21.