Practice of Accounting Theory

This report discusses the concept of fair value accounting and its pros and cons. It also explores the three-tier process of fair value estimation and the qualitative characteristics of financial information. The report provides an in-depth analysis of the topic and offers relevant study material for further understanding.

Running Head: PRACTICE OF ACCOUNTING THEORY
Practice of Accounting Theory
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Introduction
According to the accounting theory, the concept of Fair Value Accounting has been used
for around two decades. Fair value concept includes measuring assets and liabilities at their
existing value. The concept of fair value is different from the fact of books of account naturally
accounting concept based on historical cost and not on the existing value. The fair value concept
leads to debate because some of the important matters are needed for consideration investment
choices and decisions regarding business by managers (Lin et al, 2017). The following report
will aim to discuss the fact of fair value accounting and also analyzing the academic article
which is provided.
1. Fair Value Accounting (FVA): Pros and Cons
As said by Chircop and Novotny-Farkas (2016), FVA is an accounting process where the
organization creates a benchmark and reports the assets and liabilities holding by them in that
period in their fair value. The method has certain advantages, they are explained below:
Minimized Net Profit
There is a decrease in the net profit of the company when the asset value declines while
using FVA. Even when there is an increase in the value of the liabilities, the net profit value of
the organization declines as well. Net profit of an organization states the amount on which tax is
being incurred (Duska, Duska & Kury, 2018).This proves to be the advantage towards to the
business because of the fact that less net profit lowers the tax payment and also the similar kind
of advantage can be observed when the value of assets and liabilities falls in business equity
(Marra, 2016). Due to the lower business equity the business has to decide a lower amount of

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money for the business organization. Due to the above mentioned fact the bonuses for the
employee are being declined and hence the more cash will be present in the pocket of
organization.
Realistic Financial Statement
The companies who have adopted FVA concept for accounting can produce more
accurate financial statement compare to those who do not use it. Due to the representing of actual
value in case of assets and liabilities it states more accurate and realistic financial statement
(Marra, 2016). The organizations who have adopted the FVA method have to disclose the
information regarding the changes in financial statement in the form of financial note. This
practice also helps to take more accurate and realistic decisions regarding the business operations
in future (Badia et al., 2017).
Investor Benefit
The organizations who have adopted the FVA concept of accounting are able to show the
real financial health of the organization (Marra, 2016). This helped the investors to take concrete
decisions regarding the investment in the organization. The required footnote discloses
investigation of investors and impact of variations in statements.
In spite of having some superficial advantage but it still persist some limitation regarding the
using of FVA concept. They are explained below:
Frequent Changes
The market is volatile and the value of any item can change frequently. Due to this above
mentioned problem the variations in value and earnings may take place frequently (Marra, 2016).

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The write-off items of organizations may losses compared to the earnings associated with the
organizations. The listed companies will face considerable amount of problem as the
organization may face some kind of difficulties in valuing the organizations due the variations. If
any wrong valuation occurred then the issues started reading audit(Bens, Chang and Neamtiu,
2015).
Lower Liability
At the time of accounting the accountant tends to find the assets’ or investments’ new
values. The item value may differ from one place to another and thus, it requires the accountants
of the companies to do the valuation of book items through making judgment calls (Israeli,
2015). If an organizations started to valuing items with identical investments in assets will cause
a problem for accountant.
Minimized Book Value
According to the historical value there might be alteration in the book value of an
organization when the assets are purchased or when old assets are sold. In accordance with FVA
concept it tends to change the organizational book value for issues regarding arbitrary. When the
investment sees a decline in the value for short-term the organization required to modify the
accounting method (Du, Li & Xu, 2014). When the value of an organization increases it did not
conduct anything and the book value decline for a shorter time frame.

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2. The Three-tier Process
As stated by the article of Marra (2016), it is required to follows a three-tier process for
the estimation of fair value which have a perfect stagnant preference for market based measures.
The tier model is explained below:
Level I Input
The benchmark set for assets and liabilities these inputs are also unadjusted cited prices
in the active market. At the time of benchmarking the fair value the organizations need not adjust
the price since it is quoted in the active market. The market needs to be accessed at the date of
measurement by the organizations for the above-mentioned reasons. The active market can be
explained as a place where the transactions occurred in volume and the pricing information is
frequently provided. It is necessary for another method which could be used and according to the
standard it can be established. There might come the situation where the quoted price in the
market does not show the fair value at the measurement date. During the time of business
combination or the reorganization occurs after the market closure (Crain & Law, 2017).
Level 2 Input
These are the inputs which are expectation of the quoted price of Input I for the asset and
liability. These are explained as quoted liabilities or assets for the undistinguishable sunstances
in active market or support the market data such as credit spreads, yield curves and rates of
interests (Henry and Leone, 2015). It is required for the adjustments of these inputs and it is
necessary to categories the fair value in accordance of fair value.
Level 3 Input

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The presence of these input are microscopic and hence it can be observed so the usage of
these input should be minimized. At the time to determine the effective price of assets or
liabilities the market member should be utilized by developing the assumptions (Muda et al.,
2017). This occurs when the there are no possibility to observe the relevant input. The
organization should increase the usage of the inputs which can be observed while should reduce
the utilization of the inputs which are not being observed. For example, the cash flow can be
used for the valuation of the organization which is unlisted. The basis of the measurement of the
fair value is the lowest level input which has more importance (Kim et al, 2016).
3. Qualitative Characteristics of Financial Information
At the time of the use of fair value accounting by the companies, it is required to make the
assessment of the qualitative characteristics of business organizations. The financial statement
provided by the organization because of taking appropriate decisions. One characteristic is
materiality which makes the accountants and auditors to take into consideration the financial
information which will help to increase the efficiency of the decision making process of the
organizations. Another characteristic is that the financial information should be presented
without any alteration or any kind of malfunction should not happen. The fourth characteristics
the comparisons needed between the financial information of the organizations and period. The
fifth characteristics state the verifiability of the economic condition of the business operations of
the organizations. The sixth characteristics require the disclosure of the financial statement of the
organizations within the time period. The final characteristics requireto understand the financial
information provided by the organizations by shedding some light economics and business
operations.

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All the above mentioned characteristics have a relationship with the fair value of the
accounting concept. According to the method of fair value accounting, relevancy needs to be
there in the information regarding fair value accounting. Such disclosure of the financial
statement of the organizations needs to be done in timely manner for the users of the financial
statement. In the perspective of the fair value of the accounting concept there are no materiality
problem since the right information are being delivered. One crucial aspect that should be
mentioned in here is that the fair value accounting is developed for the assets as well as liabilities
which have the above-mentioned qualitative characteristics of financial information. In respect of
transferring the assets and liabilities or selling of assets or liabilities the participant of the market
follow the particular order which is as per the fair value of accounting method. The fair value of
assets and liabilities are liable to transfer in the next accounting year (Christensen & Nikolaev,
2013).
Conclusion
It can be seen from the above discussion that the fair value accounting has considerable
amount of benefits for utilizing it. The main benefits of using fair value accounting includes
investor benefit minimized net income and realistic assumption. At the same time it has some
limitations. The limitations of fair value accounting include frequent modification, minimized
the assets’ and liabilities’ book value and lower reliability. From the above evaluation it can be
seen that method of fair value accounting follows a three-tier process for measuring the market
based information and measurement. In this report the information of three inputs are discussed
including observable and unobservable inputs. At the end of this report it can be concluded that
the fair value accounting method adheres to all the qualitative characteristics of financial

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information so that it can deliver the accurate and timely information to the users of the financial
statements of the organizations.
.

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References
Badia, M., Duro, M., Penalva, F., & Ryan, S. (2017). Conditionally conservative fair value
measurements. Journal of accounting and economics, 63(1), 75-98.
Bens, D. A., Cheng, M., &Neamtiu, M. (2015). The impact of SEC disclosure monitoring on the
uncertainty of fair value estimates. The Accounting Review, 91(2), 349-375.
Christensen, H. B., & Nikolaev, V. V. (2013). Does fair value accounting for non-financial assets
pass the market test?. Review of Accounting Studies, 18(3), 734-775.
Crain, N., & Law, K. (2017). The bright side of fair value accounting: Evidence from private
company valuation. Available at SSRN 3040396.
Du, H., Li, S. F., & Xu, R. Z. (2014). Adjustment of valuation inputs and its effect on value
relevance of fair value measurement. Research in Accounting Regulation, 26(1), 54-66.
Duska, R. F., Duska, B. S., & Kury, K. W. (2018). Accounting ethics. Wiley-Blackwell.
Henry, E., & Leone, A. J. (2015). Measuring qualitative information in capital markets research:
Comparison of alternative methodologies to measure disclosure tone. The Accounting
Review, 91(1), 153-178.
Israeli, D. (2015). Recognition versus disclosure: evidence from fair value of investment
property. Review of Accounting Studies, 20(4), 1457-1503. (Israeli, 2015)
Kim, J. B., Li, L., Lu, L. Y., & Yu, Y. (2016). Financial statement comparability and expected
crash risk. Journal of Accounting and Economics, 61(2-3), 294-312.

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Lin, Y. H., Lin, S., Fornaro, J. M., & Huang, H. W. S. (2017). Fair value measurement and
accounting restatements. Advances in accounting, 38, 30-45.
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.
Muda, I., Dharsuky, A., Siregar, H. S., & Sadalia, I. (2017, March). Combined Loadings and
Cross-Dimensional Loadings Timeliness of Presentation of Financial Statements of Local
Government. In IOP Conference Series: Materials Science and Engineering (Vol. 180,
No. 1, p. 012099). IOP Publishing.