ACCT6007: Critical Analysis of Fair Value Accounting and its Impact

This essay offers a comprehensive analysis of fair value (FV) accounting, drawing insights from Antonia Marra's article, 'The pros and cons of fair value accounting in a globalized economy: A never ending debate.' The analysis begins with an examination of the advantages and limitations of FV accounting, highlighting its ability to provide accurate and realistic financial information by reflecting current market values. The essay then delves into the three-tier measurement hierarchy of FV, as defined by IFRS, which categorizes valuation based on the availability of market data. Finally, it explores the qualitative characteristics of financial information that should be considered when using the FV method, emphasizing the importance of reliability and relevancy. The essay concludes by acknowledging the ongoing debate surrounding FV accounting and suggesting the need for a balanced approach that considers both historical cost and FV methods based on the nature of the assets to protect the interests of end-users.

ACCT6007
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Contents
Introduction......................................................................................................................................3
Part 1: Pros and Cons of Fair Value (FV) Accounting....................................................................3
Part 2: Three tiers as defined in measurement hierarchy of fair value measurement......................4
Part 3: Qualitative Characteristics of Financial Information to be Considered using FV Method..5
Conclusion.......................................................................................................................................6
References........................................................................................................................................7
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Introduction
This essay is developed for carrying out an analysis of the concept of Fair Value (FV)
accounting by gaining an insight into the academic article developed by Antonia Marra ‘The pros
and cons of fair value accounting in a globalised economy: A never ending debate’. The essay in
this context has explained the advantages and limitations associated with the approach of fair
value accounting as reviewed in the article. This is followed by discussing the three-tier process
of the use of fair value accounting in detail and also analyses the qualitative characteristics of
financial information that is to be considered using the FV method in financial reporting.
Part 1: Pros and Cons of Fair Value (FV) Accounting
The given article has analyzed the benefits and limitations associated with the use of fair
value accounting for examining the debate related to its use during financial reporting process. It
has been stated in the article that the use of this concept provides users with accurate and realistic
information for facilitating the decision-making process. This is because it reflects the current
information in relation to the assets and liabilities value on the balance sheet. This is because the
financial elements such as assets and liabilities are measured as per the current market
information that enables the businesses to mark up or down the value of an asset as per the
current market price (Marra, 2016). In addition to this, the method is regarded to be
advantageous over the historical method of accounting as it helps in assessing the value of all
assets in an accurate manner and thus reflects the actual financial position of a firm. However,
the historical cost value is not regarded as accurate after a long period of time and thereby is not
able to depict the actual financial position of a firm (Veron, 2008).
However, the use of this method has received large criticism after the occurrence of the
global financial crisis in the year 2008. It has been argued by various financial experts that the
method has facilitated the business executives to manipulate the financial information due to
recording of unrealistic gains or losses (Marra, 2016). It is also sometimes possible that market
price of an assets does not indicate its fundamental value due to market inefficiency. The
condition of illiquidity in the market can have an impact on the traded and quoted prices. It has
also been stated in this context that the financial information that is obtained with the use of fair
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value accounting method can only be used for a limited time-period. This is the change in the
market conditions can impact the reliability of the financial information. The use of mark to
model accounting in the condition of absence of an active market price is associated with a risk
of recording the manipulated price of an asset as it is based on a set of assumptions. The
accounting experts have regarded the use of this model under the concept of fair value
accounting to contribute for the occurrence of financial crisis Veron, 2008).
Part 2: Three tiers as defined in measurement hierarchy of fair value measurement
There are three main levels or say tiers in the fair value hierarchy. Fair value hierarchy is
developed to provide the basis to measure the value of assets and liabilities as per the available
data. The fair value hierarchy helps to make the financial information more comparable and also
consistent. This method has been established by IFRS and it has been categorized into three
levels and all three levels differ on the grounds of inputs used to value the assets and liabilities.
As this approach to measurement is not based on judgments and arbitrary values, then it is
essential to have solid base for calculating the fair value of different assets and liabilities at given
point of time. This is the reason why fair value hierarchy gives highest importance to the quoted
prices (adjusted prices) that are available in the open market or market. It is highly important that
values of identical assets and liabilities must be considered for valuation purpose but there are
cases when identical assets and liabilities cannot be available or it is impossible to find the value
of particular assets or liabilities according to given point of time (KPMG, 2017).
There have been many cases where inputs used to value the assets are categorized into
different levels of fair value hierarchy as compare to valuation of fair value of liabilities. In such
cases, it is essential to categorize both assets and liabilities in same level of fair value hierarchy
and it should be lowest level of input that is important for entire measurement. Taking into
account the particular inputs for measuring the fair value requires management judgment and
various factors that are specific to such assets and liabilities (Marra, 2016).
The below table reflects the different level of fair value hierarchy together with example:
Particulars Level 1 or Tier 1 Level 2 or Tier 2 Level 3 or Tier 3
Definition In this level quoted In this level, quoted price It is the last and final
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price of identical
liabilities and assets are
being taken and it is
adjusted as per
measurement date and
any other criteria
relevant for valuing
such elements of
financial statements. So
it can be said level 1
provides best
measurement value as
it takes into account the
value of identical assets
and liabilities. Only
point of concern it that
this level considers
unadjusted value and it
need to be adjusted
according to
measurement date (E &
Y, 2012).
are taken but not for
identical asset or
liabilities, it is taken for
similar assets and
liabilities. There are so
many differences
between identical and
similar assets and
liabilities. So in case
when it is possible to
find the value of
identical assets and
liabilities, then as per
level 2, one can take
value of similar assets
and liabilities. In this
case also value of similar
assets and liabilities need
to be adjusted as per
measurement date (E &
Y, 2012).
categorization in
levels of fair value
hierarchy. As per this
level when identical
or similar assets or
liabilities are not
available in the active
market then,
management can use
unobservable values
for such assets and
liabilities. So it can be
said that in this level,
values of assets and
liabilities is based on
the best information
available with the
management. The fair
value taken in this
level requires
reasonable and
reliable information
available with the
management. In this
level it is important to
note that management
is free to consider
both internal as well
as external
information available
with them (E & Y,
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2012).
Example of each
level
The best example in
this case is financial
asset or liabilities for
identical product that is
traded in open market
or active market such
as stock exchange.
The level 2 examples can
be fair value of liabilities
such as bank loan,
mortgage loans etc. Here
it is essential to match
the best loan segment so
that fair value does not
very much. To value
figures of assets and
liabilities it important to
consider the interest rate
and yield curves that are
quoted at regular interval
in the active market.
The value cash flows
(projected) used to
calculate the
discounted cash flow
calculation.
Part 3: Qualitative Characteristics of Financial Information to be Considered using FV
Method
It has been stated in relation to the use of FV method in the financial reporting process
that it has an impact on the relevancy and reliability of the accounting information. Many
accounting professionals are of the view that the use of this accounting approach can lead to
deliver reliable and relevant financial information (Betakova, 2014). Reliability comes from the
fact that an asset or liability price is recorded as per the current market conditions and relevancy
on account of the nature of financial information delivered that can be easily verified. However,
it has been criticized that the FV concept can also result in negatively impacting the reliability
and relevancy of the financial information. This is because the information disclosed though the
use of the method can sometimes mislead the end-users due to high volatility present within the
market conditions. Thus, it is required on the part of the financial managers to consider the
impact on the reliability and relevancy of the financial information during its implementation in
the financial reporting process (Fiechter and Novotny-Farkas, 2011).
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This approach to measurement is most applicable to valuation of financial items as these
values change as per the given time while value of other elements does not change with the time.
The main aspect of asset and liabilities that is considered while calculating the fair value of such
elements and liabilities is measurement time as value changes according to time (PWC, 2008).
Conclusion
It can be stated on the basis of critical reviewing the article that fair value concept use in
the financial reporting still a topic of debate. Thus, it is required on the part of the business
managers to incorporate the use of both historical as well as fair value method of accounting as
per the nature of assets for protecting the interests of the end-users.
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References
Betakova, J. (2014). Fair Value Usefulness In Financial Statements. Retrieved 18 November,
2018, from
http://www.daaam.info/Downloads/Pdfs/science_books_pdfs/2014/Sc_Book_2014-
035.pdf
E & Y. (2012).Fair Value Measurement. Retrieved on November 18, 2018, from
https://www.ey.com/Publication/vwLUAssets/ey-applying-ifrs-fair-value-measurement/
$FILE/ey-applying-ifrs-fair-value-measurement.pdf
Fiechter, P and Novotny-Farkas, Z. (2011).Pricing of fair values during the financial crisis:
international evidence. Politis, J. (Ed.), pp. 27-32.
KPMG.(2017). Statement of Financial Accounting Standards No. 157 – Fair Value
Measurements. Retrieved on November 18, 2018, from
https://home.kpmg.com/content/dam/kpmg/xx/pdf/2017/12/fair-value-qa-2017.pdf
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.
PWC.(2008). Statement of Financial Accounting Standards No. 157 – Fair Value Measurements.
Retrieved on November 18, 2018, from
https://www.pwc.com/bm/en/publication/assets/usgaap_08_04.pdf
Veron, N. (2008). Fair value accounting is the wrong scapegoat for this crisis. European
Accounting Review 5 (2), pp. 63–69.
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