ACCT6007: Critical Analysis of Fair Value Accounting Article

This essay provides a critical analysis of fair value accounting, exploring its advantages and disadvantages based on a literature review. It delves into the three-tier process for fair value estimation, emphasizing the preference for market-based measures. The essay also discusses the qualitative characteristics of financial information considered when using the fair value method, particularly its applicability to owner's equity. The analysis draws upon various academic sources to support its arguments, ultimately concluding that fair value accounting can enhance the transparency and strength of a company's reporting framework. Desklib offers similar solved assignments and past papers for students.

fair value accounting
Fair Value accounting
Accounting
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Introduction
With the economic condition and complex business condition, fair value accounting
has been gaining momentum throughout the time. It helps accountants to record the assets
and liabilities in the books of account of company. This report reveals the pros and cons of
the fair value accounting and how it could be used by company to strengthen its reporting
frameworks (Choudhary, et al. 2017).
1. Explain and explore Pros and Cons of Fair Value (FV) accounting after conducting
literature review on the topic.
Fair value accounting has been used since ages and is not a modern or a just emerged
concept. The method is widely used in financial reporting to make valuation measurements.
The recent times have witnessed significant use of this method at several instances, however,
the fight between whether it is useful or not still continues. This is so because there is no
customised market where fair value is readily available and assumptions play a major role in
the valuation part (Madhavan, et. al 2014). Resultant many pros as well as cons of the Fair
Value accounting have been observed and the research material have also countersigned
some of them.
PROS
 The fair value accounting has been supported by many people on the grounds that it provides
the users with the information which is accurate as far as the valuation of assets and liabilities
is considered. The valuation is made on the basis of current prices and that helps to analyse
the current state of affairs (Marra, 2016).
 The information that is laid by this method is respectful to time, i.e. the information relates to
the current time period (Choudhary, et al. 2017).
 The financial reporting done on the basis of fair value accounting is more detailed for the
readers. There is a listing of the valuation method, risk exposures, assumptions, market
sensitivity, and etc.
 Through true valuations comes the true income calculation of the financial corporation.
 It is debated in the current times that the historical accounting method is not providing the
results that are expected out of any should financial reporting. The value that is prevailing

now is of more use and is accurate. Hence, the fair value accounting offers an in built
advantage (Cannon, & Bedard, 2016).
CONS
 For the business houses that have assets churned throughout the year and face a lot of
volatility, this valuation method is not entertained (Choudhary, et al. 2017).
 Many a times the fair value accounting method is not disclosed and hence keeping the
shareholders unaware of the use. This as a result makes the shareholders dissatisfied.
 A lot of assumptions are made while using this valuation method, and hence there are
chances of incorporation of manipulation in the whole process.
 Using the fair value method of accounting, the importance that should be vested to the
historical method is all lost (Israeli, 2015).
2. What does the author mean by the statement? ‘The estimation follows a three-tier
process, with a strict preference for market-based measures’ p586. Explain the three –
tier process in detail.
For any valuation method, there is an intense significance provided to the inputs that
are used for valuation. The sources of the inputs can be varied. However, the relevancy that is
forwarded by the different input methods is different. The three tier process that has been
labelled by the author in the statement “the estimation follows a three-tier process, with a
strict preference for market based measures” is the three level input hierarchies (Griffin,
2014). These are the different techniques of input valuation. In this the level 1 of the input
hierarchy are the prices that are quoted in the active market on an unadjusted basis. These are
those that are similar to the assets and liabilities that are to be valued. When level 2 inputs are
considered, the inputs that are left other than the ones already comprising of the level 1
quoted prices. These represent the similar assets or liabilities on a quoted basis that are
promoted in the market. These are observable inputs. Level 3 inputs however, are advised to
be used at the minimal rate and are completely unobservable category of inputs. These are
used in the situation when there is no availability of all the relevant inputs (Bens, Cheng, &
Neamtiu, 2015).
However, there is a three tier of the input availability with any organisation while
using the fair value accounting, but it should always rely upon the inputs that are completely
observable and considered relevant. However, all these inputs have their own significance.

This is so because the unobservable inputs are also used to make the fair value valuation
when the observable inputs are out of availability (Glover. Taylor, & Wu, 2016).
3. What qualitative characteristics of financial information are considered in using FV
method in financial reporting? FV measurement is most applicable to what element of
financial statements (i.e. Asset, Liability, Owners Equity, Revenue and Expense), and to
what aspect of that element?
The qualitative characteristics to be considered while using the fair value method in
financial reporting are:
 Usefulness of the information provided by the financial accounts and its relevance, i.e. the
ability that the financial reporting entails in influencing user’s decisions (Choudhary,
Merkley, & Schipper, 2017).
 The level at which the information in the financials is represented, i.e. whether it is faithful
and reliable or not. There shouldn’t be any prejudice and the actual economic conditions are
represented by them (Zheng, & Chen, 2017).
The element of financial reporting to which the fair value measurement is most
applicable is the owners’ equity. The owners’ equity comprises of both the components of
assets and liabilities. After the liabilities are deducted from the assets, the owner’s equity is
computed. Resultant when the owner’s equity comes into picture, every element of the
financials gets covered in that. However, this way it can be said that every element of
financial reporting at some place makes use of the fair value accounting when this method is
incorporated in business (Hodder, Hopkins, & Schipper, 2014).
In the owner’s equity, the aspect that is widely using the fair value method is its
valuation. When the owner’s equity is valued at the fair value prevailing in the market, a clear
picture of the current market value of the shareholders can be gathered. This way it becomes
easier to analyse the value at which the corporation stands in the market. With the use of fair
value accounting in owner’s equity, the comparison of the company’s performance can be
done easily with the other companies in the same industry, and hence the market position can
be easily known. By using the fair value accounting, company could easily evaluate the
owner’s equity and the value creation in its books of account.

Conclusion
After assessing all the information and details of the fair value accounting and
qualitative characteristics to be considered while using the fair value method, it could be
inferred that company could easily strengthen the reporting and accounting frameworks of the
business. It helps company to keep its books of accounts more transparent to its stakeholders.
The fair value measurement method is used to identify the true and fair view of the assets and
liabilities recorded in the books of account of company. Nonetheless, many big multinational
companies are using the fair value accounting methods on quarterly basis to identify the fair
value of its books of accounts.

References
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.
Cannon, N. H., & Bedard, J. C. (2016). Auditing challenging fair value measurements: Evidence
from the field. The Accounting Review, 92(4), 81-114.
Choudhary, P., Merkley, K. J., & Schipper, K. (2017). Qualitative characteristics of financial
reporting errors deemed immaterial by managers.
Glover, S. M., Taylor, M. H., & Wu, Y. J. (2016). Current practices and challenges in auditing fair
value measurements and complex estimates: Implications for auditing standards and the
academy. Auditing: A Journal of Practice & Theory, 36(1), 63-84.
Griffin, J. B. (2014). The effects of uncertainty and disclosure on auditors' fair value materiality
decisions. Journal of Accounting Research, 52(5), 1165-1193.
Hodder, L., Hopkins, P., & Schipper, K. (2014). Fair value measurement in financial
reporting. Foundations and Trends® in Accounting, 8(3-4), 143-270.
Israeli, D. (2015). Recognition versus disclosure: evidence from fair value of investment
property. Review of Accounting Studies, 20(4), 1457-1503.
Madhavan, A., Yang, J., Zosin, L., Zalutsky, K., Asriev, A., & Butler, G. (2014). U.S. Patent
Application No. 14/275,234.
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.
Zheng, X., & Chen, J. (2017). FINANCIAL REPORTING QUALITY IN CHINA: A
PERSPECTIVE OF QUALITATIVE CHARACTERISTICS. Transformation in Business &
Economics, 16(3).