Critical Analysis: Fair Value Accounting and Global Economy

This report provides a comprehensive critical analysis of fair value accounting, drawing on the academic article by Antonio Marra. It delves into the core concepts of fair value, contrasting it with historical cost accounting, and examines its implications within the context of IFRS and AAS. The report highlights the advantages of fair value accounting, such as its ability to reflect current market conditions and enhance transparency, while also acknowledging its disadvantages, including the potential for subjectivity, manipulation, and increased volatility. The analysis explores the impact of fair value on financial liabilities, the role of fair value in the context of the 2007 financial crisis, and the ongoing debate surrounding its adoption. The report also discusses the importance of fair value in a globalized economy, emphasizing the need for external auditing to mitigate the risks associated with its implementation. Overall, the report offers a balanced perspective on the complexities of fair value accounting, providing insights into its benefits, drawbacks, and its role in the context of financial reporting.

[Type the company name]
Financial Accounting Theory and Practice
[Type the author name]
[Pick the date]

It would be correct to say that books of accounts and financial statements are the
lifelines for running an organisation successfully. The whole business activities are
actually dependent on the financial reporting. There are various parties to these
financial statements which include the investors, suppliers, shareholders, creditors,
management of the company, law of the country and the list is for many more.
Every company prepares its books of accounts and financial statements after
considering the accounting theories, accounting conceptual framework and
accounting standards
If we talk about the accounting theories then it is the combination of conceptual
framework, concepts and conventions. These theories of accounting have to take
care that all the materialistic informations are disclosed by the business entities for
facilitating the external users and internal users to make better and informed
decisions. The accounting theories want that all the organisations should know the
concept of separate business entity, money measurement, dual aspect, going
concern, accounting year, realisation concept etc. The concept of business entity
states that the owner of the business and the business are recognised separately.
Money measurement concept speaks that only those transactions should be
recorded which can be expressed in terms of money. Dual aspect says that for every
debit transaction recorded, the recording of the credit transaction will also be made.
It is also assumed by the going concern concept that business will going to exist for
an indefinite period of time. The companies are required to prepare their books of
accounts and financial statements monthly, quarterly or annually as per accounting
year concept.
Now, if we discuss about conceptual framework of accounting and accounting
standards then, conceptual framework of accounting and accounting standards are
two separate entities which are not established with the motive of competition. The
functions carried out by both of them are completely independent of each other.
Accounting standards states the rules to the organisations for recording financial
information. The definition of Accounting standards is “a rule that describes how
the financial information of a company or organization must be recorded”
(Cambridge Dictionary, N.D.). Accounting standards help the users in getting those
informations which otherwise company would not have disclosed. In few countries,
these standards are sometimes formed by the country’s professional bodies and
sometimes by the government of the country (Olamide & Temitope, 2016).
Accounting conceptual framework provides enough explanation related to the
financial statements, which improves the understanding and sureness of the users.
Also, where accounting standards talk about how financial reporting can be done
more effectively, the accounting conceptual framework assists the International
Financial Reporting Standards (IFRS) in its execution. These Accounting standards
guide the financial statement preparers regarding, how the financial transactions

should be collected, classified, analysed, summarized and reported to the
stakeholders and internal users. It also provides the platform for discussing the
problems and deliver solutions which are in accordance with the accounting
practices. If we discuss about the conceptual framework, then for the account
preparers, the conceptual framework of accounting acts as a constitution. The
accounts prepared according to the framework unfolds more genuine figure, facts
and ultimately promotes the transparency enabling the corporates to make a proper
future plans to increase their profitability. Apart from the corporates, social users are
also benefitted out of the above mentioned framework in making better investment
decisions or we can say capital allocation decisions. Though we cannot relate both
Accounting standards and Conceptual framework but the differences mentioned
above are enough to comprehend their purposes and usage.
There is a concept of fair value also known as Mark-to-market price, which is a part
accounting conceptual framework which says that the assets and liabilities should be
recorded at the market value over the historical cost (Laux & Leuz, 2010) . As per
IFRS 13, the aim of fair value accounting is to estimate the exit price of asset or
liability at the time of asset sale or liability transfer.
The Australian banks and financial institutions follow IFRS which ask them to
evaluate the asset and liability at fair value (rba, 2006). In the year 2001, Financial
Reporting Council asked the Australian Accounting Standards (AASs) to adopt IFRS.
After this, the Australian entities operating with the objective of earning profit have to
prepare their financial statements as per IFRS and also as per AASs (aasb.gov.au,
N.D.). If we talk about IFRS13 (CPA Australia, N.D.) and AAS 13 (aasb.gov.au, 2014)
then both of these standards requires disclosure about fair values. Fair Values are
not an entity based measurement, rather it is a market based measurement. There
are some assets and liabilities for which relevant market informations are available
while for some assets and liabilities such informations do not exist.
In the fair value accounting there are few features which should not be ignored. One
such characteristic is, on the measurement date, the fair value should be derived
from the current market condition rather considering the valuation carried on some
earlier date or time. Fair value is also estimated on the basis of systematic
transactions, which include the transactions with no unnecessary burden to sell.
There is a proper three tier process for selecting the inputs at the time of valuation of
fair value. The process will start like, first the market price of a product will be
considered in the evaluation of fair value only if it trades regularly on the liquid
market. In case, the same product does not trade in the market then market price of
similar kind of product having the same kind of cash flow profile can be accepted.
However, we have to opt for the internal estimation like company’s own data and
internally generated financial forecast etc. in case of non-availability of proper market

informations, which results in failure of fair value method (GOH, B.W., LI, D., NG, J.
& Yong, K.K.O., 2015).
Fair Value Accounting has a great impact on the financial liabilities of the company.
For example, when the credit risk rating of credit issuing company falls, it will result a
reduction in the fair value of financial liability the reason being, now the interest rate
on the issuing date would be less than what it would have been if the credit amount
was extended at the present date. On the contrary, if the company’s credit risk rating
witnesses a rise into it, then the fair value of financial liability will upsurge.
Fair value has become a very controversial topic among the financial regulators and
those who maintains the books of accounts and financial statement of the
companies. The present research has equal opponents and supporters of fair value
accounting (Marra, 2016). Fair value accounting drew more attention when the
significant markets crashed as a result of credit crisis in 2007 (Bockova & Skoda,
2014). The value of those assets tied up in sub-prime mortgages fell sharply and
forced the financial institutions to write down the asset’s value. All these resulted a
fall in the market value of such institutions (Bowers, 2011).
(Socoliuc, 2018)Fair Value helps in estimating the current value of the assets and
liabilities but at the same time we cannot ignore the significance of historical cost.
Sometimes, the company’s net profit is reduced falsely because the assets’ down
year, which however puts an artificial cover on the achievements of the company. No
doubt, fair value facilitates the management of the company and investors to know
their actual return but at the same time users of the information desires to know the
actual cost of investment. Apart from this, there are strong chances of manipulation
risks like over-valuing the assets, undervaluing the liabilities etc. at the time
companies prepare their financial statements using fair value of accounting, but it
can be eliminated with the help of carrying out a proper external auditing. After the
case of loan failure in 1980s, the demand for fair value increased in order to protect
the interest of the investors in future No doubt investors want more transparency and
are somewhat benefitted from the process. But many a times the investors are
unaware of the fact that the company is using the fair value of accounting which
usually leaves them dissatisfied. For example- when there was a loss in the value of
net income of the company it also resulted in loss of income for the investors
(Trajkovska, Temjanovski & Koleva, N.D.).
So the concept of fair value is into discussion from the past many decades. There
are equal opponents and supporters of Fair Value accounting. Where current
business demands more transparency in evaluation of assets, liabilities, revenues,
expenses and owner’s equity, the theory of fair value accounting holds good but at
times unethical practices involved in the valuation of fair value force us to opt for
recording the transactions at historical cost.

Reference
dictionary.cambridge.org (N.D.). Accounting Standard. [Online] Available 12 April, 2019
https://dictionary.cambridge.org/dictionary/english/accounti
ng-standard
Olamide, K. O. & Temitope, A .A. (2016). Evolution of Accounting Standards in Nigeria: A
Historical Perspective. International Journal of Advanced
Academic Research [online] 2(8), p.13-24. Available 12
April, 2019 https://www.ijaar.org/articles/Volume2-
Number8/Social-Management-Sciences/ijaar-sms-v2n7-
jl16-p2.pdf
Laux, C. & Leuz, C. (2010). Did Fair-Value Accounting Contribute to the Financial
Crisis? .Journal of Economic Perspectives [online] 24(1),
p.93-118. Available 12 April, 2019
https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.24.1.93
rba.gov.au (2006). Box A: International Financial Reporting Standards. [Online] Available
12 April, 2019
https://www.rba.gov.au/publications/fsr/2006/sep/box-
a.html
aasb.gov.au (N.D.).Frequently asked questions. [Online] Available 12 April, 2019
https://www.aasb.gov.au/About-the-AASB/Frequently-
asked-questions.aspx
cpaaustralia.com.au (N.D.).IFRS 13 FAIR VALUE MEASUREMENT FACT SHEET. [Online]
Available 12 April, 2019
https://www.cpaaustralia.com.au/~/media/corporate/allfiles/
document/professional-resources/ifrs-factsheets/factsheet-
ifrs13-fair-value-measurement.pdf?la=en

aasb.gov.au (2014).IFRS 13 Fair Value Measurement. [Online] Available 12 April, 2019
https://www.aasb.gov.au/admin/file/content105/c9/AASB13
_09-11_COMPjun14_07-14.pdf
GOH, B.W., LI, D., NG, J. & Yong, K.K.O. (2015). Market pricing of banks’ fair value
assets reported under SFAS 157 since the 2008 financial
crisis. Journal Of Accounting and Public Policy [online]
34(2), p.129-145. Available 12 April, 2019
https://ink.library.smu.edu.sg/cgi/viewcontent.cgi?
referer=https://scholar.google.co.in/
&httpsredir=1&article=1253&context=soa_research
Bockova, K.H. & Skoda, M. (2014).Has Financial Crisis Been the Crisis of Fair Value
Accounting?. International Journal of Advances in
Management and Economics [online] 3(5), p.13-22.
Available 12 April, 2019
http://www.managementjournal.info/index.php/IJAME/artic
le/view/470
Bowers, K. A., (2011)."Fair value accounting debate and the future of the profession".
Honors Program Theses. 7. Available 12 April, 2019
https://scholarworks.uni.edu/hpt/
Socoliuc, M.(2018). FAIR VALUE VERSUS HISTORIC COST: ADVANTAGES AND
DISADVANTAGES. Ecoforum Journal [online] 7(2). Available 12 April, 2019
http://www.ecoforumjournal.ro/index.php/eco/article/viewFile/817/499
eprints.ugd.edu.mk(N.D.) FAIR VALUE ACCOUNTING – PROS AND CONS. [Online]
Available12 April, 2019 http://eprints.ugd.edu.mk/16917/1/Fair%20value
%20accounting-pros%20and%20cons.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 [online] 31(4),
p.583-591. Available 12 April, 2019 DOI: 10.1177/0148558X16667316