Fair Value Accounting: Applicability and Influence in Modern Finance

This essay delves into the debate surrounding fair value accounting, contrasting it with the historical cost method. It examines the relevance of fair value accounting in the contemporary world, analyzing its applicability across private and public organizations. The essay explores the influence of fair value accounting on financial crises, referencing the arguments of Laux and Leuz, and Whittington. It covers the application of AASB 13, the hierarchical system for asset/liability valuation, and real-world examples. The essay also critiques the advantages and disadvantages of fair value accounting, considering its impact during economic crises, and concludes with a summary of its significance in financial reporting.

Corporate Accounting- Fair Value Method
of Measurement
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Table of Contents
Introduction.................................................................................................................................................3
Relevance of fair value accounting in contemporary world........................................................................3
Applicability of fair value method in private or public organizations..........................................................7
Influence of Fair Value Method in crises.....................................................................................................7
Conclusion...................................................................................................................................................7
Bibliography................................................................................................................................................9
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Introduction
The debate of evaluating assets and liabilities for financial reporting of any entity faces long-
term conflict of opinion between the critiques. One such evaluation method is considered as fair
value accounting. It is argued that historical cost method has obsolete concept and fair value
method of evaluating assets or liabilities has substantial ground to consider it as reliable. But the
critiques of this concept have their views, too. It is opined by the critiques that this valuation
method has to be passed through more researches to prove its worth and reliability as the
evaluation method for financial accounting purpose. The critiques named Laux and Leuz had
argued about the present status of fair value method with the opinion that more work is to be
done in this field to make it more reliable and realistic. As per Whittington, present business
situation is not static. Its dynamic nature demands evaluation of assets and liabilities in more
practical and realistic way to meet the objective of evaluation process. In this essay, the
discussion will evolve with the opinion and inferences of the critiques about the application of
fair value method of evaluation with its limitations and scope of further development for facing
crises to make it acceptable by the global accounting stakeholders for their satisfaction.
Relevance of fair value accounting in contemporary world
Right through the revolutionary thought of accounting principles related to measurement method
of accounting, the concept of historical cost method is replaced by fair value method of
measurement. This concept is considered as “a real shield” and “a revolution in accounting”,
which can enable to mitigate all the loopholes of using other measurement methods.
There are recent developments of financial crises cropped up by following fair value method of
measurement and this situation gives birth to the controversy of the authenticity of fair value
measurement method with its benefits and disadvantages. This scenario gives rise to the
questions of financial presentation of accounting reports following fair value method. Hence, to
justify the balance between relevance and credibility of the financial information prepared
following fair value method for financial statements, the problem of consideration persists in the
domain of certainty of erstwhile costs, as endorsed by historical cost method with the evaluation
of uncertain future value of financial instruments conceptualized by fair value method in respect
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of prevailing market valuation. This concept is considered with more objectivity and greater
rationality.
To fix the guideline for fair value accounting, AASB 13 is in force. This standard describes fair
value as the coveted price to dispose of assets and liabilities as per the prevailing price of market
participants as on measurement date. This concept is applicable for any specific asset or liability.
Hence, while measuring fair value, the consideration of specific nature of that item is to be done
subject to acquisition of them by market participants. The pricing of those items are to be
considered as on measurement date. A three tier hierarchical system is followed for evaluation
purpose of these assets or liabilities. They are known as level 1 to level 3 inputs related to price
of such assets or liabilities. Level 1 inputs represent the quoted price of any asset or liability as
per market price of the equivalent items of same nature. Level 2 inputs represent any price other
than the price quoted in level 1 with observable nature for the assets or liabilities in direct or
indirect way. Level 3 inputs are considered as inputs with unobservable nature. These inputs are
used for fair value measurement, if the relevant observable inputs are not readily available. This
situation leads to the application of market survey for detection of price of assets or liabilities
during measurement period. This practice does not supersede objective of measurement, instead
it is an exit valuation at the measurement time from the viewpoint of market participant, which
holds the asset or liability. Hence, unobservable inputs would reflect the consideration used by
the market participants, when the valuation of such assets or liabilities including the
consideration of them is at risk. (AASB, 2015)
The practical aspect of fair value accounting treatment is to be based on the utility value of future
cash flow, the prevailing value in the market, the value of replacement and net book worth of the
assets or liabilities. (Sebastian et al., 2014) The debate about the authenticity of this concept is
highlighted on the ground of international approaches. Main domains of debate persist about the
concept and content of this valuation method, along with the methods to obtain and respective
application; as this concept is considered as much broader than the concept of market price. As
per the content of fair value method, this concept is considered as any of the quality of
evaluating, convention of basic principles of accounting or the application of market valuation
concept on the basis of estimation without drawing conclusion related to market evaluation and
the objective of evaluation. (Tournier, 2000) As per other authors, fair value method is based on
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the price, which is suitable for goods with changed scenario of balanced transaction, or
empowered by any generic terminology to accomplish the objectivity of projecting the real price
of the assets or liabilities. This concept is endorsed by real accounting principle with the proper
evaluation method exercised and practiced by professional assessors. This concept is adopted by
the business entities to analyze the system to ensure clear conception and communication in
accounting practice. (Deaconu, 2009)
The evaluation methods endorsed by IASB are current cost method, historical cost method,
realizable valuation method and present valuation method without giving any preference to any
of them for accounting practice. As per the latest definition provided by IASB related to fair
value method as per IFRS 13 is such valuation method, which conforms the concept of "Fair
value is the price that would be received to sell an asset or to pay in order to transfer a liability
from a common transaction between the market participants at the date of the evaluation.'' (IFRS,
n.d)
Related studies and respective analysis highlighted the emergence of financial crises tending to
the claim that those crises were formed on the background of lack of accounting regulation and
proper supervision of financial markets, anticipated economic growth, the undisciplined
approach of the financial organizations and rating agencies to provide information related to the
risks and respective values of the financial instruments like assets or liabilities. It was found that
excessive confidence generated the enhanced level of price of transaction and consideration of
old economic laws as obsolete along with the creation of hyped scenario by some stakeholders to
ensure optimistic situations through speculation due to lack of strict enforcement of regulations,
with the treatment of respective evaluation and reporting for accomplishment of re-fixed
objectives.
The discussions about the feasibility of both historical cost method and fair value method have
their own advantages and disadvantages. The historical cost method endorses the concept of
verifiability and respective objectivity coming out from the endorsement of the accounting
instruments. This concept is the consequential outcome of the accounting concepts and principles
mainly prevalent in western accounting practice and is known as monetary treatment and
respective caution with the featured advantages of easy application method provided by the
scope of verification with predetermined objectivity. The scope of comparability is more
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available in the application of this method in the accounting practice of the business entities. The
historical value method of evaluation does not restrict the accounting professional as the same
contains the qualities of objectivity, with the consideration of old transactions being understood
by the stakeholders. The disadvantages of this valuation method are its old and obsolete image
based on earlier accounting principles as per the demand of the industrial entities and the
uniqueness of this method features the absence of identification and recognition in the
consolidated financial position of the entities so far derivatives and structures are concerned. As
per Deaconu A, (2009) the main merits of fair value method are its reliability with its
consideration of derivatives for evaluation process with more emphasis on accounting objectivity
and rationality. This practice is based on market information, which is not related to the entity to
prove its neutrality. This method has allowed provision to compare better with the valuation of
assets, especially about the financial instruments to get the real value as per market price.
The disadvantages of fair value method are depicted in the main criticism of this method. This
valuation method is based upon the conceptual perspective of its application. Fair value method
is based on estimation of subjective type considering the correlation of evaluating the
precautionary rule to recognize impairment of financial instruments to ensure proper and real
valuation of them. Thus, the derived value of financial instruments makes the financial
statements more authentic. There are critiques who have not emphasized on the principle of
evaluating financial instruments through fair value method with the stringent policies; instead
they insist on the flexibility of the application to arrive at the realistic value of the financial
instruments. (Palmrose, 2009)
As per Laux and Luez (2009) the concept of fair value method is endorsed by FASB through the
rule of FAS 157 issued in 2006. This rule frames the guideline of hierarchy of inputs to find out
the fair value of any financial instruments. The derivation of fair value measurement is
depending upon different factors like quoted price in present market active in existence for
identical financial instruments. The availability of that fair value should be considered for
derivation of market value of assets. (Lodh, 2018)
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Applicability of fair value method in private or public organizations
For private or public business entities, the valuation of financial instruments is required for
financial reporting purpose. As per critiques, fair value method needs more research to refine its
application in accounting practices, the application of this model can give realistic and neutral
effect of valuing the financial instruments for the stakeholders. (Laux & Leuz, 2009)
Let us consider a real life example of fair value measurement. The case study of fair value
measurement for Angle Seafood Holdings Ltd. With ASX code AS1 showed the impact of fair
value measurement as per AASB 13 following fair value hierarchy considering Level 2 inputs.
The biological assets valued as on 30.06.2018 as per level 2 inputs are $ 1,462,753 in
comparison of 2017 as $1,019,333. This enhancement is caused by adding total gains, addition or
purchase and deductions or sales of 2017-18 to the closing figure of 2016-17. (Holdings, 2018)
As per the argument of Whittington (2008), it is not possible for the accounting professional and
regulatory bodies to introduce any generalized format of evaluation model for financial
instruments, if the objective of such valuation is not identified. For example, in a volatile market
with prevalent inflation, financial instruments are tending to change their values very often. To
provide a realistic value of those instruments, the objectivity of valuation is to be identified, so
that the evaluation can be done in more realistic and logical way to provide better projection of
valuation of financial instrument for best possible satisfaction of the stakeholders. (Whittnigton,
2008)
Influence of Fair Value Method in crises
Fair value method projects market value of different financial instruments for financial reporting.
During any economic crises like inflation, fair value method plays vital role for evaluation of
different assets or liabilities including financial instruments.
Conclusion
The conventional system of historical cost method is getting obsolete due to its conservative
method. Fair value measurement projects realistic and justified values of different financial
instruments enabling the stakeholders for their justified decision making through financial
reporting of any entity. It is observed that fair value method gives the required level of realistic
and justified measurement for the assets or liabilities of the entity based on present market value.
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Due to some financial crises, this measurement method may differ from the projected value of
the accounting instruments, but the measurement can reach near to the expected result for the
stakeholders as per set objective.
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Bibliography
AASB, 2015. AASB Standard 13- Fair Value Measurement. [Online] Available at:
https://www.aasb.gov.au/admin/file/content105/c9/AASB13_08-15.pdf [Accessed 12 Seotember 2019].
Deaconu, A., 2009. Valoarea justă: concept contabil. Bucharest, Romania.
Holdings, A.S., 2018. Annual Report 2018. [Online] Available at: https://angelseafood.com.au/wp-
content/uploads/2018/10/Angel-Seafood_2018-Annual-Report.pdf [Accessed 12 September 2019].
IFRS, n.d. IFRS 13 Fair Value Measurement. [Online] Available at: https://www.ifrs.org/issued-
standards/list-of-standards/ifrs-13-fair-value-measurement/ [Accessed 12 September 2019].
Laux, C. & Leuz, C., 2009. The crisis of fair-value accounting: making sense of the recent debate.
Accounting, Organizations and Society, 34, pp.826-34.
Lodh, S.C., 2018. Conventional accounting in determining an enterprise’s wealth: Sign or referent a
theoretical discourse for augmentation. International Journal of Critical Accounting, 10(5), pp.341-62.
Palmrose, Z.V., 2009. Science, politics, and accounting: A view from the Potomac. The Accounting
Review, 84(2), pp.281-97.
Sebastian, E.G., Dănuì, C. & Maria, D.L., 2014. Relevance and credibility of the fair value measurement
during the crisis. Procedia Economics and Finance, 8, pp.306-12.
Tournier, J.-C., 2000. La Révolution Comptable - Du Coût Historique À La Juste Valeur. Paris: Éditions
d’Organisation.
Whittnigton, G., 2008. Fair Value and the IASB/FASB Conceptual Framework Project: An Alternative
View. Abacus, 44(2), pp.139-68.
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