This research will consist of the study about the effects of the fair value accounting. A literature review is to be performed on the topic. This study will also have comprised about the pros and cons of the fair value accounting. The three-tier process in the fair value will be discussed. The qualitative characteristics of the financial information is also included. It is considered during the utilisation of FV method in the financial reporting. More emphasis is efforted on the fair value with the introduction of the IAS that is the International Accounting Standards.
It has been established that due the hazards that was experienced because of the historical cost, the implementation of the fair value accounting has been performed. In USA, in the year 1980, the Savings and the Loan crisis shifted the historical cost accounting towards fair value accounting which occasioned in major delayed write-offs (Marra, 2016). This went inadequate for the financial status of the companies as the status could not be identified properly. Thus, an outline was created for the development of the accounting standards by the IASC that is the International Accounting Standards Committee. This also guided in resolving the issues related to accounting. This frame work is termed as the Fair Value. The resources of the entity were to be valued by the fair value as well as it appears to be useful for the investors also. The fair value mentions the risks which is not to be specified by the historical cost. The fair value is used for the prevention of the future account related problems. As per the IASB the fair value is defined as an amount through which an exchange of an asset can be done, and liability is to be established among the knowledgeable willing parties in the length transaction of an arm (Zhang & Andrew, 2016). As per the FASB the fair value is defined as an exchange price among the market participants for selling the assets and for transferring the liability in the market which is the principal and most advantageous market.
The pros and cons of the fair value accounting is compared with the historical cost accounting. The riskiness of the business is visualised by the investors on the balance sheets beneath the fair value. The value of the of the company’s is dependent on the condition of the market. This value is majorly dependent on the assets’ value which is to be influenced by the condition of the market in the case of the production companies (Balanchandran et al., 2014). The compatibility of the financial statements is reduced among the companies by the visualisation of the companies’ unwillingness about the utilisation of the models as well as the assumptions which they used. The fair value has a pro-clinical effect which identifies that during the economic growth, the assets are to be overstated and at the time of recession the assets are to be understand. Thus, realized gains and losses are not led by the revaluations. Under the fair value accounting, the cash flow operations seem to be more important. Fair value accounting effects the amount which a bank can loan, which influences the bank.
Under the idealized conditions the fair value is regarded as the specific hypothetical market price by the IASB as well as the FASB (Jones, 2015). As per the result of the efficient market condition, the fair value is considered as the exit market price which is a transaction among the independent, knowledgeable as well as the economical rational parties which is interacted on the ground of complete information set. A three-tier hierarchy is used with the implementation of this concept. In the measure which is grounded on the market, the governing principle is the prevalence. Thus, the internal estimates appear to be more reliable as the data and the market prices imitates the personal information of the market participants (Macye, 2015). The best estimation of the fair value is performed by the market prices as the information is generally aggregated efficiently with these prices. Grounded on the active criterion of the market, the applicable quality of information is imitated in the prices of market. There is a requirement of daily trading of the objects on an appropriately liquid market for the estimation of the fair value. When sufficient quality is not exhibited by the market prices or unavailable, then in that case the next standard of estimation regards the modified market prices of the items that are comparable (Fulbier & Klein, 2015). In this scenario, the profile of the cash flow is referred generally with comparability. The mark-to-mark approach is failed as well as the fair value is mandated at the time when the prices are not utilised. The fair value is estimated with the utilisation of the internal estimates as well as the calculations. The SFAC that is the Statement of Financial Accounting Concept no.7, the SFAS that is the Statements of Financial Accounting Standards 157, as well as with the alteration of the IAS that is the International Accounting Standard 37 has developed the procedures as well as the principles for all these measurements (Durocher & Gendron, 2014). In the modern neo-classical finance theory, the economic view of measurement which appears as the lead for valuation is based. The fair value is the specific current value which appears as the exit current value below the idealized conditions. Thus, a three-tier process is trailed with the strict measures which are based on the market.
According to the IASB, there are four qualitative characteristics which creates the financial information more significant which are the comparability, understandability, reliability and relevance. Information should be accessible in a comprehensible way for the operators who have sensible information about the business as well as the economic actions and accounting. This also regards the individuals those are eager to learn the information meticulously (Sikka, 2017). The relevance characteristic defines that the information must chance the decision-making requirements of the operators. Relevant information effects the economic results of operators by serving them with the evaluation of the events of past, present and future as well as by settling or amending their past assessments. Timeliness also plays a significant role as the information is counted relevant when the users gains the information within a limited period. This affects the decision of the users.
If no material errors as well as bias, then the information is counted as reliable. The multiple characteristics comprising which the information is created are the faithful representation, neutrality, substance over form, prudence as well as completeness (Bracci et al., 2015). The transactions are faithfully represented in the information. The reflection of the economic transactions over the information is known as the substance over form which is not the legal form of the contract. The information should always be neutral according to the users’ decision as the users’ decision id influenced by the neutrality (Palea, 2015). Prudence is mentioning a caution degree that is work out in the judgments exercise with orientation to some indeterminate areas. Comparability is described as the financial statements are compared by the users who can do this for a company, over time, so that they can classify tendencies in the financial place as well as on the performance of the company.
The measurement of the fair value is relied on a specific asset as well as on the liability. Thus, during the measurement of the fair value, the features of the asset as well as the liability is granted in the account. On the measurement date, the market participants will count those features into the account during the pricing of the asset as well as the liability. These liabilities include the assets’ location as well as the condition and, on any restriction, which is performed during any sale or during the utilisation of the asset (Gong & Cortese, 2017). This asset or liabilities are to be of two types that is the stand-alone asset as well as liability and the group asset as well as group liability, also group liabilities and assets. The asset or the liability is swapped in an orderly transaction among the participants of the market for selling the asset or for the transfer of the liabilities. This is performed as per the condition of the present market on the date of the measurement (Hooper et al., 2017).
Conclusions:
The application of fair value has remained a trade-off among the relevance as well as the reliability. The segment of relevance was regarded more significant by the controllers because of the huge difficulties that was happened during the historical cost accounting for instance the crisis which happened in the Savings and Loan. The revelation of historical costs within the financial statements during the time when the values of the assets as well as the liabilities have got reduced to major write downs. Then the companies have misled the investors. These difficulties should have been evaded by fair value accounting, nevertheless this gave birth to diverse difficulties. Fair values are firm to control in some conditions and in a recession the instant gratitude of losses primes to an erroneously working valuing mechanism.
Reference:
Balachandran, K. R., Marra, A., & Rangan, S. (2014). Research Challenges in Accounting and Finance in a Globalized Economy: Fair value measurements, Valuation models, and Management practices. Journal of Accounting, Auditing & Finance, 29(1), 88-89.
Bracci, E., Humphrey, C., Moll, J., & Steccolini, I. (2015). Public sector accounting, accountability and austerity: more than balancing the books?. Accounting, Auditing & Accountability Journal, 28(6), 878-908.
Durocher, S., & Gendron, Y. (2014). Epistemic commitment and cognitive disunity toward fair-value accounting. Accounting and Business Research, 44(6), 630-655.
Fülbier, R. U., & Klein, M. (2015). Balancing past and present: The impact of accounting internationalisation on German accounting regulations. Accounting History, 20(3), 342-374.
Gong, X., & Cortese, C. (2017, September). A socialist market economy with Chinese characteristics: The accounting annual report of China mobile. In Accounting Forum (Vol. 41, No. 3, pp. 206-220). Elsevier.
Hopper, T., Lassou, P., & Soobaroyen, T. (2017). Globalisation, accounting and developing countries. Critical Perspectives on Accounting, 43, 125-148.
Jones, S. (2015). Development of financial accounting theory. In The Routledge Companion to Financial Accounting Theory(pp. 21-31). Routledge.
Macve, R. H. (2015). Fair value vs conservatism? Aspects of the history of accounting, auditing, business and finance from ancient Mesopotamia to modern China. The British Accounting Review, 47(2), 124-141.
Marra, A. (2016), The Pros and Cons of Fair Value Accounting in a Globalized Economy: A Never Ending Debate. Vol 31 No. 4, pp 582 – 591, Database: Business Source Ultimate
Palea, V. (2015). The political economy of fair value reporting and the governance of the standards-setting process: Critical issues and pitfalls from a continental European Union perspective. Critical Perspectives on Accounting, 29, 1-15.
Sikka, P. (2017, December). Accounting and taxation: Conjoined twins or separate siblings?. In Accounting forum(Vol. 41, No. 4, pp. 390-405). Elsevier.
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