The fair value accounting is considered as one of the financial reporting technique which is also referred to as the mark to market accounting practice and this is under the generally accepted accounting principles. The assets and liabilities are reported by different companies based on the actual fair market prices according to the fair value accounting approach. The use of fair value accounting technique often results in the generation of unrealized losses or gain for liabilities and assets outstanding, increase or decrease in net income. There are certain advantages and disadvantages associated with the fair value accounting and theses are as indicated below in the paper.
Displays True Income of Company
The ability of any particular company to manipulate its net income reported in the financial reports can be limited by the fair value accounting.A key example occurs when a particular firm intends to use the gains or losses obtained from the sale of a particular asset to raise or lower the net income in the financial report as they desire (Sellhorn & Stier, 2018). However, with the use of the fair value accounting, the losses and gains will only be reported in the particular period in which they occur and hence there will be no manipulation of the net income in the financial report.
It Provides Accurate Valuation
According to Lilien, Sarath & Yan (2018), the other key advantage of the fair value accounting is based on its role of offering certain accurate valuation. Such a valuation is on the liability and assets which is often a requirement by the users of financial information of any particular company. For example, the price of an asset or liability may increase in the future, during which a particular company will typically mark up the value to the current market price with the aim of providing a true reflection of the price it would be sold to avoid any particular liability. The same scenario also happens when the market price of a particular asset is expected to decrease and therefore the value will be marked down to reflect the amount it will be sold at in the market.
One key disadvantage of the fair value accounting is in relation to its effect on the market such that it may affect the market negatively. A key example is seen when there is a revalue downwards of the asset resulting in a decrease in the existing market trading prices (Trajkovska, Temjanovski & Koleva, 2016). When the value of an asset is decreased, there will be an increase in sales volume by a company at very low prices and this is often the negative effect on the market of the fair value accounting.
There are often times in which the market conditions in which the trade of both liabilities and assets occurs may change over time and this could be volatile at times. Such a fluctuation typically poses certain challenges to both the users of financial information and the company itself (Marra, 2016). When the fair value accounting is applied by a particular company by reevaluating the existing value of assets and liabilities in such a volatile market condition, there will be large swings in regards to the value of such assets and liabilities. However, after the stabilization of the markets, the value of assets and liabilities will become normal and this, therefore, implies that the fair value accounting often offers certain misleading information.
According to Baker (2016), the market-based measures are made up of three major elements often referred to as the three tiers. Such components include the business, corporate and functional. The top level of the three market tier is the corporate which typically entails the top management of the particular company such as administrative officers, the board of directors and the chief executive staff.
The major functions of such individuals in any particular organization include overseeing the financial performance of the company and also the financial goals of the particular organization in both the short and long term (Goh, Li, Ng & Yong, 2015). The other element of the three-tier is the business level which is mostly the corporate and business managers. The key role of such individuals in relation to market measures entails the determination of how the particular company will become competitive in the market using the same product market (Datta, Ailawadi & van Heerde, 2017). Also, the corporate and business manager could be responsible for setting the goals and plans for every particular division of an organization and this includes the marketing department with the aim of determining the fair market prices to sell the products of the particular company.
The third component of the three-tier is the functional level and it includes the functional, geographic and product sections.Some of the fundamental roles of this particular component are that it develops both the short term and annual marketing objectives of the particular company such as research and development (Strauss & Frost, 2016). Generally, the primary role of the component relates to the implementation of the marketing strategies of a particular company.
There are a variety of qualitative characteristics of financial information considered when using the fair value accounting by a variety of organizations. Such features are as indicated in the paper below;
Understandability is a feature of the financial information which entails a process of classification, categorizing, characterization and then later providing a clear and concise financial information to the users. The above mentioned future enables the different users of the financial information of a particular organization to have the ability to understand the meaning of the various financial information (Chou, Chang, Chin & Chiang, 2018). The feature understandability of financial information also implies that the financial information provided by the particular organization should be clear, concise and transparent in relation to the measurement of value using the fair value accounting.
Timeliness involves availing financial information to different decision makers and users and this is often done prior to it losing its ability to influence the decisions to be made by various users (Cavalcante, Brasileiro, Souza, Nobrega & Oliveira, 2016). Generally, the qualitative feature of timeliness entails usefulness of financial reports used for decision making by different users. It could also involve the particular time it would take to disclose the financial information in the annual reports.
According to Cavalcante et al., (2016), an information is considered as relevant when it is availed to the particular users prior to it losing its capacity to influence the decisions made by the different financial information users. The relevance of information has often been used in improving the innovations and capabilities of decision making and this is considered during the application of the fair value accounting.
According to Henry & Leone (2015), comparability is also another qualitative feature of financial information taken into account by the fair value accounting. It typically implies that a particular information has the ability to explain and even acknowledge the differences and similarities of a particular set of transactions of economic phenomena. Based on the fair value accounting, the qualitative feature of comparability is obtained through achieving an information of the company which is consistent. Such a consistent information could be attained by a particular organization through the use of similar accounting procedures and policies and this could be either on an entity or period basis.
Faithful representation is one of the most essential qualitative features of financial information when using the fair value accounting. The above mentioned qualitative characteristic implies that the particular information contained in the financial reports should be faithfully represented by the concerned individuals in the particular company (Zare, 2015). The faithful representation of the financial information could be attained by ensuring that all that information displayed is accurate, complete, free from bias and error and it has to be neutral. There are typically certain elements used in measuring faithful representation by the fair value accounting and this entails, the neutrality, freedom from material error, verifiability, relevance, and completeness.
The fair value accounting is mostly applicable to the element of assets and liabilities mostly of the financial statements. The key aspects relate to the valuation of the market prices of both the assets and liabilities of a particular company.
References
Baker, M. J. (2016). What is marketing?. In The Marketing Book (pp. 25-42). Routledge.
Cavalcante, R. C., Brasileiro, R. C., Souza, V. L., Nobrega, J. P., & Oliveira, A. L. (2016). Computational intelligence and financial markets: A survey and future directions. Expert Systems with Applications, 55, 194-211.
Chou, C. C., Chang, C. J., Chin, C. L., & Chiang, W. T. (2018). Measuring the Consistency of Quantitative and Qualitative Information in Financial Reports: A Design Science Approach. Journal of Emerging Technologies in Accounting, 100-120
Datta, H., Ailawadi, K. L., & van Heerde, H. J. (2017). How well does consumer-based brand equity align with sales-based brand equity and marketing-mix response?. Journal of Marketing, 81(3), 1-20.
Goh, B. W., Li, D., Ng, J., & Yong, 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, 34(2), 129-145.
Henry, E., & Leone, A. J. (2015). Measuring qualitative information in capital markets research: Comparison of alternative methodologies to measure disclosure tone. The Accounting Review, 91(1), 153-178.
Lilien, S. B., Sarath, B., & Yan, Y. (2018). Fair Value Accounting, Earnings Management, and the Case of Bargain Purchase Gain.
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.
Sellhorn, T., & Stier, C. (2018). Fair value measurement for long-lived operating assets: Research evidence. European Accounting Review, 1-31.
Strauss, J., & Frost, R. D. (2016). E-marketing: Instructor’s Review Copy. Routledge.
Trajkovska, O. G., Temjanovski, R., & Koleva, B. (2016). FAIR VALUE ACCOUNTING-PROS AND CONS. Journal of Economics, 1(2).
Zare, I. (2015). Study of Effect of Accounting Information Systems and Software’s on Qualitative Features of Accounting Information.
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