...changes in asset and liability values over time. The International Accounting Standards Board (IASB) defines fair value as "... an amount at which an asset could be exchanged between knowledgeable and willing parties in an arms length transaction". Under the fair value measurement approach, assets and liabilities are re-measured periodically to reflect changes in their value, with the resulting change impacting either net income or other comprehensive income for the period. The result is a balance sheet that better reflects the current value of assets and liabilities. The cost is greater volatility in periodic reported performance caused by changes in fair value. The notion of fair value accounting is intuitive when applied to quoted investments such as equities, bonds, commodities, etc. that are carried in an entity’s balance sheet at their market value. This form of fair value accounting is often termed mark-to-market accounting. However, while market prices are one aspect of fair value measurement, the term is increasingly being used to describe measurement by other means. For example, accountants often arrive at an estimate of fair value for non-quoted investments based on a model (e.g., a share option valued by applying a specialist option valuation model) or specialist opinion. Such applications of fair value measurement are referred to as mark-to-model accounting. The IASB has followed US standard-setters in dealing with the problem of fair values that do not result from market...
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...defined the fair value of an asset as the price that would be received by the holder of that asset in an orderly transaction. On September 30, 2008, SEC and FASB issued a joint clarification which stressed that fair market value is not the price that would be received in distressed sale or forced liquidation. They also provide guidance that estimates of fair value can be made using the expected cash flow of such assets, provided the estimates has also reflects the adjustment of a willing buyer in the risk of default. This concept created transparency on the value of the assets which was easily confirmed by the auditors and users of the financial statements. However, during the recent economic crisis, this concept has created havoc on the balance sheets of some major financial companies. These financial companies were forced to write down assets in which the market has dried up and made it hard for them to value these financial assets. Since these financial assets were also used as a requirement for the liquidity ratio of some financial institutions, the write down of these financial assets caused the ratio to fall and trigger some margin calls. Many financial institutions decided to horde cash in order to preserve their ratio which caused the credit market to dry up. Most bankers argued the requirement of fair value accounting unfairly punished financial companies and caused their ratio to fall. Thus, they were lobbying the governments to ease up on fair value accounting...
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...prospective criticism of Fair Value Measurement 1. Analysis of nature of Fair Value Measurement The implement basis of SFAS157 is in an efficient market. Its hierarchy of fair value measurement confirms the priority of market price for the same or similar position. But under the credit crisis, entity will expect to reverse the unrealized losses partially at present or totally in the future. Based on this assumption, some entities preferred to report amortized costs or level 3 mark-to-model fair values, arguing that level 2 mark-to–market fair values will raise larger unrealized losses. [8] In an illiquidity market, the impairment of assets caused potential risk of system and overreaction of investors. The substantial decreasing values enter into the unrealized losses, which further force investors sell their assets for financing in order to mask financial statements or to accord with the investment policy. The consequence is that counterparties are unwilling to transact with those whose assets are continually impaired. In this situation, investment having high leverage will undertake the crisis of liquidity. The bankruptcy of these investment banks may cause the liquidation of hedge fund or other issuing bond, as well as the investment loss of their counterparties. When crisis extends, so called fair value is no longer “fair”. [9] In the prosperous economic market, the carry out of fair value measurement follows the bubble price, relative to the basic value of assets and liability...
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...FAIR VALUE MEASUREMENT: IMPLEMENTATION ISSUES AND CHALLENGES (PART 1) (by Tuam Kwok Choon and Ng Kean Kok) INTRODUCTION Since the promulgation of fair value accounting by the International Accounting Standards Board (IASB), the subject matter has been hotly debated by industry players and professionals of the accounting fraternity the world over. Many problems and pitfalls have been highlighted on the "mark-to-market" premise. For example, David Gwilliam and Richard H.G. Jackson (2008) noted that Enron "was able to 'monetize' physical assets so as to bring them within the remit of mark to market accounting", suggesting misuse of fair value measurement. Fair value is said to be superior to other forms of measurement because it is easily understood by investors and stakeholders. It is also timely, neutral, representationally faithful, reliable, relevant, comparable and consistent. Fair value reporting is deemed to be more transparent and investor-confident. However equally important is that fair value measurement is subject to constraints such as human judgment, the location and condition of the asset/liability being measured, the determination of market, the most advantageous market value as against the entity's perspective, transaction price presumption (exit price verses entry price in different markets), the bid-ask spread of financial instsruments, and transportation cost exclusion, to name a few. Brief definition of fair value: Defined as, “The price that would be received...
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...The concept of Fair Value Fair value is defined as “the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction”. Prior to the introduction of Fair Value Accounting (FVA), accounting was carried out on a historical cost basis. However there were many limitations of Historical Cost accounting (HCA). HCA assumes money holds a constant purchasing power. It ignores specific price-level change, general price-level change and fluctuations in exchange rates. During inflationary periods, HCA can become irrelevant and can lead to an erosion of operating capacity. IASB framework states “the objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. It also states “financial statements also show the results of stewardship of management, or accountability of management for the resources entrusted to it”. FVA is superior to historical cost accounting for these purposes. FVA is dominant in numerous IFRS’s and IAS’s. The IASB have yet to finalise an IFRS on fair value measurement, but it is expected it will have been completed by early 2011. Furthermore, the IASB is developing extra educational material to accompany the publication of the IFRS on fair value measurement. This material will give a description on the thought process for the measurement of assets, liabilities...
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...Fair value accounting is a financial reporting approach in which companies are required or permitted to measure and report on an ongoing basis certain assets and liabilities (generally financial instruments) at estimates of the prices they would receive if they were to sell the assets or would pay if they were to be relieved of the liabilities. Under fair value accounting, companies report losses when the fair values of their assets decrease or liabilities increase. Those losses reduce companies’ reported equity and may also reduce companies’ reported net income In response to the credit crunch, some parties (generally financial institutions) have criticized fair value accounting, including FAS 157’s measurement guidance. Those criticisms have included: • Reported losses are misleading because they are temporary and will reverse as markets return to normal • Fair values are difficult to estimate and thus are unreliable • Reported losses have adversely affected market prices yielding further losses and increasing the overall risk of the financial system. During the ongoing credit crunch,1 the markets for subprime and some other asset and liability positions have been severely illiquid and disorderly in other respects. This has led various (possibly self-interested) parties to raise three main potential criticisms of fair value accounting. First, unrealized losses recognized under fair value accounting may reverse over time. Second, market...
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...In the article “Why “Fair Value” Is The Rule”, the author Karthik Ramanna, has many valid points as to why fair value should be used in the accounting system. She states that fair value takes over for the old, worn out system of keeping books at historical value. She talks about how using fair value makes account more reliable. Also, it was believed fair value accounting was part of the reason the stock market crashed in 1929. Another point that Karthik had was why people actually support fair value. Fair value replaced the old, worn out system of keep books at historical value. With historical value, you never really need to record anything if the price becomes cheaper. It is a way for your assets to look larger than they actually are. If you record an item at fair value, you are normally reducing that value, so you are also reducing your assets. Sometimes you must actually increase the value because you paid less for the item than it is now worth. Fair value also helps with an insurance policy. If you have something that is stolen, and you do not get a settlement from your insurance company, you record the loss at the adjusted fair value. Fair value is a more reliable form of accounting, at least according to some people. It is believed that if someone is using the real cost on the books, it’ll mean that they are more accurately reporting what they have. Others believe that historic costing is more reliable because you are accurately showing what the product WAS worth. I...
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...economy. Speculation was rife that accounting standards, in particular, fair value accounting was the prime reason for this significant meltdown. “This sparked a fierce debate with some experts believing that fair value accounting was primary cause of the crisis whilst others considered that it exacerbated it. On the other side of the debate were those commentators that believed that fair value accounting was successful in acting as an early warning system and effectively prevented more calamitous consequences.” (Pabuccu, 2011) In response to this speculation, the International Accounting Standards Board (IASB) and the Australian Accounting Standards Board (AASB) immediately took action to review this matter and implement the necessary changes to address the uncertainty surrounding Fair Value accounting. Body Due to the economic significance of the crisis, financial commentators around the world analysed the situation, made comment, pointed the finger; and laid blame for this event. Due to the speculation, a ferocious debate commenced, with many of them believing that fair-value accounting was the primary cause of this event. Bubbles and Busts have occurred throughout history and are closely linked to the periods preceding a financial crisis. According to McMahon (2011), “fair-value accounting amplifies business cycles and seems to significantly contribute to bubbles and busts.” In her opinion fair-value accounting is largely to blame for the global financial crisis due...
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...| BENEFITS AND CHALLENGES OF FAIR VALUE ACCOUNTING | ACCT 525-22936 Current Issues in Accounting | Professor Kabani | Robert Larison | 10/20/2013 | In this paper I look at the benefits and challenges that are likely to follow the migration into the use of Fair Value Accounting. Perhaps, there is no issue today that carries with it as much controversy as does “FVA”. | BENEFITS AND CHALLENGES OF FAIR VALUE ACCOUNTING INTRODUCTION I do not think any topic in accounting has gathered as much interest as has the subject of “Fair Value Accounting” “FVA”. Heightened by the financial crisis of recent years “FVA” has received enormous attention by both academia and the business community alike. Rarely do “conspiracy theorists” make their way into the humdrum subject matter of accounting, but when it comes to the issue of “FVA” accounting, almost anything and everything has been postulated. The most widely held belief is that the move to “FVA” is to blame for the financial crisis of 2007. (Sorkin, 2008.) I have evaluated “FVA” and the transition from “historical value accounting “HVA”. In particular, I have researched the evolution within the Financial Accounting Standards Board (FASB) as it pertains to “FVA”. I have also reviewed the move toward the establishment of one set of standards for worldwide accounting as evidenced by the “convergence” project. With that in mind, we only need to look to the International Accounting Standards Board and its IFRS to get a...
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...Questions for Fair value accounting case 1. What is fair value accounting, what are its advantages and disadvantages 2. How is it different from historical cost accounting 3. What are level 1, 2, 3 assets 4. Give a simple example of level 1, 2, 3 assets 5. Suggest 3 ways to improve reporting fair value assets. ------------------------------------------------- QUESTION 1: Fair value accounting is method of accounting the value of assets, liabilities and shareholders’ equity in rational and unbiased manner by taking into consideration several objective and subjective factors. The objective factors include but are not limited to acquisition/ production/ distribution costs, replacement costs, or costs of close substitutes, actual utility at a given level of development of social productive capability supply versus demand. Certain subjective factors include risk characteristics, cost of and return on capital, perceived utility, etc. Advantages of fair value accounting: 1. Timeliness: The valuation reflects the most up-to-date and market value as of reporting date. The impact of fair value measurements—whether positive or negative on a company—is the result of market forces. 2. Transparency: Investors benefit when companies disclose their views on the impact of market illiquidity in their financial reporting. Investors and other users have greater insight into management’s views as to ultimate settlement amounts. 3. Relevancy: the valuation...
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...Project Summary Background The objective of this project is to provide guidance to entities on how they should measure the fair value of assets and liabilities when required by other Standards. This project will not change when fair value measurement is required by IFRSs. Discussion at the September 2005 IASB Meeting At the September 2005 meeting, the IASB added the Fair Value Measurements topic to its agenda. The aim of the project is to provide guidance to entities on how they should measure the fair value of assets and liabilities when required by other Standards. This project will not change when fair value measurement is required by IFRSs. Discussion at the November 2005 IASB Meeting The staff conducted an education session on the FASB's working draft of a final Statement on Fair Value Measurements. In addition, the staff reviewed the scope of FASB's Fair Value Measurements project as it relates to IFRSs and the issues and questions to be addressed in preparing an IASB Exposure Draft and related Invitation to Comment. No decisions were made. At a previous meeting, the Board decided to issue the FASB's final Statement on Fair Value Measurements as an IASB Exposure Draft with an Invitation to Comment. The appendices in the FASB document dealing with consequential amendments and references to US GAAP pronouncements will be replaced with proposed consequential amendments and references to IFRSs. The Board further decided that there should be limited changes to the FASB's...
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...the amounts paid/ received at acquisition Problem: +) inflation, +) increase in asset values are not reflected in financial statements (wearing out of assets, increase in market value) Advantage: +) objective method: documentary evidence to prove the purchase price of an asset, or amounts paid as expense. +) costs can easily be verified. * Alternative method of accounting that have been developed to address the problem: Measurement of the elements of financial statements: measurement options rather than historical cost include: +) replacement cost/ current value: means the amount need to replace an item with an identical item. Ex: XY Co purchased a machine five years ago for $15 000. It is now worn out and needs replacing. An identical machine can be purchased for $20 000. Historical cost is $15 000 Replacement cost is $20 000 +) net realisable value: is the expected price less any costs still to be incurred in getting the item ready for sale and then selling it. Ex: XY Co's machine from the example above can be restored to working order at a cost of $5 000. It can then be sold for $10 000. What is its net realisable value? Net realisable value = $10 000 – $5 000 = $5 000 +) deprival value: is the loss which a business entity would suffer if it were deprived of the use of the asset. Value to the business, or deprival value, can be any of the following values: (a) Replacement cost: in the case of non-current assets, it is assumed that the replacement...
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...Case analysis: Classification of instruments in fair value hierarchy Instrumental 1 In the case, there was a significant decrease in the volume and activity for the instrument because of (1) significant widening of the bid-ask spreads in the markets and the widening continued throughout Q4 2012 (2) a significant decrease in the volume of trades comparing with historical level in Q4 (3) no recent transactions. According to 820-10-35-54-c, it was reasonable to determine that market is not active. Because the adjustments were based on management’s assumption, FFC didn’t used level 1 inputs in the income approach valuation technique (present value technique). In addition, significant adjustment inputs includes credit adjustment (level 3 inputs) and liquidity risk adjustment (level 3 inputs), and implied rate of return (level 2 inputs) under ASC 820-10-35-48/52. According to ASC 820-10-35-37A, when the inputs are categorized within different levels of the hierarchy, the entire instrument should be in the same level of hierarchy as the lowest level inputs that is significant to the entire measurement. So, CDO should be categorized within level 3 of the fair value hierarchy. Instrument 2 There was no significant decrease in the volume and activity for the MBS, because no significant factors occurred. Therefore, the market should be still active, even the market became increasingly volatile with some declined activity in the Q4 2012. In my opinion, FFC should still use market approach...
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...3. Trade off between fair value accounting and historical cost accounting a) Relevance: Financial information is relevant when it influences the economic decisions of users, Fair value reporting is more relevant as it will allow users of financial statements to obtain a truer and fairer view of the company's real financial situation since it reflects the prevailing economic conditions and the changes in them. In contrast, historical cost accounting shows the conditions that existed when the transaction took place and any possible changes in the price do not appear until the asset is realized. b) Reliability: This relates to the degree of assurance capable of being obtained through verification that information faithfully represents what it purports to represent. Historical cost is considered more reliable as fair value requires estimations. FASB has expand the disclosures and framework for all companies to enhance the reliability of fair value accounting. However the drawbacks of the FV accounting is still holds as many of the valuations incorporates many subjective input data and assumptions. c) Decision usefulness: In general, financial information is considered to be useful if it enhances one's ability to make investment and credit decisions. (i) For investors: Investors will need to broaden their knowledge of fair value measurement methodologies to effectively analyze a company's financial statements and make a sound comparison. Given that institutions may use different...
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...June 2010, Vol.6, No.6 (Serial No.61) Journal of Modern Accounting and Auditing, ISSN 1548-6583, USA Fair value accounting under financial crisis HE Cai-xia1, ZHANG Chi2 (1. School of Accounting, Zhongnan University of Economics and Law, Wuhan 430073, China; 2. School of Management, Huazhong University of Science and Technology, Wuhan 430073, China) Abstract: The recent financial crisis has led to a vigorous debate about the pros and cons of fair-value accounting (FVA). This debate presents a major challenge for FVA going forward and standard setters’ push to extend FVA into other areas. In this article, we highlight three important issues as an attempt to make sense of the debate. First, much of the controversy results from confusion about what is new and different about FVA. Second, while there are legitimate concerns about marking to market (or pure FVA) in times of financial crisis, it is less clear that these problems apply to FVA as stipulated by the accounting standards, be it IFRS or U.S. GAAP. Third, historical cost accounting (HCA) is unlikely to be the remedy. There are a number of concerns about HCA as well and these problems could be larger than those with FVA. Key words: fair value accounting; historical cost accounting; financial crisis 1. Introduction The recent financial crisis has turned the spotlight on fair-value accounting (FVA) and led to a major policy debate involving among others the U.S. Congress, the European Commission as well banking...
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