While researching articles to use, how controversial fair value accounting has been in prior
years to current.
The article I chose to use for this week's discussion can be found here:
https://accounting.uworld.com/blog/cpa-review/fair-value-under-fire/. "Fair-value is a
method of accounting for assets, based on the value of that asset in its current market. This
takes the place of the previously used method known as historic value accounting, which
based the value of an asset on the price it was originally purchased at." The fair value method
just doesn't seem "fair", especially if there is no market to value certain items to. d d
When the 2007-2008 financial crisis hit, lenders were loaning money to people for houses
they could not afford based on their income. The housing prices were inflated as well. When
it all came crashing down, banks and other lending institutions were left with foreclosures on
houses that were nowhere near the value of the loan they issued, and many people who kept
their houses were left owing more on their mortgage than their house was worth. This made
investors lose confidence and pull their assets out of the market. "Firms were forced to
liquidate these Level 3’s at a time when there was simply no model to reflect fair market
value. The lack of confidence reached near panic levels as banks and financial institutions
stopped lending funds to one another, after sustaining staggering losses due to the
plummeting value of what many once thought of as a sure thing." Because of the investors
pulling their assets from the market, many people lost a lot of money in various investments
and the stock market as well. It has taken quite a while to dig out of that hole, and now we are
seeing inflated prices again on used cars, houses, and gas prices. All things that will take a
serious hit when the market stabilizes again.
I agree with the author's assessment of fair value accounting. The general public should not be
left holding the bag when big corporations make investing mistakes. The corporations need to
be held accountable and learn from their mistakes, without bailouts from the government,
who in turn, taxes the people who lost money because of the corporations' failure in the first
place. Cost accounting makes more sense to me, it brings accuracy and stability to the table.
Sure, an item may be worth once it's been fully depreciated, but at least it's been done
properly without the inaccuracies of fair value accounting where there may or may not be
stability in the current market.
In 2008, we were at the height of the financial crisis. William Issac, former chair of the FDIC,
blamed the crisis on the accounting rules that the federal government enforced. At the time, a
lot of bankers and investors agreed with Mr. Issac. The accounting rules that were being
blamed were the "fair value" accounting that was led by the Governmental Accounting
Standards Board (GASB). Although the accountants for bankers and investors hated the fair
value accounting, they were being made a big part of how local and state governments
"manage their pensions, investments, and health care" (Marlowe, 201 5).
According to the author, fair value is seen as fair by some and unfair by others, based on what
side you are on. During the crisis, the financial industry pushed the Securities and Exchange
Commission to do better at reporting fair market values. They argued that this would lead to a
better reflection of "normal market conditions" (Marlowe, 201 5). At the same time, GASB
opened its fair value framework, even though most of its stakeholders disagreed with the
definition of fair value.
I agree with the author that there are always two sides to a coin, and depending on your side
will greatly influence how you feel about fair value accounting. I prefer cost accounting over
fair value accounting. I think that is because I am more comfortable with the rules associated
with cost accounting. If I was in a different role or a different company and needed to know
the fair value of an asset over time, I am sure that would be my preferred accounting method.
For this week’s discussion, I found an article titled “Charles Lee: Why Fair-Value Accounting
Isn’t Fair” by the author Edmund L. Andrews.
The article goes into detail on how Professor Charles Lee, an accounting professor at Stanford
Graduate School of Business, believes that fair value accounting does not align with the
“fundamental purpose of accounting.” Professor Charles Lee believes that accountants should
be acting as record keepers and story tellers based on historical transactions. He believes that
as accountants, we should be using actual values instead of predicting the value of assets. In
this article, it continues to detail how Professor Lee thinks that using fair value would cause
great uncertainty in financial reports and that shareholders should make their own predictions
on the company’s future value based on using the historical costs. d
I agree with Professor Lee’s stance in this article. He articulates that it is not the job of an
accountant to predict the future value of the company but to provide information based on
transactional history that will help shareholders forecast the company’s future. There can be
so much inconsistency when trying to predict a value or the future value of an asset. It can
open an avenue to providing even more inconsistent information. I believe cost accounting to
be more favorable to fair value and agree with this article on Professor Lee’s take. Cost
accounting provides a clear guideline on using historical data and as a financial statement
user, this helps prevent any uncertainty that the information I am reporting is correct. d
Justin Marlowe, a research professor at the University of Chicago’s Harris School of Public
Policy, stated in his article that fair value accounting is only fair in the eye of the beholder. He
stated fair value accounting is loved by government accountants but is scorned by bankers
and investors. Justin explains that there are typically two ways to determine something's
worth, it is either worth what you paid for it, or worth what someone else is willing to pay for
it. Government accountants manipulate the numbers and give false information by reporting
the average value of pension investments during a specific point in time, when the markets
are doing well, rather than over a period to show average market trends to reflect normal
market conditions.
I agree with Justin, it is not exactly fair if you are only reporting during specific time periods
because you know the numbers will reflect favourably. Investors should know the full story
of a business, the good the bad, and the ugly. They need to have the full picture painted over
the course of average market trends so they can make decisions.
Cost accounting is the better choice, there is benefit in real-time data that comes from fair
value accounting, however, fair values are built on assumptions and markets change daily so
it is not 100% accurate. Whereas cost accounting displays actual historical data that has
already occurred.
Fair value accounting is “the practice of measuring assets and liabilities at estimates of their
current value” (Ramanna, 2020). Historical costs values assets at the costs of their initial
purchase price. Fair value accounting was partially blamed for bad accounting methods that
contributed to the Wall Street crash in 1929 (Ramanna, 2020). In the period from 1930
through the 1970s fair value accounting “was virtually banned by the U.S. Securities and
Exchange Commission” (Ramanna, 2020). It is speculated that the reason fair value
accounting is gaining popularity is due the increase of members on the Fair Accounting
Standards Board (FASB) who have “a background in the financial services industry—defined
for our purposes as investment banking or investment management—are more likely to
propose the use of fair value methods” (Ramanna, 2020). FASB is responsible for setting the
standards that companies follow to adhere to GAAP rules (Kenton, 2021
The article Enron scandal: The fall of a wall street darling to learn how fair value accounting
contributed to the demise of Enron. Multiple accounting methods were used together to create
a false image of how Enron was doing, the first method employed was fair value accounting.
In 1992 Enron CEO Jeffrey Skilling received approval from the Securities and Exchange
Commission to move Enron from historical costs accounting to fair value accounting (Segal,
2022). This set the stage for Enron to do things like build a brand-new power plant and book
projected profits as real profits even though no money had been made yet. They also
combined fair value accounting with creating “off-balance-sheet special purpose vehicles
(SPVs), also known as special purposes entities (SPEs), to hide Enron’s mountains of debt
and toxic assets from investors and creditors” (Segal, 2022). These methods also were not
illegal but were used in ways that were later deemed illegal. Eventually all the lying and
manipulating of the books caught up with Enron and they filed for bankruptcy in December
2001 and were banned from the New York Stock Exchange the next month (Segal, 2022).
The author of the Enron article did not really take a stance on fair value accounting, they just
took stated facts. However, the Why fair value is the rule article I cite in the first paragraph
takes a more firm stance against fair value accounting and tries to expose how corrupt it is,
and I agree. I think fair value accounting is another thing that gives corporations more
opportunities to mislead the public as to what they do and how they operate. If everyone was
on the historical cost’s method, it would be a lot more difficult to falsely represent the books.
I also do not find it coincidental that investment bankers and investment managers would be
in Favor of this method, it makes it easier for their clients to think they are making money. I
think fair value accounting creates an unnecessary risk, one that is not outweighed by the
alleged benefits of showing values at the current market value. Real people are impacted
when businesses are run poorly, it is not just the CEO. When Enron went under many people
were blindsided when they lost their jobs and their pensions.
References
Kenton, W. (2021, May 19). Financial Accounting Standards Board (FASB). Investopedia.
Retrieved March 24, 2022, from
https://www.investopedia.com/terms/f/fasb.asp#:~:text=The%20Financial%20Accounting%2
0Standards%20Board%20(FASB)%20is%20an%20independent%20nonprofit,accepted%20a
ccounting%20principles%20(GAAP).
Ramanna, K. (2020, October 24). Why "fair value" is the rule. Harvard Business Review.
Retrieved March 23, 2022, from https://hbr.org/2013/03/why-fair-value-is-the-rule
Segal, T. (2022, February 8). Enron scandal: The fall of a wall street darling. Investopedia.
Retrieved March 24, 2022, from https://www.investopedia.com/updates/enron-scandal-
summary/
Marlowe, J. (2021, April 21). Is 'fair value' accounting actually fair? Governing. Retrieved
March 23, 2022, from https://www.governing.com/archive/gov-fair-value-accounting.html
Charles Lee: Why Fair-Value Accounting Isn’t Fair | Stanford Graduate School of Business
Marlowe, J. (201 5, December). Is 'fair value' accounting fair? Retrieved from
www.governing.com/columns/ public-money/gov-fair-value-accounting.html
