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).
I chose 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 didn't 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 costs
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 isn’t
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%20Standards%20Board%20(FASB)%20is%20an
%20independent%20nonprofit,accepted%20accounting%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/
