Regarding fair value accounting, a company should consider under which tier the pricing of
most of their assets would fall. If the assets are mostly level 1 then, "Level 1 inputs are quoted
prices in active markets for identical assets or liabilities on the measurement date. A quoted
market price provides the most representationally faithful evidence of fair value and is to be
used whenever available." (Whalen et al., 2017 p.4-3c) If a company's assets would fall under
level 3 where there are no comparable assets in active markets then it means the pricing
would be made by estimate. At level 3 pricing, it allows for an overstatement of values to
occur therefore the company should use historical cost-based accounting for accuracy and
aversion to risk.
What is most valuable to management, lenders, and investors are the financial reports and the
statements. They provide the actual numbers of a company for the analysis of anyone
interested and for whatever decisions they may need to make. The report is also valuable
because it summarizes information about the business as well as information on liquidity,
turnovers, and changes between periods. The reports translate the numerical figures of the
statements without bias into facts leaving the interpretation of that information to the user.
The fair value accounting standard will always have its pros and cons depending on the
company (how big or how small) and the nature of the business. Also, how the market is
faired at that specific time. There are constant changes in the market especially right now with
all prices skyrocketing and once things stabilize, consumers who have purchased vehicles or
property will end up being upside down if we hit a financial crisis as bad as 2008.
A company should be able to change their books to account for changes in the market,
especially when your company is not producing like it was in the past. I agree there should be
a uniform method with exceptions to the rule depending on how the market is fairing at that
present time. Production might be great but assets such as building, and equipment might not
be fair value. For example, Housing prices 6 months ago were great because interests’ rates
were low, but now interest rates are going up and buyers are hesitant to purchase a house at
selling price with interest rates starting to increase, and the uncertainty of future fair values
are skewed.
One of the potential impacts of reporting fair value accounting would be that financial
statements can be compared on an international level instead of just in the United States. Fair
value accounting could help investors in making a decision about investing in a company
when they seem to be similar, but one is in the United States and the other is International it
would be a better apple to apple comparison. According to McCollum (2008) “this lack of
information increases estimation uncertainty and raises material misstatement risk” (pg 14). I
would have to agree with this statement because an estimated is not accurate and so many
things can affect an estimate and to me the financial statements are not correct. As
accountants we are supposed to be reporting what is true and accurate and how can you do
that when you are estimating what the cost is of an asset.
Things to consider when reporting fair value accounting would be the economy and looking
at the history of the asset how it has fluctuated in price over the years. I personally do not
think that fair value accounting is a good decision for any business when it comes to reporting
fixed assets. The reason is mainly because you as an accounting you are reporting what your
best educated guess would be on an asset, I would rather leave that up to the investors to
decide or upper management. Also, by the time I enter my best guess the economy could
crash and then I would feel bad because I reported false numbers. If a company does choose
to use fair value accounting, then I think there should be a separate Balance Sheet similar to a
proforma and financial notes explaining in detail how the fixed asset numbers are figured out
and the value was chosen.
Accurate and true financial statements along with detailed financial notes would be the most
valuable information to management, lenders and investors, without that they can not make
informed decisions. Managers for the most part know the day to day activities, but lenders
and investors do not know the day to day activities so having accurate financial statements
with notes helps everyone understand the health of a business. I always tell my clients to give
me all the information they can as they can never provide to much, I would rather make an
educated guess than an assumption because of missing information.
The potential impacts of fair value within the professional field are inflated numbers and false
future predictions. Fair value is trying to predict a business's success off current market value,
which is subject to change. Information that would be most valuable to management, lenders,
and investors should be accurate numbers. Being 100% honest with where a business is
financially could help resolve a lot of issues, instead of simply hiding them for short-term
gain. To understand a business's financial health, the best data to look at would be historical
data, data that is factual and can be researched fully.
According to the article, fair value has a huge impact on the professional field because the
lack of information increases estimation uncertainty. Market changes can significantly affect
all companies and the not so accurate representation of assets can affect a company
negatively. Taking into consideration is the type of company you have, will help to determine
if it will be affected by the fair value. You should also determine whether there would be
significant changes in the company’s assets and liabilities based on history, helping to
determine if the fluctuation will affect them negatively. Valuable information for
management, lenders, and investors includes what challenges they face in the future, asset
worth, and looking into previous financial statements noting any major changes or
fluctuations.
When we discussed fair value accounting in Module 4, I was very set against it and believed
it gave businesses the tools to manipulate their books like Enron did (Segal, 2022). After
reading Fair Value Under Fire it reminded me that the intention of fair value accounting was
to make businesses more transparent, but I still think it is problematic (McCollum, 2008).
According to McCollum, in September 2008 the American Banking Association President
Edward Yingling asked the Securities and Exchange Commission for fair value accounting
guidance to be suspended (2008). Since this occurred in 2008 this request was likely driven
by the housing market collapse and all the people who went upside-down on their home
loans, so the banks wanted to hide how poorly they were doing. The request was denied but I
think this shows how quick banks and corporations are to take measures to hide their
problems (McCollum, 2008). I understand that in this case fair value accounting was causing
the banks to be more transparent than they would have liked.
I understand that fair value accounting helps to show when an asset that could be sold is
valued much higher than the residual value, investors and management need to know this to
make educated decisions about how to manage their assets. I know that it is just as important
to know when the current value of an asset or investment is far less than what it was
purchased for. I personally think that businesses should maintain their historical value books
and then present their fair value figures separately. When you compare the two side by side it
provides the investors with the opportunity to ask educated questions about the financials. For
example, Enron had purchased a new facility and booked it at the value of everything being
up and running and profitable, which may have technically been okay using fair value, but I
think investors need to see in black and white the differences between the actual profitability
of the facility and the projected profitability (Segal, 2022).
I found it very interesting that human resources risks are typically not investigated on a
regular basis or disclosed with financials (McCollum, 2008). Items like regulatory
compliance are very important and help to prevent a lawsuit. Talent management and
succession planning are also very important as you never know when somebody might leave
a position suddenly (McCollum, 2008). It is very important to assess these human resources
items when considering the overall health of a business.
To define fair value, "fair value accounting is defined as the practice of calculating the value
of a company's assets and liabilities based on the current market value" (Cooper, 2021).
Fair value is great for some companies but in general, it is not an ideal method to calculate the
value of a company's assets and liabilities when the market is always changing. Since Covid-
19 hit, many companies have taken a HUGE hit to the value of their assets and liabilities. For
example, the housing market. Houses are being appraised WAY over what people originally
purchased their homes at with little to no improvements made. When the bank grants a loan to
someone for 30k over what the home sold for a year ago with no updates, eventually the
market will go back down and the home will lose value and the homeowners will be upside
down on their loans if they go to sell. This is happening with other industries as well right
now. Lumber is WAY more than it was two years ago.
"Political and business leaders in Europe and the United States say fair value, or market to
market, accounting has made matters worse by forcing banks and other businesses to assess
the value of assets at current market rates, which have plummeted in the past year"
(McCollum, 2008). When the market is not stable, people lose or gain value. It is not
sustainable or accurate of what the value of the asset or liability really is.
Information that would be most valuable to management, lenders, and investors is the most
accurate and up to date information about the assets or liabilities. What are they truly valued
at given what they were acquired for and what life is left in the asset or has been used up.
Fair value accounting is one of the topics in accounting that is highly subjective and can be
seen as a positive and negative concept by different people at the same time, and it can change
as the market and economy change. It is extremely important that financial information,
which is generally presented via financial statements, of an organization is done is a way that
is cohesive and comparable so that one can get the gist of the financial health and status of a
company. However, when the company is not able to utilize their own resources, as
determined to be appropriate, they must rely on banks and other entities to determine values
in the current economic atmosphere, which are obviously ever changing. Transparency is
essential when communicating with management, lenders, and investors and some argue that
fair value accounting hinders such (Fair Value Accounting, n.d.).
Fair value accounting has long been a controversial issue. Many believe that fair value
accounting has made matters worse by forcing banks and other businesses to assess the value
of assets at current market rates, which have plummeted in the past year. Fair value
accounting uses current market values as the basis for recognizing certain assets and
liabilities. Fair value is the estimated price at which an asset can be sold or a liability settled in
an orderly transaction to a third party under current market conditions (Bragg, n.d.).
Financial accounting is crucial for investors and lenders to assess the solvency of businesses.
Financial accounting also provides transparency and access to information concerning the
operations of a company (How Do Investors and Lenders Benefit from Financial Accounting?
2019). Financial accounting allows outside actors to observe the profitability and value of a
business. An investor can see which companies have consistently performed well, paid
dividends, and appear to have positive margins. A lender can review the financial accounts to
assess liquidity, cash flow, leverage, and overall solvency.
Fair value accounting has long been argued in the financial community whether it should be
used or not. Fair value accounting is essentially what price can be put on an asset based
around what the current economic market is like at that time. For example, a bank could buy a
home during a low costing housing market time. That bank could then hold onto that asset
and wait for the market to rise dramatically and then sell at an absolute high. Investors will
see these profits being made and not realize the bank made this transaction when prices were
set very low and make potentially bad investment decisions. The more traditional way is
known as cost accounting. This keeps prices more at historic rates and shows what price the
asset was bought at and what price it was sold for. This is a clearer view to an investor of what
these deals look like and helps them decide if it is smart to invest. It is speculated that
companies using fair value accounting were taking these large profits and using some of it as
bonuses to themselves or the company and is also linked to the economic crash in 2008. It is
very valuable to investors to see what price things were bought at and how successful a
company can really be while being transparent. All of this must be considered before deciding
to invest in a company.
https://hbr.org/2013/03/why-fair-value-is-the-rule
Bragg, S. (n.d.). Fair value accounting. Accounting Tools. Retrieved April 19, 2022, from
https://www.accountingtools.com/articles/fair-value-
accounting.html#:~:text=Fair%20value%20accounting%20uses%20current.
How do investors and lenders benefit from financial accounting? (2019). Investopedia.
https://www.investopedia.com/ask/answers/041015/how-do-investors-and-lenders-benefit-
financial-accounting.asp.
Bragg, S. (n.d.). Fair value accounting. Accounting Tools. Retrieved April 19, 2022, from
https://www.accountingtools.com/articles/fair-value-
accounting.html#:~:text=Fair%20value%20accounting%20uses%20current.
Cooper, K. (2021, October 5). What is fair value accounting? The Balance. Retrieved April
19, 2022, from https://www.thebalance.com/what-is-fair-value-accounting-5204601
McCollum, T. (2008). Fair Value Under Fire. Internal Auditor, 65(6), 13–14.
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/
Wahlen, James M., et al. Intermediate Accounting: Reporting and Analysis. Cengage
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