Fair Value Accounting
Fair Value Accounting
In 1993, FASB (Financial Accounting Standards Board) introduced fair value accounting in an effort to make financial statements easier to compare, and balance sheets more reflective of assets and liabilities true values. In the last few years fair value accounting has caught the brute of the blame for the financial recession. Many argue that the regulations of fair value and mark-to-market accounting have led to the decline of asset values, the start of the “Great Recession,” and a feared global recession. Others believe fair value offers essential information concerning the market-value of assets and provides useful information to investors concerning the financial status of institutions. To prevent increasing market declines and bank failures the IASB (International Accounting Standards Board) and FASB have been working together to refine common fair value standards.
Fair value accounting was established under US GAAP to establish the value at which an asset may be bought or sold in a transaction other than a liquidation sale, and is based on mark-to-market valuation. Mark-to-market values an asset or liability based on the current market price of the asset and “provides vital transparency into companies’ financial health” (money.cnn). If markets functioned with normal liquidity determining the value of assets would be simple, the market values would remain consistent (PWC). Although, the U.S. economy is currently in one of the worst recessions it has seen since the “Great Depression,” and has not functioned with a normal liquidity rate since 2007.
The foundational ideas of fair value accounting divided financial assets into three categories known as “fair value hierarchy.” The categories included those held “to maturity,” those held “for trading purposes,” and those “available for sale.” FASB’s regulations for these categories allowed institutions to easily manipulate their earnings by transferring their assets between categories. Peter Wallison, a critic for AEI, points out how and why an institution would manipulate their assets to show an increase in earnings:
“A management that wanted to increase earnings during a reporting period could transfer appreciated assets from the available-for-sale category to the trading category, where the appreciation would add to the bottom line; in the same way, moving a depreciated asset from the trading category to the available-for-sale group would reduce reported losses.”
Companies manipulate their assets in order to their true financial health. The issue with manipulating assets is that in transferring assets, if the company does not have additional collateral to supply, they are forced to sell their assets at a liquidated price even though the cash flows of these assets have not necessarily depreciated. Companies that continue