Advanced Financial Accounting
Essay Preview: Advanced Financial Accounting
Report this essay
“Measurements by using fair value accounting have played an instrumental role in the creation of global financial crisis. Therefore, we should abandon the use of fair value accounting as a measurement tool.”
ABSTRACT
This report is a debate on whether or not fair value accounting was responsible for the market crash or global financial crisis. The fair value accounting, popularly known as mark to market accounting is when assets and liabilities are recorded on the financial reports as per the value of them on the market at that particular stage with recording of any changes from the book value of the assets in the income statement as either profit or loss. Accounting critics provided lots of backed up evidences to prove that fair value if not caused the crisis has majorly helped to increase the rigorousness of the financial crisis that occurred in 2008. However, this report explains that the financial crisis could not have been avoided even if the companies used any other accounting method at that time (historical accounting).
This study emphasizes on the impact of the fair value accounting on the banks securities gain and losses. It compares the two most widely used accounting measures namely fair value (mark to market) and historical cost method of accounting.
The investment securities of the bank provide an opening to examine two methods of accounting namely historical cost and fair value accounting for assets and its related earning components.
Furthermore, two companies have been analysed and sufficient information on what method those companies use and how do they use it. The two companies this reports deals with are BHP Billion
INTRODUCTION
Fair value can be defined as ” the amount at which an asset can be exchanged between knowledgeable and willing parties in an arm length transaction.”(International Accounting Standard Board IASB).
This accounting method re-measures assets and liabilities to record the periodic change in their values. Thus current value of the assets and liabilities are reflected in the balance sheet.
Fair value or mark to market value was majorly criticized for the financial crisis but no sufficient evidence is found so as to prove fair value caused it or even increase the severity of the crisis. It was said that leverage was provided in excess in boom and then loads of write down was made available in busts as a result of fair value accounting which depleted bank capital and started the fall as assets were sold at “fire sale” prices. However, overvaluation of bank assets could have been a major component that increases the severity or harshness of the financial crisis.
Findings suggests that large losses were faced by banks and financial institutions that came across as a huge problem but no one is yet to prove that reporting the losses in fair value made it even worse.
Comparison of fair-value accounting with historical cost:
To better understand how using any other method would have prevented the global financial crisis, lets take historical cost into consideration.
Historical cost is the main alternative to fair value accounting. It is basically a method of keeping the value of any particular assets to its initial cost. These cost are sent to impairments and amortization but they have no impact on the increase in the valuation of the assets. The argument with the historical cost is if amortization or impairments still prevails and is compulsory to adjust the value of accounting assets according to the increase or decrease in the value of the same, it is no different to fair value accounting. Various types of assets effect in various accounts or various statements of finance with some particular type that has to be reported as either profit or loss in the income statement. This further matches the credential of historical accounting with fair value or mark to market value accounting.
With these facts and similarities of fair value accounting to historical accounting we can say that fair value though may have a little significance in the crisis was not one of the major reason of the so-called “downward spiral.”
Advantages of Fair-value Accounting
There are loads of advantages for fair value accounting. Some of the important advantages are as follows:
Clear and Transparent
Fair vales are more transparent and are clear. It requires very few assumptions as compared to historical cost. It gives general public clear view about the financial position of the company.
Accurate Valuation
The major advantage of fair value is that accurate valuation of assets and liability on an updated basis. Under fair value accounting the value of the asset or liability is marked up with the increase in the market value of the assets or liability. This means that the assets are recorded in the books of account for the value they would attract if they were to be sold or the liabilities for the value that needs to be paid to relieve itself from the liability.
True Income
Fair value helps in prevention of the manipulation