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I need to support the view of the auditor pushing for an etensive use of market values (fair value) when recognition of assets and liabilities of the company. Essay Example

Valuation holds a key in the success of business as using the correct methods and principles help to improve transparency and builds consumer confidence. The International Accounting Standard Board (IASB) and Financial Accounting Standard Board worked in tandem to develop and bring changes in the accounting principles and policies so that the presentation of financial statements becomes more consistent and recognized internationally. One such area where they have worked is replacing historical cost with fair value.

According to GAAP fair value of an asset is the amount both the parties are willing to pay for an asset; and liabilities is the amount at which the liability can be settled. Here, it is important to note that fair value might not be the market value as fair value explains the benefit a particular resource will give in the future (Tournier J. 2000, pg 2). Even FASB considers the fair value as “exit value” i.e. “the amount for which an asset or liability can be settled” (Villmann R. 2006).

The growing importance of fair value accounting and using it for business purpose arises due to several reasons. Since, fair value involves a “logical pattern which reflects globalisation and international economic integration” (Barlev & Haddad, 2003) the results and decision taken on the basis of this are better and correct. Even investors prefer fair value as the results reflect the actual scenario prevalent in the organisation. Some of the reasons why the concept of fair value is gaining ground are

  • It is helpful to the investors and lenders as they know the actual position of the company. Since, it’s the financial statement which speaks about a company’s financial health so representing the true picture will help investors to decide their future course of action. (Penman S, 2006)

  • As financial statements reflect the future of the company and past transactions are of less relevance it is important that they present the true picture. (Barth M, 2006)

  • In case of inventories we see that the value of inventories is done at market price which is closer to the fair value than the historical concept. This gives a better picture as the actual value helps to make decision making process better.

  • It helps in better comparison of performance among firms as it includes the price changes and brings every organisation to a similar platform.

Fair value accounting will also be helpful in case of financial crisis. This concept will improve the liquidity with banks by creating more volatility. Since, this measure will reflect the actual position of the company so it will help to avert the crisis which are very prominent in today’s world and would also help to deal with the crisis as people know the actual position. (Boyer R, 2009)

Some ways in which the fair value can be estimated are (Villmann R. 2006, pg 2)

  • Using the actual market price by making necessary adjustments which are market based

  • Using some models like “option pricing model” to estimate the real worth

  • When the fair value cannot be estimate then calculating the worth by finding out how much would it cost to replace the object

  • The value which is found after both the party willingly agree to a particular transaction

  • Some studies have also said that fair value can be estimated by “cost, income and market comparison”. They say that “cost means the replacement cost, income is continuous utilization and market means actual market value” (Deaconu, 2004)

One important development in the field of fair value is the development of “hierarchy”. This “increases consistency and comparability in fair value and better disclosure of information”. (FAS-157) This had led to many companies favouring the concept of fair value and more measures are being devised to make it more prominent.

Fair value accounting is slowly gaining legitimacy as accounting policies are getting more standardised. Some countries like Australia have already recognised the importance of fair value and have been using it. Even the Federal Reserve supports the fair value accounting concept as it improves transparency. They support it as this would involve more disclosure so verifying the true value will be easier and investors will get a very good idea about the way the company is performing. Still, the application of fair value in the field of accounting has not gained prominence and more analysis need to be done to device better tools is devised to calculate the value which is free from biasness.

References

Barlev, Y. & Haddad, T. (2003). Fair value accounting and the management of firm. Critical perspective on accounting, Australia Taxation Board, Australia

Barth, M. (2006). Including Estimates of the Future in today’s Financial Statements. Accounting Horizons, 2 (3), 271-285

Boyer, R. (2009). Assessing the impact of fair value upon financial crisis. International Swaps & Derivatives Association, Australia

Financial Accounting Standard-157. (2010). Retrieved on April 11, 2011 from http://www.gasb.org/pdf/aop_FAS157.pdf

Penman, S. (2006). Financial reporting quality: is fair value a plus or a minus? The CPA Journal

Tournier, J. (2000). La revolution compatible. Accounting Values & Reporting, Chapter 18, Paris

Villmann, R. (2006). Fair Value, Historical Cost, Replacement Cost how should asset and liabilities be measured on Initial recoginition? Accounting Standard Board, Canada