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4Fair Value Accounting

Fair Value Accounting Case Analysis

Table of Contents

  1. The Pros and Cons of Fair Value Accounting………………………………………………..3

  2. Cost & Revaluation Model…………………………………………………………………………..5

  3. Fair Value & Recent Financial Crisis…………………………………………………………….6


Part A: The Pros and Cons of Fair Value Accounting

The proponents of fair value have continued to provide a significant number of perceptions for the measurement model. First, they are of the opinion that fair value accounting assets as well as liabilities reflects more relevance in comparison to such other model as historical cost since it portrays the economic value of the instrument at hand (Benston, 2006). Consequently, it is ascertained that the fair value as well as the related volatility results to a portrayal of existing fundamentals and most importantly, the risk associated with an instrument. This is reflected in the manner for which entities execute risk management-related operations, which is highly focused on fair value approach. In essence, it is established that fair value accounting avails reliable information to different stakeholders like the investors; regulators and management hence act as a mere messenger. As a result of this, it is provided that fair value accounting, whenever effectively and efficiently managed, leads to simplification of information for investors especially when they engage in making informed decisions. To possibly eliminate aspects of capital erosion, fair value accounting is adopted since it results to subsequent changes in the overall regulatory capital structure mechanisms (Benston, 2006). A perfect example lies whenever pre-existing adjustments are effected in relation to regulatory capital for such instruments as available-for-sale securities. Another important argument for fair value accounting rests with the fact that it upholds the overall concept of transparency, which in fact fails to exist in historical cost measurement. It is critical to note that a failure of transparency definitely prevents different users of accounting information from comprehending the true economic picture and as a result; allows entities not to disclose possible losses (Benston, 2006). Following this line of reasoning, fair value accounting can be seen to be transparent enough to promote aspects related to credibility of financial markets and therefore, contribute to their long-term stability as a whole.

The cons related to fair value accounting mainly revolves around the opponents of the measurement model. First, fair value accounting causes a pro-cyclical downward pressure especially in matters related to asset pricing (Scott, 2010). Due to this, the price of assets certainly falls below their true economic values. This shortcoming can be witnessed with the underlying write-downs of companies that have continued to occur thereby propelling the issue even further. Scott (2010) notes that the overall decrease in the immediate value of asset-base as presented within the company statement of financial position results to imminent panic and a lack of confidence thereby resulting to the boom effect from a single economy to another. The procyclical nature of fair value accounting is said to cause an accounting acceleration, which prolongs a perception of instability and fragility to a given economic system. Subsequently, Laux and Leuz (2009) argues that fair value measurement causes intense volatility especially since financial institutions will likely record losses that they will never incur in actual sense. The volatility also occurs whenever a given item of accounting is certainly held for a prolonged period that surpasses the period for which valuation was expected to be effected within an illiquid market. Notably, opponents of fair value accounting notes that it results to financial institutions to overlook regulatory capital stipulations, impending lending attributes and thereby compelling them to sell off assets in order to sustain a recommendable level of proper capital threshold (Laux & Leuz, 2009). In fact, it is ascertained that the measurement calls for improper write-downs of assets especially in markets deemed to be highly inactive and illiquid in nature.

Part B: Cost & Revaluation Model

It is important to note that with cost model, non-current assets are recorded at their immediate historical costs minus ant possible accumulation of depreciation and impairment losses hence at no single time will there be an upward adjustment of the asset value despite possible changes in the economy. On the contrary, revaluation model permit management to adjust values either upward or downward to reflect changes in the underlying marketing conditions.

Agency theory sets to address the agent-principal conflicts that arise within any given organisation. It seeks to delegate duties of stockholders to management especially in relation to how decisions pertaining to operations should be conducted. Notably, it is ascertained that agency theory recommends that within a given imperfect labour as well as capital market, management will try to maximise their own benefits while overlooking the immediate needs of the shareholders at hand (Bosse & Phillips, 2016). In fact, research indicates that agents can do this comfortably since they have easier access to asymmetric information like uncertainties. As a result, Bosse and Phillips (2016) notes that the possibility to act on self-interest as opposed to that of the corporate stockholders causes management or rather agents to avoid optimal risk positions especially in cases whereby risk-averse managers is able to counter profitable chances.

Taking into consideration the information above, it is probably true that QLD Nickel Group resulted to a change of accounting policy from the cost to revaluation model to avoid optimal risks that hinder profitable opportunities of the company hence act on self-interest. Considering the fact that revaluation model allows for either upward or downward valuation of asset-base, the management resorted to its application since it allows them act on their self-interest of maximising profits as opposed to wealth. It is important to note that while it is crucial to meet the needs of the stockholder through maximising their wealth position, managers act on self-interest to maximise profits of the company in order to benefit from such incentive initiatives as bonuses.

Part C: Fair Value & Recent Financial Crisis

Fair Value accounting might have played a significant role in the recently witnessed financial crisis. This is, in fact, the reason why most of the financial institutions across the globe have called for the immediate elimination of the measurement altogether. It is critical to note that in the case where markets are deemed to be liquid in nature, the accounting measurement compels these financial institutions to write-down assets despite the fact that the amounts can never recovered even when the owner was allowed to maintain security for a long period of time (Liao, Kang, Morris& Tang, 2013). Of particular interest to note, these write-downs results to surplus levels of volatility leading to capital erosion and since these write downs are deemed to be occurring at almost a similar period, they end up be overstated.

I also agree that there are problems that resulted with the immediate implementation of fair value accounting especially since despite being showcased in the media in the event of discussing a market-to-market challenge, there has been failure to account for the substantial level of change the accounting policy had especially for mortgage backed securities as well as other related debt-related instruments that were employed in the past years. The immediate implementation of fair value accounting has also been done in an ineffective manner especially since it remains unclear for financial institutions like banks to alter their respect approaches of valuation for instruments in some cases that are not well-defined and illustrated (Huizinga & Laeven, 2012). The flexibility allowed to entities to establish whether a given market is active can result to manipulation due to implementation process altogether.


Benston, G. J. (2006). Fair value accounting: a cautionary tale from Enron, Journal of Account­ing and Public Policy, 25, 465–484

Bosse, D. A., & Phillips, R. A. (2016). Agency theory and bounded self-interest. Academy of Management Review, 41(2), 276-297.

Huizinga, H., & Laeven, L. (2012). Bank valuation and accounting discretion during a financial crisis. Journal of Financial Economics, 106(3), 614-634.

Laux, C., & Leuz, C. (2009). The crisis of fair-value accounting: Making sense of the recent debate. Accounting, Organization and Society, 34, 826– 834.

Liao, L., Kang, H., Morris, R. D., & Tang, Q. (2013). Information asymmetry of fair value accounting during the financial crisis. Journal of Contemporary Accounting & Economics, 9(2), 221-236.

Scott, I, E. (2010),Fair Value Accounting: Friend or Foe?, William. & Mary Business Law Review, 1, 489-542.