This document is concerned with the relationship between the financial crisis and fair value accounting. Its purpose is to make an understanding of the strengths and limitations of fair value accounting. The report also gives some examples of fair value accounting measures used in several Australian companies. In this report, City Weat Water LTD and JB HI-FI LTD are used to explain that. Introduction
With the modern transportation and communication technology development, in the industrial society, the segmentation of market is going to be narrow and towards the integration of world economy. The traditional historical cost based on the transaction price measurement is no longer the only reliable source of information. Fair value accounting due to the high relevance information will become increasingly important in the new century and the future accounting measurement. With the financial crisis, more and more professionals and bankers believed that the fair value accounting was the principal reason that the U.S. financial system melted down in 2008. By contrast, some investor groups and accounting interests emphasize that the fair value accounting gave investors an early warning of the looming financial crisis and continues to give them useful information. This report is a brief analysis about fair value accounting. It is divided into three parts. In the part A, this report briefly discussed the role of fair value accounting in providing useful information for economic decision making. In the part B, this report has critically discussed the limitation of fair value accounting. For the last part, part C, two Australian companies from different industries been given as examples to indentify and discuss the extent to which fair value accounting is being applied.
Part A The role of fair value accounting relates to provide useful information for economic decision making.
FAS 157 defines “fair value as the price received to sell an asset or the price paid to transfer a liability in an transaction taking place in an active market.”(Curtis,J. 2009) This is sometimes referred to as "exit value". In the futures market, fair value is the equilibrium price for a futures contract. Fair value is a dynamic reflection; embody the spot true value of assets or liabilities. Fair value can provided accounting information which has predictive value to assess the entity’s future cash flow for the investors and creditors. Supporters of fair value accounting believe that the regime provided a beneficial early warning of the financial imbalances and generally provides investors with useful information. The strength of fair value accounting to provide information for economic decision making can briefly divided into four aspects: the benefit of the capital maintenance, improve the relevance of financial information, the attribute of the measurement and the reflection of entities’ profit. Fair value accounting is benefit of capital maintenance
Capital maintenance can be divided into two big concepts: physical maintenance and financial maintenance. Physical maintenance can only recognized when the total investment amount at the end of the period greater than the investment that can maintain the same capacity at the beginning of this period. Financial maintenance means if the total investment at the end of this period equal to or more than the monetary unit of measurement of the initial investment amount, the capital has been maintained, and the over parts can be recognized as income. In the time of inflation, the fair value accounting can assure all the two concepts of capital maintenance, and can avoid holders of monetary assets lose in real term. It can provide a more real situation of an entity. The use of fair value accounting reduces the possibility of income smoothing. Fair value accounting can better reflect a company’s exposure towards risk, when the changes in market conditions cause the income and equity become more...