Fair Value Accounting

Topics: Balance sheet, Generally Accepted Accounting Principles, Income statement Pages: 10 (3094 words) Published: September 7, 2010
1.0 Introduction

Using fair value accounting in preparing financial reports is often being argued. Starting from past few decades, the creator of accounting rules around the world are starting to abandon the very first model of accounting measurement which is historical cost model and practicing fair value of accounting (Elad 2007).

In past 1938, it was necessary to banks and financial institutions to record their mortgages and financial holdings based on market value (Barlev & Haddad 2003). In these years, recession caused decreasing in market value of these assets, therefore banks and financial institution forced to mark down their asset, report losses and reduce their capital (Barlev & Haddad 2003). Banks needed to maintain their minimum capital adequate ratio, so they had to limit their loans, which then affected business activities and lead to financial crisis (Barlev & Haddad 2003).

Traditional measurement of profits did not prove sufficient task of registering and value of the financial instrument because there was zero cost in trading (Pita & GutiÉrrez 2006). Consequently, it cant be recorded in historical cost basis because the valuation development of methodologies that were accepted and being used in financial market had undercut the credibility of historical cost based information which given in the financial statements (Pita & GutiÉrrez 2006). Accounting body agreed that to overcome this problem and to achieve transparency of financial instrument information was by introducing fair value (Pita & GutiÉrrez 2006). However, until now there were still many arguments regarding how appropriate this valuation method was, considering it has high degree of subjectivity and will lead to unreliable financial statement (Pita & GutiÉrrez 2006).

This report serves purpose to verify how far fair value accounting can influence user’s decision-making and analyze some limitations of fair value accounting as a measurement tool. In order to make clear comparison on the coverage of fair value application, annual report from two companies in different industries will be provided.

2.0 Discussion
2.1 Definition of fair value accounting

According to FASB 13 (FASB, 1976) definition of fair value accounting is an amount for which a property can be sold between the irrelevant parties within arm’s length transaction (Barlev & Haddad 2003). Fair value of accounting is being used to determine how much assets or liabilities can be liquidated in a transaction based on current market condition (Pita & GutiÉrrez 2006).

Some who support the practice of fair value of accounting argued that by using this measurement, user of financial statement could achieve a true and fair view of a company’s financial performance because it revealed the overcome of economic condition as well as any changes in them (Pita & GutiÉrrez 2006). Further, fair value of accounting caused increased in consistency and comparability valuation of framework because the institution valued at the same principle at the same time (Pita & GutiÉrrez 2006).

However, the most important was the impact caused by fair value of accounting for decision makers (Pita & GutiÉrrez 2006). Relevance can be obtained when the financial information was able to confirm expectation of decision makers and reduced any uncertainty associated with any decisions (Pita & GutiÉrrez 2006).

2.2 How fair value accounting can help user to achieve useful information for economic decision-making?

Fair value of accounting played important roles for financial statement’s user in making economic decision. In financial instrument, credit portfolio held until maturity in balance sheet and which generated yields over the time, consequently, the difference between costs of financing and amount paid by customer occurred (Pita & GutiÉrrez 2006). However, in this case, return can be determined by considering whether the payments has been made and whether the...
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