Summary Understanding the Issues Raised by the Credit Crunch
Fair Value Accounting: Understanding the Issues Raised by the Credit Crunch
(Pieter-Jan Wils Summary)
Executive summary
Fair value accounting: a financial reporting approach in which companies are required or permitted to measure and report on an ongoing basis certain assets and liabilities (generally financial instruments) at estimates of the prices they would receive if they were to sell the assets or would pay if they were to be relieved of the liabilities. Under fair value accounting, companies report losses when the fair values of their assets decrease or liabilities increase. Those losses reduce companies’ reported equity and may also reduce companies’ reported net income.
September 2006: (FASB) issued an important and controversial new standard, Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). * more comprehensive guidance to assist companies in estimating fair values * guidance has been tested by the extreme market conditions during the ongoing credit crunch
Criticism (after crisis): * Unrealized, reported losses are misleading because they are temporary and will reverse as markets return to normal * Fair values are difficult to estimate and thus are unreliable * Reported losses have adversely affected market prices yielding further losses and increasing the overall risk of the financial system.
Criticism is overstated, some of the key reasons why fair value accounting benefits investors include: * It requires or permits companies to report amounts that are more accurate, timely, and comparable than the amounts that would be reported under existing alternative accounting approaches, even during extreme market conditions * It requires or permits companies to report amounts that are updated on a regular and ongoing basis * It limits companies’ ability to manipulate their net income because gains and losses on assets and liabilities are reported in the period they occur, not
(Pieter-Jan Wils Summary)
Executive summary
Fair value accounting: a financial reporting approach in which companies are required or permitted to measure and report on an ongoing basis certain assets and liabilities (generally financial instruments) at estimates of the prices they would receive if they were to sell the assets or would pay if they were to be relieved of the liabilities. Under fair value accounting, companies report losses when the fair values of their assets decrease or liabilities increase. Those losses reduce companies’ reported equity and may also reduce companies’ reported net income.
September 2006: (FASB) issued an important and controversial new standard, Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). * more comprehensive guidance to assist companies in estimating fair values * guidance has been tested by the extreme market conditions during the ongoing credit crunch
Criticism (after crisis): * Unrealized, reported losses are misleading because they are temporary and will reverse as markets return to normal * Fair values are difficult to estimate and thus are unreliable * Reported losses have adversely affected market prices yielding further losses and increasing the overall risk of the financial system.
Criticism is overstated, some of the key reasons why fair value accounting benefits investors include: * It requires or permits companies to report amounts that are more accurate, timely, and comparable than the amounts that would be reported under existing alternative accounting approaches, even during extreme market conditions * It requires or permits companies to report amounts that are updated on a regular and ongoing basis * It limits companies’ ability to manipulate their net income because gains and losses on assets and liabilities are reported in the period they occur, not