Fair Value Accounting Essay Example for Free

mean(a) Value Accounting EssayTopic To what extent is Fair Value Accounting an effective method in amount the set of fiscal instruments in fiscal statement?In recent years, the breakout of global fiscal crisis has raised controversial debates about whether or not fair tax be (FVA) is an effective method in measuring the set of fiscal instruments (Laux Leuz, 2009). As two main account system standards around the world, both International Financial Reporting Standards (IFRS) and US Financial Accounting Standards (FAS) have adopted FVA as an accounting method to judge the values of just about fiscal instruments (Mala and Chand, 2011). This essay will argue that although FVA generate provide timely and downright expenditure instruction to the users of accounting tuition in somewhat cases, there are potential problems of FVA in measuring the values of monetary instruments on account of unreliable evaluation models, biased prices in inefficient food food markets and a cast out price transmission effect. There are terzetto main parts in this essay. Firstly, it will accord the definition of FVA and whence it will analyze why the effectiveness of FVA may be limited from triad aspects, namely unreliable evaluation models, biased prices in inefficient markets and a negative price transmittal effect. At last, it will consider the pros of FVA regarding the timely and sheer(a) information it provides in some cases and analyze the pros. correspond to Financial Accounting Standards 157, fair value accounting tail be define as an accounting method to saloon the values of assets and liabilities based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the sum of moneyment date. That is to say, FVA relies on the actual market prices of the financial instruments and records the exact market prices on the financial statements. In fact, FVA replaces historica l cost accounting (HCA) with the development of accounting standards (Boyer, 2007).Compared with FVA, historical cost accounting can be described as an accounting measurement of values based on the accepted or historical cost when the confederacy got the assets or liabilities. For example, a company bought a lineage for 50 pounds last year. In this year, the price of the stock increases to 100 pounds. Under FVA, the company should record the value ofthe stock at 100 pounds this year while 50 pounds will be recognized under HCA. As the replaced FVA has been regarding as accelerating the global financial crisis, it draws a lot of attention in respect of its potential weaknesses in the accounting field.Firstly, the model to assessment fair values of financial instruments in illiquid markets seems to have insufficient reliableness (Laux Leuz 2009 and Mala Chand 2011). If the markets for the identical or similar financial instruments whose values need to be evaluated are active, the available prices can be used to evaluate the fair values of them (Laux Leuz 2009). However, if the markets do not exist, which means the the markets are indolent or illiquid, the fair evaluation model is needed to estimate the fair value of the financial instruments (Ball 2006). specifically speaking, the model to evaluate fair values of financial instruments rely on the incoming funds prey of the financial instruments and borrowing rate of the company.The future tense cash flow can be described as the future cash inflow (income) and outflow (expense) brought by the financial instruments whilst the borrowing rate of a company can be considered as the cost of capital which can be invested in other investments quite an than the financial instruments. The users of the evaluation model should firstly predict the future cash flow of the financial instruments and then use the borrowing rate of the company to calculate the present fair values. Ljiri (2005) states that using model t o estimate the values of financial instruments provides significant discretionary power to the users and gives uncertainty, which may influence the objectivity of the valuation of financial instruments.Indeed, the same financial instrument could be evaluated differently on account of different estimation of future cash flows and distinct borrowing rate. Because the users of the evaluation model have the power to forecast the future cash flow, different users may have distinct estimations of the same financial instrument based on their perspectives of its future profitability. In addition, different companies may have different borrowing rates due to distinct industries involved. Thus, the supra two uncertain factors affects the objectivity of the fair evaluation of the financial instruments, which limits the reliability of the evaluation model.Secondly, the inefficient markets could heave prices, which has a negative effect on the basis of FVA (Laux Leuz 2009). An inefficient mark et can be defined as a market in which the prices of financial instruments can not be measured accurately due to the inefficient information it provides (Aboody et. al 2002). Additionally, Lim and Brooks (2010) review the empirical literature about the growth of market efficiency over time and find that the market cannot be always efficient and market inefficiency can be easily caused by investor irrationality and liquidity problems.That is to say, the market prices of financial instruments could be depraved by biased behaviors of investors, such as overconfidence or overreaction to a stock, and liquidity problems, such as illiquid market for a long-term bond. Whats more, the distorted prices can not reflect the real values of financial instruments, which makes FVA lose the reliable basis to measure the fair value of financial instruments. Therefore, the biased prices in the inefficient markets tend to the appropriateness of fair evaluation of financial instruments.Thirdly, Laux a nd Leuz (2009) argues that FVA could enforce negative price contagion in the financial markets, which has been considered as the main cause of rapid spread of global financial crisis. It is argued that FVA has ruttish the financial crisis in a bestial spiral and leading to the spread and depth of the financial crisis (Begtsoon 2011, Allen and Carletti 2007, Appelbaum 2009 and Jones 2009). To be specific, after financial crisis broke out, the liquidity of financial instruments markets dried up, which means very hardly a(prenominal) trades of the financial instruments existed in the markets (Begtsoon 2011). As a result, the market pricing mechanism became dysfunctional because the prices should be evaluated from very few trades, which resulted in low prices of financial instruments (ibid).In turn, the low prices put pressure on the financial statements of some financial institutions in terms of assets depreciation under FVA (Allen Carletti 2008). In order to keep capital requireme nts, the financial institutions had no choice but to sell assets at low prices, which led to lower prices of financial instruments in the markets and stimulated further assets depreciation on other financial instruments financial statements under FVA(Plantin et al. 2008a). To sum up, the prices in the market could negatively influence the evaluation of financial instruments under FVA and at the same time, the evaluation of financial instruments under FVA could have a further negative effect on the market prices, which forms a vicious circle that can speed up the price contagion and fluctuations.Nevertheless, supporters of FVA believe that FVA can provide transparent and timely information for the users of accounting information (Brown 2008). As Hughes (2009) says, the function of FVA is like that of the thermometer-it mirrors reality, it does not create it. Since FVA can reflect what is happening in the market on the financial statements immediately, it allows the information users to get easy vex to the most timely and transparent market information. In addition, Hinks (2009) argues that the useful information provided by FVA allows the investors and regulators to approach to the street smart position of financial institutions and encourage them to make corrective decisions.Indeed, it cannot be denied that FVA can provide prompt and transparent price information in some cases. However, it is not always the case which contributes FVA to an effective measurement to value financial instruments. First of all, in an illiquid or inefficient market for some financial instruments, even if FVA could provide timely price information of the financial instruments, the timely information provided is unreliable, which leads to the uselessness of the timely and transparent information provided by FVA.Secondly, even though the financial instruments have an active or efficient market, FVA cannot result in increased transparency of information in financial statements as expe cted (Krumwiede 2008). Thirdly, under FVA, timely price information would lead to volatility of financial statements (Barth 2004). The continuous volatility of financial statements causes confusion for the users of accounting information and raises the companys cost to keep accounts. Hence, although FVA could offer some timely and transparent information to the users, these information limits to some extent because of unreliable information, limited transparency and volatility of financial statements.In conclusion, this essay has discussed three aspects limiting the effectiveness of FVA to measure the values of financial instruments, including evaluation model, inefficient markets and price contagion effect. In addition, it also considers the pros of FVA in terms of timely and transparent information provided in some cases. It can be concluded that even though up-to-date and transparent information could be provided by FVA occasionally, the effectiveness of FVA to measure the values of financial instruments has been limited due to the unreliable evaluation model, distorted prices in inefficient markets and a negative price contagion effect.Because of word limit, this essay cannot cover the detailed application of FVA to specific miscellanea of financial instrument. However, the above discussion can clearly show that FVA has some general problems in measuring the values of financial instruments. Based on above analysis, it can be suggested that the problematic aspects of FVA could be ameliorate or revised by providing more clear explanation and more specific regulations by the constitutors of accounting standards and for some specific financial instruments with illiquid or inefficient markets, it is better to use some other methods to measure their values.