Essay: How Fair is Fair Value - Extended
Essay: How Fair is Fair Value?
In this essay an examination will be made of what fair value is; under which accounting standards it can be found; and generally where, how and why it is used at present. Following reports, discussions and subsequent amendments that have been made to fair value recently, an exploration of these areas may uncover what changes have occurred overall in the way fair value is reported; it's transparency in the public domain; and how it affects business as a whole. The concluding points will examine if there is a need to remedy the present system and if so how to establish better reporting of fair value.
It is important to understand that good financial reporting is essential to provide a true and fair picture of the financial position at a particular time. Without this in place great difficulties would be faced by many organisations and individuals; unreliable or non-relevant information would be difficult to use at best and misleading at worst. If there are vast differences between the information provided by some organisations to those given by others, comparison is somewhat difficult and can prove useless. If the rules are not clear and stringently maintained it can allow personal interpretation. It is, therefore, understandable why the IASB has taken steps to adopt a more definite and understandable approach.
... Historical cost accounts were traditionally based on three concepts: realisation, where profits were not recognised until they were realised, matching, where revenues were matched with costs and lastly prudence, where an element of conservatism was implied (Ernst & Young/ey.com/fairvalue; /14.01.2007).
Positively stating in the fair value argument is Jane Croft writing for the Financial Times. The fair value option in IAS39 "would allow companies to measure all financial assets or liabilities at fair or market value, and records gains and losses on them in the profit and loss account" (Jane Croft/FT.com/19.12.2004). There are arguments to the contrary, in favour of historical costing. Inder K. Khurana and Myung-Sun Kim of the School of Accountancy, University of Missouri when looking at the effects on small bank holding companies (BHCs), highlight this in their American study. They were "unable to detect a discernable difference in the informativeness of fair value"(www.sciencedirect.com/14.01.2007). Although for small BHC's historical costing proved more valid than fair value; the existence of a suitable market had significant affect on whether fair value was more or less useful.
Having examined fair value reporting, the system is clearly not satisfying its users as yet. Whilst the ideas behind the changes already undergone have to some extent been welcomed, there is a general feeling that they do not go far enough and have their order of importance incorrectly rated. If it is accepted that the traditional method of historical cost accounting is unreasonable an alternative must be considered. Yet for fair value to be accepted and advocated further changes need to be undertaken to emphasise the financial reporting principles, namely, understandability, reliability, relevance and comparability (Ernst & Young/ey.com/fairvalue; /14.01.2007). This will ensure that those involved in financial reporting follow these principles stringently. There is no room for unreliability; the IASB must reconsider its present position to accommodate a more judged and less calculated qualification of fair value. The concept of 'true and fair' within accounting does not lend itself to a mathematical approach; it should not be taken in its full emotive meaning either, a careful evaluation within set principles that all could understand and adhere to would be a sensible and appreciated step forward for the IASB.