Accounting World Magazine | Fair Value Reporting of Financial Instruments

The Accounting World Magazine:

Fair Value Reporting of Financial Instruments

Pub. Date	:	February, 2009
Product Name	:	The Accounting World
Product Type	:	FINANCIAL REPORTING
Product Code	:	AWFR10902
Author Name	:	Aparna Hawaldar
Availability	:	YES
Subject/Domain	:	Finance
Download Format	:	PDF Format
No. of Pages	:	5

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	Abstract
	Since the turn of the century, the Financial Accounting Standards Board has been moving away from the traditional historical cost method to fair value accounting. There has been an intense discussion about the efficiency of fair value accounting of financial instruments. One of the opinions has been that it creates an unjustifiable volatility in reported earnings often leading to credit crisis. The debate basically revolves around the issues of relevance and reliability. The challenges of employing fair value accounting are complex. The abruptness by which the active markets disappear only aggravates these difficulties. The pressure to give up-to-date information to the investors has been building up, which has resulted in the demand for some valuation models.

Description

Fair value accounting reflects the existing market conditions, thereby, providing more transparency than the historical cost-based accounts. It also provides reliability in illiquid markets. It also makes it possible to compare the value of financial instruments purchased at transactions at different time periods.

Since the turn of the century, the Financial Accounting Standards Board has been moving away from the traditional historical cost method to fair value accounting. Starting with the SFAS 12 to the most recent standards like SFAS 107, SFAS 115 and SFAS 133, it necessitates recognition or disclosure of all assets and liabilities in fair value. FASB 133 states that "all financial instruments should be carried in the statement of financial position at fair value when the conceptual and measurement issues are resolved" as per accounting standards (FASB 1998, para 334)

Since then, there has been an intense discussion about the efficiency of fair value accounting of financial instruments. One of the opinions has been that it creates an unjustifiable volatility in reported earnings, often leading to credit crisis. The debate basically revolves around the issues of relevance and reliability.

The Preliminary Views document of FASB defines fair value as:

"An estimate of the price an entity would have realized if it had sold an asset or paid if it had been relieved of a liability on the reporting date in an arm's length exchange motivated by normal business considerations."

"The fair value of an asset is the amount at which that asset could be bought or sold in a current transaction between willing parties, other than in liquidation. On the other side of the balance sheet, the fair value of a liability is the amount at which that liability could be incurred or settled in a current transaction between willing parties, other than in a liquidation".

Many financial instruments—such as shares traded on an exchange, debt securities (US Treasury bonds), and derivatives—are measured and reported at fair value.

Though the accounting standards vary from country to country, Fair Value Accounting for Financial Instruments is prevalent in most countries of the world.

Keywords

Accounting World Magazine, Fair Value Reporting, Financial Instruments, Financial Accounting Standards Board, Financial Instruments, Fair Value Accounting, Cost-based Accounts, Financial Instruments, Commodity Markets, Capital Markets, Financial Assets, Capital Budgeting Decisions.