ACT301 | Accounting Theory | The Fair Value Measurement Methods

Literature Review

In the recent years, the wide use of Fair Value accounting can be over the use of historical accounting all over the years as the accountants can get some major benefits while using fair value measurement. At the same time, there are many instances where companies face difficulties in the implementation and use of fair value measurement methods. The following discussion sheds light on the issues of fair value measurement in general and in emerging economies:

In General Context

Under the fair value measurement, it is required for the business organizations to consider the current market price of the assets and liabilities. For this reason, large swings in the value of the assets can be observed throughout the year. This fluctuation in the value of the assets can create impact on the income statements of the companies that are not actual in respect to the long-term financial planning as it can create misleading losses or gains in the short-run of the businesses (Goh et al., 2015). This whole aspect leads to the loss of income of the companies. Moreover, the investors do not always notice that the companies are using fair; and thus, the decrease in the net income of the company creates a sense of dissatisfaction among them as loss of income is the loss of value of the investors as well.

Apart from this, there are some instances when the accountants have considered the fair value measurement method as less reliable due to the fact that they are needed to consider the market value of an asset or investment. As per Magnan, Menini & Parbonetti, (2015), in the presence of fair value measurement method, an asset or investment shows different values in different regions; thus, the accountants are needed to make a judgment call on the valuation of that particular asset or investment. Apart from this, the accountants also face challenges in the book value of the assets while dealing with the fair value measurement method. Book value of a company is considered as the total of all owned assets. In case of historical accounting method, change occurs in the book value of the company at the time of purchasing or disposing off any asset. As per Betakova, Hrazdilova-Bockova & Skoda, (2014), fair value method involves in the change in the book value of the assets for arbitrary issues. For example, accountants are needed to make significant judgment in case the company experiences any significant drop in the value of an asset. In case the value of the asset goes back, then the adjustment did not do anything but to drop the book value of the asset for a small time. Thus, it can be seen that the companies face some major issue while implementing the fair value measurement.

In Emerging Economy Context

Apart from the general context, the challenges of fair value measurement can be seen in case of emerging economy. As per Marra, (2016), even in the presence of many positive sides of fair value measurement, the implementation of fair value measurement can fail and the entire valuation process become unreliable in case the companies in emerging economy fails to hold the relationship between the exit price and fair value to the shareholders. For this reason, the fair value measurement become meaningless when a company holds net assets whole value generates from the business plan execution rather than from the market price fluctuations, even when the presence of exit price can be seen in the emerging economy. For this reason, there are many instances where the use of value in use and entrance value can be seen instead of the exit price under the fair value method (Macve, 2015).

Apart from this, the limitation in the implementation of fair value measurement can be seen related to the transaction costs. As per He, Wong & Young, (2012), under the fair value measurement, the accountants are needed to exclude transaction costs, but they are not often. This aspect presents a fair concern related to the use of fair value measurement at the time of market illiquidity and irrationality in the emerging economy that can be seen from the time of the financial crisis of 2007. It implies that the use of fair value measurement leads to the reduction in in-formativeness of the earnings due to the unpredictability in the change in fair value; their inclusion makes it harder for the accountants in identifying the recurring components of earnings. As per Liang & Riedl, (2013), the absence of the role of fair value measurement can be seen in the prediction of future earnings. Thus, the limitations of fair value measurement in emerging economy can be seen from the above discussion.

References

Betakova, J., Hrazdilova-Bockova, K., & Skoda, M. (2014). Fair value usefulness in financial statements. DAAAM International Scientific Book, 433-448.

Goh, B. W., Li, D., Ng, J., & Yong, K. O. (2015). Market pricing of banks’ fair value assets reported under SFAS 157 since the 2008 financial crisis. Journal of Accounting and Public Policy, 34(2), 129-145.

He, X., Wong, T. J., & Young, D. (2012). Challenges for implementation of fair value accounting in emerging markets: Evidence from China. Contemporary Accounting Research, 29(2), 538-562.

Liang, L., & Riedl, E. J. (2013). The effect of fair value versus historical cost reporting model on analyst forecast accuracy. The Accounting Review, 89(3), 1151-1177.

Macve, R. H. (2015). Fair value vs conservatism? Aspects of the history of accounting, auditing, business and finance from ancient Mesopotamia to modern China. The British Accounting Review, 47(2), 124-141.

Magnan, M., Menini, A., & Parbonetti, A. (2015). Fair value accounting: information or confusion for financial markets?. Review of Accounting Studies, 20(1), 559-591.

Marra, A. (2016). The Pros and Cons of Fair Value Accounting in a Globalized Economy: A Never Ending Debate. Journal of Accounting, Auditing & Finance, 31(4), 582-591.