| Fair Value AccountingCreating Financial Stability in an | | | | On level two, prices are observed on similar, rather |
| Unfair MarketElizabeth | | | | than identical, assets and liabilities traded actively. |
| | | | | Values on level two assets can also be derived from |
| Following the international financial crisis beginning in late | | | | market information widely used in determining present |
| 2008, an outcry rang out, largely from the financial | | | | values on securities, such as interest rates, spreads, |
| services industry, to rescind or revise the practice of | | | | and yield curves. (CIGNA) Finally, level three assets are |
| fair value accounting. Declining market values coupled | | | | valued with the least reliable information accepted in |
| with low trading volumes were creating a cycle of | | | | the hierarchy of FAS 157. Assets and liabilities not |
| declining consumer confidence that only intensified the | | | | actively traded are valued largely through estimations |
| severe market conditions. Today, the Financial | | | | and assumptions of the exit price of the hypothetical |
| Accounting Standards Board is attempting to respond | | | | transaction. (Cheng) Although the reliability of |
| effectively and efficiently to these valid concerns, while | | | | information used in valuing assets varies throughout the |
| establishing regulations that will be beneficial long-term. | | | | three levels, the objective of determining the fair |
| The following is a brief analysis of Statement of | | | | market value of an orderly transaction at the date of |
| Financial Accounting Standards No. 157 (FAS 157) and | | | | measurement is shared by all. |
| its effect on financial reporting. | | | | Due to fair value accounting’s subjective nature, |
| Prior to the issuance of FAS 157, instructions on | | | | there are both supporters and opponents of FAS 157. |
| reporting different items at fair value were scattered | | | | Many financial institutions are already rallying for a |
| throughout numerous other accounting | | | | change in fair value accounting requirements. As the |
| pronouncements. Not only did this create confusion for | | | | financial crisis has proven, valuing certain assets at fair |
| financial statements providers and auditors alike, but | | | | market values can be an inaccurate measure of the |
| also sometimes created inconsistencies in applying | | | | expected futures benefits of that asset. (Gazzaway) |
| GAAP. By issuing FAS 157, confusion was dispersed, | | | | For example, many financial services firms were |
| while consistency and comparability were both | | | | forced to significantly write down mortgage-backed |
| enhanced. (FASB) | | | | securities when their markets dried up and short-term |
| FAS 157 defines fair value as “the price that would | | | | values declined dramatically. However, due to the |
| be received to sell an asset or paid to transfer liability | | | | long-term nature of these assets, many firms will |
| in an orderly transaction between market participants | | | | realize benefits greater than the current market values |
| at the measurement date.” (FASB) The price | | | | indicate when held long-term. |
| accepted in the hypothetical transaction described in | | | | When such assets are marked down so drastically, |
| the definition is the price that would be received by the | | | | those institutions are forced to retain capital to meet |
| company when selling the asset or transferring the | | | | requirements. To do so, they much cut back on their |
| liability being values. The requirement that assets and | | | | lending. (Gazzaway) This example was realized in the |
| liabilities be measured based on market perspectives, | | | | recent financial crisis, and the cycle only exacerbated |
| and not the individual entity, aims to eliminate bias in | | | | the situation. As is evident, opponents of fair value |
| valuing a firm’s assets and liabilities. Also, recording | | | | accounting have a valid and relevant argument. |
| values as they would be at the measurement date, | | | | Of course, the Financial Accounting Standards Board |
| regardless of market conditions, is in effort to ensure | | | | would not have issued FAS 157 had it only served to |
| an accurate depiction of the company’s well-being | | | | worsen the financial crisis. In fact, FAS 157 has |
| as of the report date. (Cheng) All of these | | | | provided the tremendous advantage of greater |
| requirements enhance the reliability and relevance of | | | | transparency in financial reporting. This has allowed |
| the data being presented on the financial statements | | | | investors to easily compare companies in similar |
| when fair values are being employed. | | | | economic situation, and there properly allocate their |
| Information used to derive an asset’s or liability’s | | | | capital to top-performing entities. (Gazzaway) The |
| fair value is ranked on a hierarchy of three levels of | | | | increased investment in turn allows financial services |
| reliability. Level one represents the most reliable | | | | firms to increase their lending to individuals and |
| information employed in valuation. On the first level, | | | | businesses, creating an upward trend in expansion, |
| inputs are observed market prices on identical assets | | | | which is the exact opposite situation as was described |
| or liabilities in active markets at the date of | | | | by the opposition. Clearly, there are valid arguments |
| measurement, or the report date. With transactions | | | | both for and against fair value accounting. The |
| occurring as frequent as at least once a week, quoted | | | | question remains, then, what lies in the future for |
| prices provide the greatest reliability in determining fair | | | | financial accounting. |
| value. (Cheng) | | | | |