According
to the International Accounting Standards Board (IASB), fair value is the
amount at which an exchange of assets is undertaken among willing and
knowledgeable parties in a one-on-one transaction. This approach is characterized
by periodic re-measuring of assets and liabilities in an effort to understand
their change in value. This results in a change in the net income or the
overall income for a specified period, all of which can be reflected in a
balance sheet. Fair value accounting is frequently used in financial
liabilities and assets because for such elements, reliable estimates and alternative
market prices are likely to be in existence. On this note, fair-value
accounting is also referred to as mark–to–market accounting. The financial
crises being experienced in the global space have brought about much
speculation and talk in the world. For instance, the US congress amongst other
worldwide economic organization. These financial problems are credited to some
factors, for instance, making asset values in times of financial dismay falls
as one of the problem. Secondly, another highlight could be implementation
problems. To note, much of accounting rules interact with other institutional
framework, which could lead to spontaneous repercussions(American Economic Association, 2018). On the other hand,
it would also be less wise to bring back historical cost accounting (HCA) as it
has made mistakes too in the past.

FINANCIAL
CRISIS

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First,
FVA and assets write-ups let the banks increase the leverages hence resulting
to more financial vulnerability. The point of banks involving in ‘gain trade’
that is selling financial instruments selectively was not a practice to be
underrated. However, it might be more appropriate to adjust the banking
regulation than the accounting system.

Secondly,
the FVA can impose contagion in financial market such that all assets sold at a
price below the fundamental value becomes relevant to other institutions that
required to mark their assets in the market. This states that there are direct
and indirect ties to the accounting system, which leads to the sale of the
assets(NBER, 2009).

CAUSES:

The
entire crisis begun when the housing prices declined and default rates rose up.
Crucial for banks investment, investment funds and large bank holdings,
information asymmetry dried up the financing and repo markets. The asset sales
and downward spirals occurred but there is little evidence stipulating that
fair-value was responsible for the dismay. Despite the banks not stating not
stating the mortgage related assets, they where highly levered during the
crisis.

Accounting
numbers also played an important role for regulatory capital requirements.
Therefore, it would be right to examine the impact of fair-value accounting on
bank holding companies. For the majority of back holding companies the fraction
of assets reported at fair value with a direct impact on income and regulatory
capital was limited.

For
instance, many banks with substantial real estate exposure and large trading
platforms used to cash-flow-based models to value their mortgage related
securities by the third or fourth quarter of the year 2017.

Further
more, we find little empirical evidence that banks’ reported fair values
suffered from excessive write-downs or undervaluation in 2008. As the observed
prices may not always reflect true fundamental values and that in those cases
market to market is not appropriate. Clearly, it is conceivable that at times,
observed market prices deviate from fundamentals.  However, the most important question is how to
deal with the issue. Historical cost does not reflect the current fundamental
value of an asset either. It might be therefore better to use market values and
to supply them with additional disclosure.

To
another realization, market reactions are even more extreme if current market
prices or fair value estimates are not disclosed to the market. Setting
accounting standards always involve tradeoffs and any accounting regime will
have costs and benefits(Schoon, 2017).

DOES
IT HAVE IMPLIMENTATION PROBLEMS?

It
cannot be cited as obvious that extant accounting standards can be blamed for
causing contagious effects. On the other hand, it can be realistic to state
that in practice or in crisis, standards do not always work as intended. Now
focusing on implementation issues, many have argued that both the emphasis on FAS
and SEC guidelines make it hard for firms to deviate from market prices.
Consistent with these claims, we find relevant standards in US IFRS and GAAP as
well as the guidelines for these standards are quite restrictive as to when it
is appropriate for managers to deviate from observable market prices. Thus,
without this restrictive guidance, the standards could be reluctant to take
write-downs even when assets are substantially impaired.

Secondly,
implementation problems may arise from litigation risk. On the other hand,
directors, managers, doctors, and auditors too face serious litigation risks
including penalties such as prison terms, which currently have been increased. In
this implementation, directors, managers, and auditors are prone to many risks
associated with deviations from market prices. Giving an example, it is
realistic for a manager to be reluctant and use an appropriate model- based
fair value that is higher than an observable price fro a very illiquid market,
especially when there is enough substantial risk of the economy or the firm, as
there typically is in financial crisis. Guidance as to when deviations are
appropriate is likely to play an important role, especially in litigious
environments and when enforcement is strong.

 

 

CONCLUSION:

Illustratively,
it is evident that the debate about FVA is full of arguments that require
holding less scrutiny. It’s also important to recognize that standard setters
face trade offs and in this regard we find FVA is no exceptional.

First,
it introduces volatility in the normal times, when prompt action is not needed.
Second, it can give rise to contagion effects in times of crisis, which need to
be addressed. Finally, despite all the factors, ideas and suggestion regarding
the crisis, its important noting that the role of the political forces further
complicates the analysis. For instance, it is possible that changing the
accounting rules in a crisis as a result of political pressure leads to a worse
outcome.

In
this regard, the intense lobbying and political interference with the standard
setting process during the current crisis provide a fertile ground for further
study.