The arguments against fair value accounting generally center on the increased uncertainty it can introduce into financial reporting, the potential for manipulation, and its possible conflict with the fundamental purpose of accounting.
Here's a breakdown of the key arguments:
-
Increased Uncertainty: Fair value accounting relies on market values, which can fluctuate significantly, especially during volatile economic times. This volatility can lead to swings in reported earnings and equity, making it difficult for investors to assess a company's long-term performance and financial health.
-
Potential for Manipulation: Determining fair value often requires subjective judgments and estimates, especially for assets that are not actively traded. This subjectivity creates opportunities for companies to manipulate their financial results by inflating asset values or deflating liabilities. The reference even explicitly states that it "might even create new opportunities for companies to cook their books."
-
Conflict with the Purpose of Accounting: Some argue that fair value accounting deviates from the traditional focus of accounting, which is to provide a reliable and objective record of historical costs. By emphasizing current market values, fair value accounting may prioritize short-term performance over long-term stability and sustainability. As per the reference, fair value accounting "goes against the fundamental purpose of accounting."
-
Procyclical Effects: Fair value accounting can exacerbate economic cycles. During periods of economic downturn, asset values may decline sharply, leading to significant losses on a company's balance sheet. This can further depress market sentiment and trigger a downward spiral.
-
Implementation Challenges: Applying fair value accounting can be complex and costly, particularly for companies with a wide range of assets and liabilities. Determining the appropriate valuation techniques and obtaining reliable market data can be challenging, especially in illiquid markets.
In summary, while fair value accounting aims to provide more relevant and timely information to investors, critics argue that its inherent subjectivity, potential for manipulation, and procyclical effects can undermine the reliability and stability of financial reporting. These concerns have led to ongoing debates about the appropriate role of fair value accounting in different contexts.
