Importance Of Fair Value Accounting

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Recommended: Controversy of fair value accounting

On the other hand, fair value accounting raises the concerns of reliability. The estimation of fair value tends to be subjective since because “many assets and liabilities do not have an active markets, therefore the valuations are less reliable” (Bies, 2005). It is reliable only if markets for assets and liabilities are liquid and transparent. Even though fair value accounting has its own importance in term of measurement, the perspective of historical cost should be taken into account. As fair value reflects the current market conditions, an asset for example should have been valued at $50,000 may suddenly fall to $30,000 due to the economic downturn. It results a loss of $20,000 in net income since historical perspective was ignored. Also, …show more content…

There are three critical aspects to say that the application of FVA is still inappropriate. Firstly, relevance is a concern. Under fair value accounting practice, the core business management of banking sectors are not properly reflected, according to ECB (n.d.). Fair value accounting is concerned for the short-term profitability which has the conflict with the long-term decisions of bank management. Financial instruments are held for maturity will demand a longer timeframe to be effective. In order to achieve the goal, banks have to “reduce their exposure to increased volatility of income by shortening the average maturity of loans” (ECB, n.d). Banks can also choose to enter in a shorter contract by using hedging techniques combined with using variable interest rates. Therefore, banks have to face the tremendous risks in order to achieve the short-term pay-offs. The second issue is the feasibility. There is a requirement of active trading market to determine adequate fair value. However, some financial instruments have no secondary market in FVA practice unable to use fair value measurement. Also, “relevant information for the determination for the fair value of loans would never be priced in a market” (ECB, n.d). Therefore, errors in measurement may occur and cause the uncertainties that

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