Advanced Financial Reporting & Regulation - Essay Example

Advanced Financial Reporting & Regulation Contents 2 Contents 2 Introduction 3 Discussion 3 i. Relation of fair value with financial crisis 3 Advantage of fair value 4 Disadvantage of fair value 5 ii. Benefits and drawbacks of fair value of measurement in relation to other methods of measurement. 6 Benefits of fair value measurement 6 Disadvantages of fair value measurement of accounting 7 Historical cost accounting 8 Replacement Cost 9 Deprival value 9 Conclusion 10 References 11 Introduction Fair value of accounting can be defined as the estimation of the value of assets and liabilities of the acquired company that is mainly used in consolidation with the financial statements of companies. According to the International Accounting Standard Board fair value can be defined as the amount at which the assets of the company are exchanged between the willing and knowledgeable parties. The assets and liabilities under the application of the fair value measurement are reviewed and monitored within the interval of certain period in order to reflect and evaluate the changes or variation in the value which impacts or influences the net income or the comprehensive income of the company for the certain period of time. The fair value measurement is considered as the better approach for preparing the balance sheet as it reflects the current liabilities and current assets of the company. This approach of measurement is commonly used in relation to the financial assets and liabilities since these elements are mostly influenced by the market prices and other estimates. The fair value of measurement is related to the quoted investment which includes the equities, bonds and commodities that assist in the preparation of balance sheet at the market value. The market price is considered as an important element and aspect in case of fair value of accounting. The values in case of fair value accounting may be misplaced or distorted due to the irrationality of the investors, inefficiency in the market and the problem of liquidity. Discussion i. Relation of fair value with financial crisis During the time of the financial crisis in the economy, the market faced the subprime crisis and the position of the assets and liabilities were severely distorted. This situation has resulted in the arguments for and against the concept of fair value measurement (Jaara, 2014). The application of fair value has been criticized on the basis of various aspects since when it is used or applied fully it is unable to determine the financial position leading to the situation of unrealized profits and losses in the income statement and it has lead to the situation of melt down which has resulted in the increase in risk and liability and thereby leading to the fall in prices and therefore it reduces the net income and equity In case of the banking sector the application of the fair value accounting has lead to the increase in the risk arising out of failure (Jack, Davison and Craig, 2013). Fair value measurement has played a major and vital role in United States as it was considered as the Generally Accepted principle and it contributed towards the process of providing guidance for assisting the companies for the estimation of fair values. The drawback or the limitation of the application of the fair value has been focused or highlighted with the failure of the fair value measurement in 2008 during the time of the severe financial crisis (Hopper, 2012). Advantage of fair value In spite of the failure of the application of the fair value measurement in reducing the risk and controlling the rise in the prices during the situation of financial crisis in the economy the fair value measurement has several advantages or benefits (Banerjee, 2010). Fair value measurement has resulted in providing various advantages or benefits to the investors which includes, fair value measurement approach has facilitated the companies to prepare the report on the basis of the amount that are updated periodically on a regular basis, it provides a option to the companies in comparing the financial report of other companies accurately and on the timely basis even during the situation of crisis in the economy, the changes in the fair value related to profits and losses which reflects the economic event of the related companies and the change in the fair value is generally preferred by the investors since they have the option of additional disclosures and the main or the important benefit or the advantage of the fair value measurement is it does not allow the companies to manipulate its net income since the losses or the gains that is incurred by the companies are included and reported in the period in which they have occurred and not during the period when it is realized as the outcome of the transaction. The fair value of measurement approach is considered as the important and appropriate approach as compared to other approach or methods (Shamrock, 2012). Disadvantage of fair value Taking into consideration the situation of economic of financial crisis or the situation of credit crunch in the economy, the fair value measurement has been argued and criticized by various parties which mainly include the estimation or measurement of fair value which is very critical and complex, the reported losses that is estimated under the fair value measurement are misleading and manipulative since the value that is find out are temporary and will reverse the return from market to normal and the reported losses has also affected severely the market prices that has lead to the increase in losses and thereby increasing the risk in the financial system. The fair value measurement fails to provide appropriate value when they apply mark to model values or mark to market values (Abbas, 2012). But on the basis of the criticism in favour and against the fair value measurement accounting during the time of financial crisis and the situation of credit crunch in the economy it can be observed that fair value provides less discretionary values as compared to other measurement approach and it is observed that sometimes the liquid market may generate wrong result. And the fair value accounting focuses on providing importance and benefits to the investors. The crisis that has taken place recently has leaded the fair value measurement to consider on the broader aspects of accounting (Gary, and Curtis, 2014). The disadvantages or the limitation of the fair value accounting can be estimated by the fact that it has challenged the basic principles of accounting that is based on reliability, verifiability and conservatism in accounting and increased the unrealized gain and losses in the economy and it also leads to the rise in the volatility in the earnings and disconnect the relation between the real economy and financial statements. Therefore it is advised to apply and use the amortized cost for the preparation of report and the mark to model values as compared to the mark to market values in case of the fair value measurement since the mark to market fair values generally results in the generation of large unrealized profit (Ball, 2006). ii. Benefits and drawbacks of fair value of measurement in relation to other methods of measurement. The issues arising during the credit crunch in the economy has been surrounded or backed by various issues that are related with the recognition and measurement of the fair values that is incorporated in the financial statements and this generally remains unsettled (Brown, 2003). The recent or the present financial crisis in the economy has highlighted on the fair value of accounting has lead to the situation of argument both in favour and against the application of fair value accounting Benefits of fair value measurement In case of the crisis that is faced by the banking sector it can be observed that the fair value accounting measurement generally provides a prior warning indication about the crisis that is likely to prevail and thereby encouraging or advising the banks to adopt adequate and appropriate measure which as a result decreases the risk of crisis. In case of the hedge funds the fair value measurement approach is applied for evaluating and estimating the values in case of the illiquid assets. Fair values can be applied in case of the real estate sector where no prior planning is required for developing the real estate business (Helfert, 2001).The investment done in the insurance company can adopt the fair value measurement since the securities in case of the insurance companies are valued depending on the market prices and it can also evaluate and ascertain the assets and liabilities of the insurance companies other than the investment assets. The pension asset is affected by the performance of fund which affects the welfare of the shareholders. The fair value accounting affects or influences the companies in preparation of the financial statement and it assist the accountants in the preparation of the financial statements since it provides proper and in depth understanding and knowledge about the market condition and scenario and therefore in the situation of credit crunch the application of fair value of measurement is suitable and preferable since it provides information about the market condition prevailing in the economy (Ryan, 2008). Disadvantages of fair value measurement of accounting Due to the severe limitations of the fair value measurement of accounting, the fair value of accounting has been criticized by many of the accountants its disadvantages mainly includes Fair value of accounting is suitable for application only in case of determining the value of the shareholder, the error in the calculation and estimation of the value in case of the balance sheet provides unreliable data or information (Khan, 2010).The fair value of accounting has failed in controlling the credit crunch and subprime crisis in the economy which has resulted in worsening the economic condition of United States during the time of the great depression. The fair value of accounting has increased the systematic risk and it adopted mark to market approach which has lead to the situation of financial meltdown during the time of subprime crisis. During the financial crisis the main issues or the problem that was faced due to the application of fair value of accounting is that the greater proportion of assets and liabilities of the banks subjected to the application of fair value of accounting has faced the pressure of selling the assets of the bank in the scenario of declining market situation that has resulted in the problem of increase in the price of the assets that is likely to affect the assets and liabilities. Therefore it revealed that fair value of accounting has increased the contagion that develops for establishing the financial linkages in case of the banking industry (Christian, 2010). Historical cost accounting The historical cost accounting is considered as an alternative of the fair value accounting since it deals with the liquid assets in the trading book of account that is maintained by the banks and it is also considered as an alternative for the loans. The fair value of accounting fails to provide relevant and proper information which sometimes is not possible in case of the historical cost accounting (Magnan, 2009). The historical accounting cannot be termed as the best alternative of the fair value of accounting as the historical cost do not reflect or focuses on the current value of the financial assets. The historical cost of accounting generally lacks transparency which creates problem for example the situation of excessive subprime lending. While comparing the fair value of accounting along with the historical cost of accounting it is observed that fair value in spite of its limitations and disadvantages it is superior as compared to the historical cost of accounting since the investors of the companies are interested in the value and not only on the cost. Historical cost accounting is not up to date and it does not deal with the assets and liabilities therefore it is unable to reflect the true financial position of the business as compared to that of the fair value accounting. Historical cost and fair value can act alternatively with each other only in case of the similar assets and liabilities at different point of time (Penman, 2007). Replacement Cost The fair value and the replacement cost are related in a way that the assets are generally valued at a replacement cost and the current cost which is included in the income statement and the unrealized profit and losses estimated by the fair value is also recognized and therefore the matching of the recognition of revenue is maintained but the income that is generated on the basis of the current cost is considered as the better indicator for determining the future dependent (Gron and Winton, 2001). Deprival value The deprival value and the fair value are considered as the better alternative to each other. Deprival value can be defined as the value which is measured in terms of the replacement cost and whose value has exceeded from the replacement cost. The deprival value can be termed as the modification of the replacement cost valuation (Watts, 2003).In recent years the application of fair value is more preferred as compared to the deprival value or the replacement cost since the fair value measures the value at a current cost. The deprival value is termed as the technique for solving the problem that arises out of the application of the fair value accounting. The fair value measures and estimates the assets and liabilities in a proper way as compared to that of the deprival value. The deprival value generally underestimates the value of the asset which is overcome by the application of fair value accounting (Ryan, 2007). The main aim of the fair value accounting is to measure the firm’s current position which can change with the change in the prices and it reflects the current position of the business on the basis of the balance sheet of the company the fair value estimates and considers the asset and liabilities of the company it played a major and important role till the period prior to the occurrence of the financial crisis but with the occurrence of financial crisis in the economy the importance of the fair value has decreased (Schrand and Skinner, 2000). The alternative to fair value measurement are historical cost, replacement cost and residual value but the alternatives measures the value or the cost on the basis of previous data or information but does not considers the current value. And the investors generally prefer to evaluate on the basis of value as compared to that of cost (Magnan and Cormier, 2005). Conclusion The study reflects the role, advantages and limitations of the fair value measurement and its implication during the financial crisis in the economy. The fair value cannot operate effectively in case of the illiquid market and the unrealized income and profit and losses has lead to the volatility in the firms or companies. The application of fair value accounting has severely and adversely affected the banking sector as it leads to the situation of financial meltdown and decrease in the price of its assets. The advantages of providing timely and important information under the fair value accounting overcome the shortcomings or the limitations of the historical cost accounting when the market is competitive and liquid. The role of the fair value at the time of financial crisis has been evaluated. The impact of the fair value has been realized gradually. The fair value accounting is suitable for overcoming the problems arising due to the miss match in the assets and liabilities and it functions well in case of the valuation of investment funds. Fair value generally provides an indication or signal before the occurrence of the financial crisis and therefore the companies are required to adopt necessary measures for avoiding the financial crisis or the credit crust in the economy. The application of the fair value accounting has exacerbated the economy leading to the situation of crisis. Therefore it has been observed that it is required to adopt regulation for loosening the constraint in case of the crisis in the economy. References Abbas, A. M., 2012. Wiley International Trends in Financial Reporting under IFRS, Canada: John Wiley & Sons. Ball, R., 2006. International Financial Reporting Standards (IFRS): pros and cons for investors. Accounting and Business Research, 14(2), pp. 956-960. Banerjee, B.K., 2010. 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