Fair Value Accounting - Essay Example

Since then, the pros and cons of fair value accounting have been debated. On one hand, fair values provide a better view of current market conditions and therefore provide him with more relevant information. However, on the other hand it increases volatility in earnings and may not necessarily ensure reliability and relevance. This is because if an active market does not exist, it would be determined by calculations which are subject to management bias. While some people argue that fair value accounting provides us with truer financial statements, others question its validity.

Hence, those institutions that use more and more of fair value option should also disclose adequate information regarding the assumptions, changes in acquisitions or sales, predictions and all those factors that affected the values that show in the financial statements as fair values. This would enable the users of financial statements to make knowledgeable and wise decisions. Fair value accounting is a way of accounting in which an asset or liability is valued at its current exchange price at a measurement date, in absence of an actual transaction for that asset or liability.

In financial statements, all financial instruments may be valued at fair value. Before 200. The statement defines fair value of an asset as the price at which it can be traded or sold in an orderly transaction between 'market participants', other than in insolvency. Similarly, fair value of a liability is the amount at which it can be acquired or settled in an existing transaction between 'market participants', other than in insolvency. (KPMG, 2007) Market participants refer to buyers and sellers in the most principal or beneficial markets for those assets or liabilities.

They meet four criteria: they are unrelated with the reporting body; they possess the knowledge required to have a realistic insight into the transactions; they are financially and legally able to carryout transactions for the entity; they are prepared to transact without any pressure. (KPMG, 2007)Principal market is the market with maximum volume and level of activity where assets and liabilities are sold or traded by a reporting entity. An entity that does not have a principal market determines its most beneficial market by including the transaction costs.

(KPMG, 2007)ExplanationFair value of an asset may be equal to its quoted market price. However, this may not always be true. Fair value takes into account advantages and disadvantages that each party may gain from the transaction whereas market value may not always consider that. Also there might not be a quoted price for all assets or liabilities. In such circumstances, fair value has to be generated using the best information available to the preparers. Consequently, difficulties arise in creating those estimates.

(KPMG, 2007)In accounting, fair value is used for those assets or liabilities whose carrying value is rooted in mark-to-market value. Carrying value is the amount