Fair Value of Accounting - Research Paper Example

Fair value accounting has cemented its place really well in the world of accounting on the grounds that it gives more relevant information to users. This method is a realistic approach that gives the actual worth of an entity. According to Patricia McConnell1, fair value accounting method requires the preparers of financial statements to adjust them according to the fair values. This requirement helps the investors to make a better analysis of financial statements. The primary objective of financial statement analysis is the comparative measure of risk and return.

General purpose financial statements do not provide the required data for this comparative analysis without significant adjustments. A clearer picture of financial statements provides the investors with a chance to make good decisions. “…fair value accounting method gives fair value estimates and discloses a range of possible outcomes which may help a sophisticated investor but at the same may plague the unsophisticated investor with ambiguity and information overload.” Fair value’s biggest drawback, and the major reason of its opposition, is the lack of reliability.

It is because unless an asset is exchangeable in an arm’s length transaction, its value would always be an estimate. According to a study by Avinash, Arvi & Alan Reinstein3, critics have argued that fair value accounting method aggravated the recent crisis by requiring significant write-down of assets and hence resulting in sharp decreases in regulatory capital of banks and other financial institutions. Fair values tend to fluctuate vastly in a short period at times. According to Michael Power4, there are many arguments against the fair value accounting method but they don’t automatically become arguments in favor of historical cost accounting method.

The definition of fair value shows that it is the amount which might be obtained in a market. Various commentators have argued about