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In a recent article in the Financial Times, Jonathan Ford argues that accounting information has become significantly less useful over time due - at least in part - to the increasing use of fair values over historical cost. He states: “The use of fair values tends to accelerate the recognition of profits, introducing procyclicality because the prices themselves bake in estimates of anticipated earnings as well as what has actually been realised to date.”
Such criticisms of fair value are not uncommon. In their December 2018 report on reforming the audit industry in the UK, Prem Sikka and colleagues implicate fair value accounting in major corporate collapses, such as Carillion and BHS. They point out that “the adoption of Fair value Accounting (FVA) imports speculative capital market valuations into both earnings and a variety of asset classes held on company balance sheets”. (Though they also cite pension deficit values without observing the related inherent uncertainty). Fair value accounting is again linked to the financial crisis: “The banking crash showed that fair value accounting over-emphasised the returns in boom years and thus mispriced risks and investment in the economy. In the bust years, risks are under-emphasised and investments were still mispriced.”
Against the background of such claims, it is reassuring to see that academic discussion of fair value accounting continues. In a recent collection Companion to Fair Value Accounting published by Routledge, Gilad Livne and Garen Markarian have assembled a comprehensive set of discussions by distinguished academic and professional commentators (contributors include the Chief Economist of the Bank of England and the Director of Research at the UK Financial Reporting Council, as well as highly experienced academics).
After the opening discussion of whether fair value increases systemic risks, the collection is presented in four main parts: (i) Standards and conceptual issues; (ii) Fair value, risk and financial crisis; (iii) Development [of fair value] and (iv) Specific topics. Inter alia, the latter includes discussions of fair value from a manager’s perspective, the role of fair value in executive compensation and tax implications of fair value accounting (which has received comparatively little attention in the literature).
The collection contains thoughtful and original analyses that even seasoned commentators on fair value will benefit from reading. It raises important questions about whether fair value standards have gone too far or not far enough, the role of entity-specific or market perspectives, whether fair value is suitable for all varieties of capitalism, whether foxes should guard the henhouse and how fair value taxation may affect investment decisions.
Nobody will come away from reading this collection with the view that fair value accounting is perfect – far from it. However, through its careful consideration of the various contingencies that affect the performance of fair value and - very importantly - the performance of the alternative measurement bases, readers will entertain a more enlightened view. Virtually everyone will have some sympathy for the mixed measurement model accountants have ended up with.
Routledge, the publishers of The Routledge Companion to Fair Value Accounting, have kindly made two chapters freely available for a limited time for users of the ARC. They are also providing ARC members with the chance to win a free copy of the book in a prize draw, where there are also three runners up prizes of £50 worth of Routledge book vouchers. To enter (by March 31), visit this link.