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A 7 pages term paper on Accounting Hot Issue


Introduction:

         The essence of accounting theory and practice lies in the fair presentation and explanation of the financial affairs of a company. The responsibilities of an accountant today are much more than what it was ever before. The reason for this increasingly important role of accountants is the increasing size and complexity of American businesses. The importance of economic role played by the government is has also further made the job of an accountant to be more important. To meet these challenges, accountants are expected to have a logical and reasonable set of accounting rules or body of accounting theory. This theoretical structure should be developed by keeping in mind the economic environment and the needs of the business entities with respect to financial reporting issues. In this paper we will discuss one of the major and most important issues of financial reporting i.e. Fair Value Measurement.

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Fair Value Measurement:

Definition:  

Under GAAP, the fair value of an asset is the amount at which that asset could be bought or sold in a current transaction between willing parties, other than in liquidation. On the other side of the balance sheet, the fair value of a liability is the amount at which that liability could be incurred or settled in a current transaction between willing parties, other than in liquidation.

         The best means of estimating the fair value of any product is to find out the market price of that product in the current market. This value is the best measurement of the fair value of any product. However, it is not necessary that the current market price for any product can be known. In some circumstances, the current market price of any particular cannot be known. In such a case, an estimate of the fair value is made on the basis of the most relevant information available regarding the product. However, it is not easy to make such an estimate.

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         The requirement of implementing the fair value instruments in financial reporting is considered to be one of the major contributions, on behalf of the FASB, towards the advancement in accounting practices. To make things more improved and efficient, the FASB has used an incremental project approach. However, this approach has brought the business entities to a situation of difficulty in dealing with a mixed attribute model. The lack of knowledge regarding the approach to be used to apply the model to unique new transactions is the major difficulty faced. An inconsistent model in the financial accounting text is the primary reason for the existence of this problem. This is the reason that the FASB is continuously insisting to use the fair value measurements in all financial reporting instruments. In this way, a single model will provide the investors a much better opportunity to analyze and evaluate a company’s performance. The FASB need to educate the financial reporting practitioners about the impact of fair value measurement on financial reporting.

         One more issue to be considered while talking about the fair value measurement method is that of relevance. The most important aspect in today’s dynamic and fast changing markets is the knowledge of an assets current market value or worth. The fair value measurement approach fully supports this declaration. It has been argued by the FASB that the most relevant and appropriate measure for financial reporting practices is the fair value method. The FASB has been continuously insisting on the use of fair value approach in all financial reporting practices.

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         It is assumed that the fair value approach can provide more relevancy, accuracy and precision financial reporting as compared to the historical cost based approach. It is claimed that if the fair value method might have been implemented before as well, the investors, regulators and other entities involved in business may have avoided some of the major losses that they have experienced and had paid a high price for it during the slowdowns of the economy, in the past. Though it is claimed that the fair value approach is more relevant as compared to other approaches, but there are some experts who believe that the fair value method lacks the level of reliability needed in financial reporting and there should be some focus on the issue of reliability as well. The issue of reliability should not be ignored as well because any information to be used for making any business decision should necessarily be reliable. If any information is relevant but not reliable then it is not a useful piece of information in that case as it cannot be used for the purpose of making any decision. Any unreliable information used for business decision-making means that the user of that information is exposing him or her to a huge risk. 

         Paragraph 58 of FASB Concepts Statement No. 2 explains, "That information should be reliable as well as relevant is a notion that is central to accounting. It is, therefore, important to be clear about the nature of the claim that is being made for an accounting number that is described as reliable." (Fair Value)

         This paragraph explains very clearly the importance of reliability and relevancy and the need to keep a balance between relevance and reliability.

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         It is also important to keep in view the view point of the users of the financial reporting instruments i.e. investors, regulators etc. It should be known that whether these entities prefer to use financial instruments based on fair value or on the historical cost approach. The FASB has already considered the opinions of the users of financial reporting instruments with regards to the issue of using fair value or historical cost approach, as a part of their exercise to implement their fair value project. The result to their study was in the form of mixed responses i.e. some preferred the fair value method while some preferred historical cost approach. A majority of the respondents said that they would use both methods. The argument for preferring both approaches was that the fair value approach helps them in determine the current worth of their investments and assets. On the other hand, the historical cost method helps them in analyzing their past performances and to measure the past cash flows. It also helps them in determining that whether the company successful in meeting it’s financial objectives and have achieved the predicted operational targets. The fair value information is important for the investors but historical cost information is of the same importance for them. Getting fair value information at the cost of historical cost information is not a very pleasant idea for investors. There is a need to educate the investors and other end users of the financial information as to what the concept of using fair value approach actually is with respect to the financial reporting practices. The more they will be aware of the significance of the fair value approach the more likely are the chances for the acceptance of the fair value method as the single approach for financial reporting.


References

Speech: Fair Value: from the World Wide Web: http://www.sec.gov/news/speech/spch436.htm (referred to as Fair Value)

Fair Value: from the World Wide Web: http://www.actuary.org/pdf/finreport/fasb.pdf

Fair Value Accounting: from the World Wide Web: http://www.bba.org.uk/html/1922.html
 
 


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