07_JAF XXXXXXXXXX
Journal of Accounting,
Auditing & Finance
2016, Vol XXXXXXXXXX–591
�The Author(s) 2016
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DOI: XXXXXXXXXX/0148558X XXXXXXXXXX
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The Pros and Cons of
Fair Value Accounting in a
Globalized Economy: A
Never Ending Debate
Antonio Ma
a
Abstract
Fair Value Accounting is not a new concept, either in business decisions or in financial report-
ing. Nonetheless, due to big changes that took place over the last 20 to 30 years in the
worldwide economy and the influence of the 2007 financial crisis, it has reemerged as one
of the ‘‘hottest topics’’ on the agenda of Accounting Standards setters both under U.S.
Generally Accepted Accounting Principles (GAAP) and International Financial Reporting
Standard (IFRS). Cu
ent research seems well balanced across the pros and cons of fai
value, lending ammunition both to those ‘‘in favor’’ and to the ‘‘opponents’’ of fair value
accounting. Subjectivity, estimates, and managerial discretion permeate the concept, defini-
tion, and measurements of fair value, leaving such measurements open to an aggressive use
of judgment and estimates. However, fair value accounting is more closely related to the
needs of a globalized and information-based economy and is likely to grow in importance
and use in the future. This article discusses evidence and summarizes some cu
ent papers
on the informational impact of fair value measurements on market participants.
Keyword
Fair Value, Fair Value Accounting, Fair Value Measurement
Introduction
The concept of Fair Value is not new: It dates back at least to the past century (Zyla,
2012) and its application to accounting is increasing in scope (Barth, XXXXXXXXXXNonetheless,
opinions on Fair Value are conflicting (Laux & Leuz, 2009) and there is considerable room
for documenting and analyzing the trade-offs resulting from the application of fair value in
different economic settings. In favor, the main argument is that the Fair Value reporting
fulfills the need for more decision-useful financial information given the increasing com-
plexity of a globalized and innovation-based economy (Barth, 2006; Zyla, XXXXXXXXXXSome
others, instead, see the use of fair values on balance sheet as controversial because they
equire model-based estimates using management’s expectations and projections as inputs
(among others, Hughes & Tett, 2008; McCreevy, 2008; Penman, XXXXXXXXXXThis article
1Universitá Bocconi Milano Italy
Co
esponding Author:
Antonio Ma
a, Universita’ Bocconi Milano Italy.
Email: antonio.ma
XXXXXXXXXX
Article
presents evidence concerning the strengths and weaknesses of fair value accounting, both
in general and on the basis of a set of papers selected for presentation at the Journal of
Accounting, Auditing, and Finance (JAAF) conference in India.1
On their side, the Securities and Exchanges Commission (SEC), the Financial Accounting
Standard Board (FASB), the International Accounting Standard Board (IASB), and other reg-
ulators have revealed, through actions, their moderate, but unambiguous, preference fo
eporting fair values. Over the last decades, standard setters have issued many new guidelines
for the measurement, recognition, and the disclosure of fair value estimates for assets and
liabilities (Barth, Landsman, & Wahlen, XXXXXXXXXXStarting with an initial focus on financial
instruments, the FASB and the IASB have progressively considered fair value as a possible
measurement attribute in almost every standard, including revenue recognition, business com-
inations, insurance contracts, and in the conceptual framework, as well (Barth, 2006).
This gradual process of widening the scope of fair value measurements ran into a critical
storm during the financial crisis of 2008. Many scholars argued that the use of fair values
increased pro-cyclicality leading to market bu
les and crashes and suggested that it was
etter to use historical costs (Allen & Carletti, XXXXXXXXXXOthers, however, suggested that
sales-type accounting for derivatives was the true underlying reason for distorted financial
statements (Bryan, Lilien, & Sarath, XXXXXXXXXXIn any case, there were serious critical ques-
tions raised about the market consequences of reporting assets and liabilities at fair value.
Cu
ent research on the consequences of fair value continues to be inconclusive and dis-
agreement on the topic exists, both theoretical and empirical. The relevance of fair value
measurement is largely grounded on the concept of market efficiency. In recent years, effi-
cient market theory has been challenged and, of course, if markets are inefficient, even
Level 1 valuations become suspect.2 Nonetheless, even acknowledging fair value account-
ing drawbacks, a return to historical cost accounting is considered unlikely to happen
almost unanimously and not to be the proper response to fair value concerns.
For assets and liabilities that are not traded in liquid markets, (discretionary) managerial
estimates become central to the measurement of fair values.
However, a detached and uncritical analysis on fair value accounting suggests that this
accounting change is simply the natural evolution of accounting standards which follows,
and better serves, the evolution of assets and liabilities used in cu
ent economy, which has
substantially changed in the last few decades.
Changing Economy, Globalization, and Capital Markets: Toward
Fair Value Accounting
Fair Value Accounting is not a novelty as far as financial reporting requirements are con-
cerned and the concept of Fair Value has been evolving for more than a century (Zyla,
2012). Indeed, in a U.S. Supreme Court case that dates back to the 19th century,3 we can
find an enlightening discussion about concepts and meanings underlying Fair Value.
To ascertain that value, the original cost of constructions, the amount expended in permanent
improvements, the amount of market value of its stocks and bonds, the present as compared to
the original cost of construction, the probable earnings capacity of the property under particula
ates prescribed by the statute, and the sum required to meet operating expenses, are all matters
for consideration, and are to be given such weight as may be just and right in each case. We
do not say that there may not be other matters to be regarded in estimating the value of the
property. (Smyth v. Ames, 1898)
Ma
a 583
As can be seen, this statement of the U.S. Supreme Court clearly refers to several Fai
Value measurement concepts that are cu
ently in place and embedded in most of the
Accounting Standards at worldwide level such as market approach, economic value,
expected income, and the application of judgment in many value assessments.
Over time, the FASB, the IASB, and several other local Standard Setters have issued
hundreds of statements that use Fair Value to measure companies’ resources. And, even
when Fair Value is not required—and Financial Statements are prepared according to othe
measurement systems (such as historical cost)—there are chances that Fair Value disclosure
elated to some items will be required in the notes to the Financial Statements.
The information revolution that has characterized the global economy over the last
decades has accelerated the inclusion of Fair Value measurements into financial reporting.
Changes such as Internet, computers, and media channels have determined a twofold shift
in cu
ent economic activity: (a) innovation, which has generated industries that did not
exist before and has moved the economy from a ‘‘hard’’ (
ick) one to a ‘‘soft’’ (informa-
tional)-based one and (b) rapid communication, which has enabled mobility of people,
information, and capital across countries resulting in a globalized economy.
Innovations have increased the awareness that value drivers of many business activities
are embedded into intangible items (i.e., intellectual properties, rights,
ands, etc.) and not
just into tangible ones (such as inventories and Property Plant and Equipment [PPE]). In
this framework, since the 1990s, users, policy makers, standard setters, and market partici-
pants have figured out—at different speeds and stages, and with divergent outcomes—that
Financial Statements might not have been able to properly measure companies’ values
(Lev, XXXXXXXXXXThe reason may be that accounting principles were mainly developed during
the industrial age and do not reflect the needs of an economy where modes of production
change very rapidly.
Globalization, since the 1980s, made international financial market transactions and
cross border investments much easier. The International Monetary Fund (IMF) defines eco-
nomic globalization as ‘‘a historical process; the result of human innovation and technologi-
cal process. It refers to the increasing integration of economies around the world, particularly
through the movement of goods, services and capital across borders.’’ To allocate capital effi-
ciently on a global scale, market prices should be the result of the proper assessment of all
the available financial information pertinent to rapid decisions. Both the increased value of
intangible assets in business and the greater need for information—which is relevant fo
acquiring or disposing these intangible assets—have led to a demand for Fair Value account-
ing in financial statements.
The ability to co
ectly evaluate critical accounting items such as intangible assets, and espe-
cially goodwill, turns out to be of great importance in light of the fact that in December 2007,
the constituents of the S&P 500 reported in their accounts e1.2 trillion in goodwill and e0.6
trillion in intangibles other than goodwill overall. On the same date, the constituents of the EU
STOXX 600 reported e1.0 trillion in goodwill and e0.5 trillion in specific intangibles overall.
(Bini & Penman, XXXXXXXXXXP 11)
The 2008 financial crisis accelerated the commitment of regulators, standard setters, and
practitioners for providing decision-useful financial information regarding large and rapid
changes in market values to all firms’ stakeholders. The introduction of new accounting
standards that were more Fair Value oriented came also as a response to public opinion cri-
ticisms to the ability of the accounting rules to prevent financial scandals. Combined
584 Journal of Accounting, Auditing & Finance
together, these factors led to a reevaluation of asset and liability measurements that we
explore in the next section.
Fair Value Accounting: Definitions and Measurement
Starting as a specific remedy for the inaccuracy of cost-based measures of certain financial
instruments, fair value has become the dominant measurement paradigm for non-financial
items as well (Hitz, XXXXXXXXXXEven the opponents of fair value recognize that cost- and trans-
action-based reporting model is in decline, and a new market-value and event-based model
is developing, with dramatic implications for the role and the measurement properties of
alance sheet items and, thereby, accounting income.
Despite different wordings, the definitions and meanings of the term fair value are basi-
cally equivalent in FASB and IASB pronouncements.4 The general FASB definition on
Section XXXXXXXXXX1B of Topic 820—Fair Value Measurement—states that the objective of
fair value measurement is,
to estimate the price at which an orderly transaction to sell the asset or to transfer the liability
would take place between market participants at the measurement date under cu
ent market
conditions.
The IASB framework, at present, does not include any official definition of fair value,
yet a uniform definition can be found at standards level5:
Fair value is the amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length transaction.
The FASB/IASB considers fair value as a specific hypothetical