What are the benefits & disadvantages of fair-value accounting?
Fair value is the price for which a company could sell a liability or an asset. Many accountants use fair value as a means of financial measurement and apply it to the price of hypothetical or real transactions in the marketplace. In this context, accountants make various businesslike and reasonable assumptions.
However, commentators have pointed out that disadvantages sit alongside the benefits of fair-value accounting.
Fair-value accounting examines all the available information about a liability or asset. This means that the fair-value price of a liability or asset allows for any risks and expectations from businesses and consumers within the market. The result is a reasonable market price at a given point in time. Accountants can use this information to make accurate comparisons of fair-value prices for the same liability or asset over a period of months or years.
As well as providing accurate prices for comparison, fair-value accounting gives investors the chance to assess liabilities and assets in a clear and equitable manner. Advocates of fair value suggest this creates efficiency by revealing valuable information and imposing greater levels of discipline within the market. They also point out that fair-value accounting supports the trend towards improved levels of transparency in financial reporting, thereby helping to create internationally-accepted standards of accounting practice.
Critics of fair-value accounting say that accountants may not be able to obtain fair values for all the liabilities and assets of a company. Similarly, fair-value comparisons among companies could be hard to make if teams of accountants use subjective assessment criteria for risks and expectations. Critics also believe that fair value estimates do not always allow for economic trends or anticipated cash flows. As a result, the estimates do not reflect fundamental economic principles.
Some detractors also argue that fair-value accounting evaluates liabilities and assets from one particular time to another and therefore fails to account for liability or asset appreciation. Another disadvantage that critics highlight is the expense of making regular valuations of liabilities and assets. In response to such disadvantages, fair-value supporters blame the way some companies use mixed attribute accounting. This combines fair-value methods with cost-based accounting. In the process, it creates confusion between accounting methods, undermines the fair-value approach, and raises costs.
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