Author Archives: raviraj.tarale

Every one of us is familiar with the adage honesty is the best policy. In business honest behavior can be profitable in the long run. The only question that remains is how to quantify honesty and ethics. Till not so long ago, investors used the financial statements and the history to measure a firm’s future performance. However, as stated in the article investors lost billions of dollars by using this measure because the numbers on the financial statements were easy to play with. Accrual accounting was adopted so that the financial implications of a transaction were reflected on the statements as soon as the transaction took place. However, I believe it is the fair value accounting (FVA) that made comparisons and future estimations more reasonable.

The article sights that the reason people do not advocate FVA is because they believe it will add to accounting inaccuracies. May be FVA predicts future performance inaccurately but is estimation the only thing for which FVA is useful. I don’t think so. For example, as an investor I would prefer to have a current value of all the assets and liabilities for the firm I choose to invest and FVA definitely serves my purpose. FVA also helps the managers to divert a firm’s working capital appropriately according to current market conditions which in turn would reduce operational risks. Irrespective of what the antagonists say, I would consider myself as a proponent of FVA. Fair value accounting is the best method to determine future performance of a firm if the subjective factors associated with it are taken care off. Subjective factors include but are not limited to analyzing risk characteristics and return on investments. There are many cases in which the managers used FVA as a tool to inflate financial statements but it’s due to lack of internal controls. This could be avoided with proper auditing.

I think FASB‘s decision to devise a hierarchy for FVA is crucial. David Bianco’s concern could be alleviated if firms explicitly add footnotes stating their assumptions while calculating the fair value for instruments of lower hierarchy. Finally I consider accounting to be highly subjective but this should never be a reason for not using FVA. On the other hand, objective factors such as production costs, inventories should be strictly monitored to get closer to actual estimates.