Measurement In Accounting Is A Complex Area - Essay Example

Measurement in accounting is a complex area. Measurement issues generally, and in particular the use of fair value measurement, have contributed to the current Global Financial Crisis” On a purely theoretical plane it is correct to assume that there can be many acceptable ways of "accounting"- an act of explaining business realities to multiple stakeholders of socio-economies (Biondi and Suzuki, 2007). The global financial crisis that started in the US with the sub prime crisis a year and half back has translated to a full blow recession and a global economic crisis which has resulted in the collapse of the one of the best known financial institutions of the world (Lehman Brothers) and an emergency bailout for many other giants like CitiGroup and General Motors. Presently, the recession is ebbing but recovery is still a long way off. When at its peak, the global financial crisis engulfed Wall Street and caused stock collapses the world over. One of the better-known prospective casualties of the crisis along with certain institutions would probably be the fair value measurement method of accounting. The system of fair value stands in direct contrast and was perceived to be the logical development of the method of historic cost that is defined as the amount of money or equivalent sacrificed to obtain an item. The fair value in essence is an exit value measurement One of the key challenges of the system of fair value is the issue of objectivity. The subjective nature of the process ensures that it is independent from management and determined by market forced. This is the case only when and IF there is indeed an active market (Drever, Stanton and McGowan, 2007). The problem basically is that fair value is a reflection of the market prices and hence cannot be reflective of the real value of the product-the market prices is representative of the expectations of the buyers and the sellers in the market. The problem therefore would be with respect to the fact that if accounting is to challenge the price bubble, it must not be influenced by bubble prices. The method of accounting that had once brought wealth to the Wall Street regulars is now causing them to balk at its mere mention. The issue at stake here is that the new found allegations that question the ability of the fair value method to be able to objectively show the value of the assets; there is also the problem of the belief that it was this method of accounting that made many look “ugly" during the crisis affecting company reputations and in turn having a none-to-positive impact on financial performances, or investors’ confidence. The global financial crisis led to a debate heretofore unseen on the advantages and the problems that would define the fair value system of accounting measurement. The debate has also triggered off one of the most exhaustive trends of research in modern times-the quest of discovering the weaknesses of the system and whether or not the system was actually a contributor to the global financial crisis (Laux and Leuz, 2009). One such debate identifies four major factors to be placed under consideration in this context. First and foremost, there is the issue of the fact that much of the problems in the past two years have essentially been manifestations of the fact that there is a prevailing sense of confusion about the intricacies that define the novelty factors inherent in FVA. The second point of concern raised by the authors is the fact that while it is correct to presume and to validate some of the concerns about marking accounting standards to the standards prevalent in the market, it would also be incorrect to assume again that given the financial crisis the IFRS or US GAAP systems would be of any help. Moreover, the method of historical cost accounting (HCA) is yet to prove its worth as a likely candidate for replacing FVA, given the fact that there already exist problems with the implementation of and could indeed be a lot more difficult to deal with than even the FVA. Last, although it is difficult to fault the FVA standards per se, implementation issues are a potential concern, especially with respect to litigation. Worse still, some people believe that the international accounting standards’ provisions for the fair value are one of the culprits that causing the financial crisis. The sound was immediately received by a number of financial industry and members of Congress. So they combined to pressure the government and require fair value measurement method will be changed back to historical cost method in order to stabilize the people's hearts. Fair Value Measurements and Financial Crisis: It is required by the American Fiscal Accounting Standard, rule Number 157 and its relevant guidelines that they’re by three basic levels of fair measurement applicable in the process of corporate accounting. These include (Santon and McGowen, 2007): First and foremost, fiscal merchandise with assets in the form of a process of market transaction that is alive and active-the idea here is that the fair value of a product would be measured by the existing market value of the product in question The second element important in the context of the fair value measurement of a product is that if there is no value measurement available for a given product then the accounting assessments would be made backed by the fair value of the similar products that are available in the active trading market. The method could also use the models of value measurement, which would then be supported by an objective reference value. The third aspect of the FAV model which is also perhaps one of the most controversial aspects of the accounting system is that if there is no acceptable method of valuation for an asset or an acceptable valuation available on the active trading market, it is acceptable to agree with the fair value of the product that has ultimately been established through the subjective valuations of the involved parties and the market assumptions. The idea in this context therefore basically is to state that the most reliable inputs are usually those that are the results of active markets such as stock prices quoted in public markets. These inputs owe their reliability to two basic factors: -- They come from external sources rather than being developed internally by the management and -- They involve numerous market participants-this is in fact the defining features of the active market Factors adding to crisis: Before the financial crisis and the global recession actually took affect, the first level was the method of valuation where assets were concerned. With the outset of the crisis however the situation changed given the fact that the crisis automatically made it difficult to arrive at exact asset valuation. The real market became inactive, thereby bringing into effect the marking that in case of an inactive market the third level would come into the picture. Given the fact that much of the valuations methods asked for the third level are subjective there is a turned to continue with valuations in keeping with the first level which has again led a tangible departure in the value of assets and derivatives from the real value to their accounted value, thereby showing a loss of liquidity and assets and hence a loss of overall profits-deepening the tend of the crisis. The problem has been that most assets that have valued based on the FAV methods have been undervalued, leading to a dilution of investor confidence. One would be unfair if one was to lay the blame for the crisis and its deepening trend through 2008 and 2009 solely at the FAV accounting technique’s door for much more than being the culprit the method was a catalyst for the crisis. The problem was not the issue of assessing and recording fair value but with respect to the fact that since the crisis started during the peak months of the now ebbing financial crisis, the active trading market did not even exist, which therefore meant that the fair valuation of the product was not even determined by the factors such as stock prices. The problem with the method could be understood in the context of the fact that under a comparatively free atmosphere, corporate management is expected to react to community and shareholders anticipations by revealing personally sensitive information when their company is placed in a situation of higher shareholder and public scrutiny and when it is structured to meet expectations of good corporate governance (Liu and Taylor, 2008). The idea here therefore is that the method of fair value accounting essentially opens up the playing field for valuation, making its flexible and vulnerable to the ethos of the market, open to movement and changes that are brought about by variables ranging from performance to simple public perception. In an atmosphere of increasing doom therefore, with the collapse of stocks, the method is bound to increase uncertainty and panic just like at a time of boom it is likely to multiply euphoria. References: Biondi, Y & Suzuki, T. (2007), 'Socio-economic impacts of international accounting standards: an introduction', Socio-Economic Review: Special Issue. The Socio Economics of Accounting. 5(4). pp. 585-602 Laux, C & Leuz, C. (2009), 'The crisis of fair-value accounting: Making sense of the recent debate', Accounting, Organisations & Society. 34(6-7). pp. 826-834 Liu, J. and Taylor, D. (2008). 'Legitimacy and corporate governance determinants of executives' remuneration disclosures', Corporate Governance. 8(1). pp. 59-72 Drever, M. Stanton, P. & McGowan, S. (2007). Contemporary Issues in Accounting. John Wiley & Sons Australia Drever, M. Stanton, P. & McGowan, S. 2007, ‘Contemporary Issues in Accounting’, John Wiley & Sons Australia. Pp99-105 Read More