There are several approaches to financial reporting used by businesses today, and one of them is fair value accounting, which is a method that allows for the measurement and reporting of assets and liabilities on their actual or estimated fair market prices. As asset liability changes over time, there could also be unrealized asset gains or losses. Basically, this accounting approach helps with measuring and charting those gains. Like any other accounting practice, fair value accounting also has its own set of pros and cons that should be considered before it should be fully adopted.
List of Pros of Fair Value Accounting
1. It is an accounting standard agreed by most people.
This accounting method accurately tracks all kinds of assets, from the smallest piece of equipment to a huge land, unlike historical cost value that is not always accurate especially after a long period of time. This makes such a practice the “most agreed upon” accounting standard, as set prices will not be the same due to monetary inflation.
2. It offers a measurement of real income.
With this approach, there will be fewer opportunities for people to manipulate accounting data. Rather the using the asset sales to affect gains or losses, it tracks price changes based on actual or estimated values. Changes to income occur with changes to asset values, which will then be reflected in the final numbers of the net income.
3. It allows for accurate valuation.
Fair value accounting helps ensure more accuracy in terms of current asset and liability valuations, so if price increases or decreases are expected, then so as the valuations. And if sales are closed, then there will not be discrepancies to be charted if the valuations differ from the transactions. In this method, current market prices let businesses and individuals know exactly where they should stand.
List of Cons of Fair Value Accounting
1. It can lessen investor satisfaction.
Not all investors do not always notice that a business is using fair value accounting, which can result in dissatisfaction among them due to the loss of net income value becoming a loss in income. Since a lot of investors trade commodities, rather than using them for investment, there will be a huge hit on their portfolio, causing these people to stay away from the business in question altogether.
2. It can create downward valuations.
If a business experiences a decrease in net income due to asset losses, it can create a domino effect throughout an industry or a region. These downward valuations can often trigger unnecessary selling because of market volatility. When fair value accounting is not used, then downward valuations will not happen, and there will be more investor stability.
3. It can cause huge swings of value throughout a year.
Not all businesses benefit from this accounting method, especially those with assets often fluctuating in value throughout the year. Take note that volatile assets could report income changes that are not actually accurate in the long term, creating inaccurate gains or losses in the short term.
Based on the pros and cons listed above, it would mean that fair value accounting provides businesses an accurate and transparent method of tracking profits and losses. But if investors are not kept in the loop and not informed of what is going on, the benefits would not outweigh the drawbacks. On your end, do you think this practice is good for business, or not?
Crystal Lombardo is a contributing editor for Vision Launch. Crystal is a seasoned writer and researcher with over 10 years of experience. She has been an editor of three popular blogs that each have had over 500,000 monthly readers.