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While at Ben E. Keith they had me working on many balance sheets. I realized that there are many items that use the Fair-Value accounting. The items I mainly saw that had to accounted under the fair value system was the property that Ben E. Keith was sitting on and the heavy machinery and warehouse items they used. The biggest concern about having the right number for these items, and how much they really are if the company where to sell them is tricky. If the company was going to use the GAAP way of accounting for Fair-Value then they could use the Historical cost method but the FASB says to use the market price of the land and present day events to measure the value of the land. This is where it's difficult to determine what is best for the company and the investors especially during an ill economy.
Table of Contents
Fair value accounting is used in every company and most people never even hear about accounting standards on the news, but Fair value accounting is in such high debate it is on the front page news. The United States along with other countries the world must value there assets with the historical cost (GAAP) or with the market value (FASB). Ben E. Keith along with others has millions of dollars worth of assets that they have on their balance sheets and report each year to the SEC. This reporting of these assets can be valued wrong. This is why there is a major debate what type of method people should use to find out the value of these assets.
Among the traditional models for valuing financial instruments, the most widely used has been called mixed model, in which instruments held for trading purposes are marked to market (i.e. valued at market price) while the rest are registered at their historic cost. Against this is the fair value method, in which the majority of financial instruments are recorded at their market value.
It has only been lately that this problem has arisen to people's attention if Fair Value Accounting is good for investors because of the Market Crash and the ill economy. If companies put down the low value of the assets during the down economy what might happen to the company and how it will affect investors is it good or bad to use fair value? Or problems like if the banks wrote down lower asset values that are only temporary what will happen to them? These are all debates and problems people and companies are having with the Fair Value accounting.
This first thing to do to understand the problem is to understand what GAAP says about fair value. GAAP would use normally two types of fair value methods. Historical cost and Amortized value are the two most common ways that companies and people would use to find out the fair value when making a security trade/transaction. They would use these mainly because it was cold solid proof that the transaction amount was bought at that price so they can use that price. Further down is the break down and the meaning of both Historical cost and Amortization.
The definition of Historical cost is (SumÂ ofÂ moneyÂ that was (or is assumed to have been) spent, on aÂ purchaseÂ or anÂ operationÂ of a company.Â HistoricalÂ cost does notÂ takeÂ the effects ofÂ inflationÂ intoÂ account, and ignores theÂ replacement costÂ of theÂ resourcesÂ consumed. Although (inÂ inflationaryÂ times) historicalÂ costingÂ canÂ leadÂ to inadequateÂ allocationÂ forÂ replacementÂ of assets, it is a very usefulÂ conceptÂ by virtue of being based onÂ fact. (Business Dictionary)
To better describe the way GAAP would find the Fair value of an asset in the Historical cost is say that company A bought land for one million dollars and they mark that in their balance sheet. Later down the road they would still have that land set at one million dollars because it is the historical cost and most of the time they would have that has their basis. Even though the land is worth much more now, but the historical cost is a hard copy fact of what the price was and so companies could not miss represent the price of the land and have their assets worth more than they are.
Most companies would also use Amortization on their assets. Amortization can get pretty confusing to a lot of accountants. The most clear definition found is amortized value of anyÂ stock exchangeÂ security, which is determined by the process of amortization. Amortization is understood to mean the gradual depletion of a liability from the company's portfolio, such as aÂ mortgage, loan, or lien against the company's property. The reduction of the liability occurs when the company makes regularly scheduled payments over a time specified in an agreement or contract. These payments are usually calculated to pay off both the principal owed and any interest that is occurred during the specified period. Just like when you buy a house through a bank? it is amortized to be paid back by a specific date. (Business Dictionary)
These two ways are the old ways that GAAP would mainly use for financial value finding and recording. They are very reliable because they have a lot of facts backing them up but the problem was they had a hard time keep up with the actual value of the item.
FASB has issued many standards and revisions in the past few years to help the use of or provide guidance for calculating fair-value measurements. The change from prior practices signifies to many a purposeful movement away from historical-cost financial statements and Amortization so they are moving toward fair market value accounting.
The Fair Value method from FASB is financial assets are reported at current or market value (commonly referred to as "mark to market"). Market value is the price at which buyers and sellers would be willing to transact for a particular asset.
When markets function with normal liquidity and robust capital flows, fair value is simple: the current market price for a particular asset is the one reported based on transactions occurring that day. This is where it starts to get the companies and people upset about the fair value method of FASB because in a good economy the method is great but in a down economy it is a little more difficult. In result of the bad times FASB has continuously published new revisions. Here is a good example of how many time they changed the method.
The Financial Accounting Standards Board defines it as
"The framework for measuring fair value considers the concepts in FASB Concepts Statement No.Â 2,Â Qualitative Characteristics of Accounting Information.Â Concepts Statement 2 emphasizes that providing comparable information enables users of financial statements to identify similarities in and differences between two sets of economic events.
The definition of fair value considers the concepts relating to assets and liabilities in FASB Concepts Statement No.Â 6,Â Elements of Financial Statements,Â in the context of market participants. A fair value measurement reflects current market participant assumptions about the future inflows associated with an asset (future economic benefits) and the future outflows associated with a liability (future sacrifices of economic benefits).
This Statement incorporates aspects of the guidance in FASB Concepts Statement No.Â 7,Â Using Cash Flow Information and Present Value in Accounting Measurements,as clarified and/or reconsidered in this Statement. This Statement does not revise Concepts Statement 7. The Board will consider the need to revise Concepts StatementÂ 7 in its conceptual framework project.
The expanded disclosures about the use of fair value to measure assets and liabilities should provide users of financial statements (present and potential investors, creditors, and others) with information that is useful in making investment, credit, and similar decisions-the first objective of financial reporting in FASB Concepts Statement No.Â 1,Objectives of Financial Reporting by Business Enterprises."(FASB)
Publics Views of the Issue
Many companies have had disagreements over the Fair Value Accounting that FASB has issued and the biggest disagreement over a shift to fair-value measurement is the debate over relevance versus reliability. These two areas relevance and reliability is where the public is having strong disagreements. These two areas are broken down because both the old way and new way are good but have some issues. Fair-value accounting argues that historical-cost financial statements are not relevant because they do not provide information about current values. The fair-value dissenters argue that the information provided by fair-value financial statements is unreliable because it is not based on arm's-length transactions. People and companies argue that if the information is unreliable then it should not be used to make financial decisions or statements.
One side of the public argues that Fair-value accounting measurement is more relevant to decision makers even if it is less reliable. First, fair-value accounting would produce balance sheets that are more representative of a company's value. Specifically, unless the values of fixed assets are assumed to remain the same over time, historical-cost information is relevant only upon obtaining the asset. Furthermore, because historical-cost measures remain unchanged over time, users do not get valuable feedback about appreciation or depreciation following the purchase of the asset.
For example, if A Corporation purchased a two-acre tract of land in 1990 for one million, then a historical-cost financial statement would still record the land at one million on A's balance sheet. If Z purchased a similar two-acre tract of land in 2005 for two million, then Z would report an asset of two million on its balance sheet. Even if the two pieces of land were virtually identical, A would report an asset with one-half the value of Z's land; historical cost is unable to identify that the two items are similar. This problem is compounded when numerous assets and liabilities are reported at historical cost, leading to a balance sheet that may be greatly undervalued. If, however, A and Z reported financial information using fair-value accounting, then both would report an asset of two million. The fair-value balance sheet provides information for investors who are interested in the current value of assets and liabilities, not the historical cost. (CPA Journal)
The public likes that it can be more relevant but Despite the advantage of having more-relevant information, the change to fair-value accounting is met with much resistance. The primary argument against fair-value accounting is that it is not reliable. This statement was said in the CPA Journal "Relevant information that is unreliable is useless to an investor. We must, therefore, be clear about the nature of the claim being made for an accounting number described as reliable."(CPA Journal)
One advantage of historical-cost financial information is that it produces earnings numbers that are not based on appraisals or other valuation techniques. Therefore, the income statement is less likely to be subject to manipulation by management. In addition, historical balance sheet figures comprise actual purchase prices, not estimates of current values that can be altered to improve various financial ratios. Because historical-cost statements rely less on estimates and more on "hard" numbers, proponents believe that historical-cost financial statements are more reliable than fair-value financial statements.
Furthermore, fair-value measurements may be less reliable than historical-costs measures because fair-value accounting provides management the opportunity to manipulate the bottom line. Continuing the example from above, ABC could argue that its tract of land is undervalued by $1 million and that it should record a gain in the financial statements. What if ABC argued that its tract of land was worth even more because it had a slightly better location? Therefore, instead of a $1 million gain, ABC could choose to report a $1.5 million gain, recognizing an additional $500,000 gain on the income statement. (CPA Journal)
Developing reliable methods of measuring fair value so that investors trust the information reported in financial statements is critical if FASB continues its movement toward fair-value accounting. This is no easy task, especially in light of recent scandals in financial reporting.
Investors are the most important issue believed by most people. That is why the SEC is around to make sure that all the statements are clear and true so that investors will put more money in to the business and thus helping the economy. People are worried about the investors mainly because they will not be getting the full information about the company or might get lied to about the information shown. FASB requires companies to record acquired intangible assets at fair value, but intangible assets that are internally developed are expensed immediately. Because of this type of inconsistency, investors will likely remain uninformed regarding the true measurement of many intangible assets.
Baruch Lev said in his "Remarks on the Measurement, Valuation, and Reporting of Intangible Assets" (Economic Policy Review, Federal Reserve Bank of New York, September 2003), fair-value information that is provided regarding intangible assets is largely inconsistent, partial, and confusing, and prevents boards of directors and investors from intelligently allocating resources.
One argument that investors brought up to attention was on October 29, 2008. Is that Fair value accounting is being blamed for billions of dollars in write downs by U.S. Banks and policy makers. This is destroying the value of lots of banks and financially making them unstable. One banker said "There are loans that banks hold and intend to hold," said Maimbourg. "The fact that the market will only pay us 20 cents ... (is not) a reason to mark it down to 20 cents on the dollar."(Reuters) the argument is that some mortgages have no market so banks are being forced to value assets at fire sale. This is miss leading because the banks do not plan to sell the assets immediately and their value could rise in the future. They argue that it might be hurting the banks but over all its providing the investor transparency.
Investors said it is important to see fair-value data on loans held for sale, equities owned for the long haul, traded securities and on derivatives. But they assigned less importance to fair value when it comes to deposits and loans held to maturity. For those kinds of assets, they indicated that amortized cost - the method currently used - is more useful to them.
Overall, to investors the Fair Value accounting method is the best way to look into companies and how they are valued. They can accurately see how companies have grown and that their assets are up-to-date about their value because they do not have to use just the historical cost but they are what the rest of the market is at and that amortization diminishes the value and doesn't represent the true value of some items but they want to use it on some things but the Fair Value approach is still clear.