Fair value accounting a ‘bubble-blowing’ model

Two influential academics have slated fair value accounting as a
‘bubble-blowing accounting model’ that has contributed to the recent market
crash and credit crunch.

Stella Fearnley from Bournemouth University and Shyam Sunder from the Yale
School of Management have said that the model is ‘built on sand’.

‘Instead of informing markets through prudent valuation and controlling
management excess, “fair” values feed the prices back to the markets,’ the
academics wrote in the FT.

They added: ‘For example, a drop in the market value of the borrowings of a
troubled company is reported as an increase in its income because the reduced
liability flows through the income statement, thus obscuring the problem.’

The academics said fair value system was partly to blame for the problems of
the sub-prime lending market and needed a rethink, and that the convergence
between IFRS and US GAAP needed to be put on hold.

‘Auditors sign off that accounts comply with the accounting standards,’
Fearnley and Sunder said. ‘What use is that to investors when it means complying
with a bubble-blowing accounting model. The pursuit of convergence in accounting
standards needs a radical rethink if this is what it leads to.’

Further reading:

SEC probes sub-prime links after stock market

M&A outlook bleak after credit

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