All the fun of the fair!

Fair value accounting is criticised for not reflecting economic substance,
particularly in financial institutions stressed by the credit crunch.

IFRS has been disparagingly referred to as ‘academic’ but many accounting
scholars are critical of fair value and the unseemly rush by regulators to adopt

The IASB’s mantra of a single set of high quality standards is reminiscent of
Edward Lear’s What I Tell You Three Times Is True (The Hunting of the Snark).
Yet fair values are anything but fair and high quality is questionable.

Fair value has two fundamental flaws. First, with the method chosen, exit
values and their determination cannot be applied in the same way to all items
caught by the standards. Price volatility varies across sectors and
transactions. Second, there is an underlying assumption that markets are liquid
and able to price accurately. This economic theory would only work if markets
were not run by people and fraud and greed did not exist.

The fair value model supports bubbles as it picks up prices in a rising
market, which are reflected in accounts and feed back into higher prices.
Conversely, it exacerbates downturns in a falling market and another set of
issues emerge where there is no market.

So what is the way forward? The IASB has, until recently, been intransigent
in its belief that nanny knows best and has not demonstrated an inclination to
listen. The global standards tanker has been supported in the public policy
arena by global companies, large firms and regulators who will benefit from the
adoption of global standards, have invested hugely in IFRS, and accept the high
quality mantra.

IFRS is being adopted widely but what is it bringing with it? A massive
increase in disclosures and complexity; a standard setter with very wide
constituency and a consultation model which is self-selecting, thus limiting its
accountability and making change difficult; and at least one underlying
principle which doesn’t stand up in a stressed market.

Some influential IFRS users are breaking ranks and criticising fair values.
The IASC Foundation has recognised that IFRS should be understandable. This is a
start but it doesn’t mean that the resultant outputs would be understandable.

We should welcome the slightest glimmer of light ­ but this will be a long
haul, if we get there at all.

Stella Fearnley is professor of accounting at
Bournemouth University

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