Those who criticise fair value accounting should recall that the alternative
is not historic cost, but the lower of cost and market.
This rule is long standing and reflects the prudential approach. Perhaps in
the past, under the lower cost and market rule, the need to writedown impaired
assets was ignored on many occasions, but it should be applied and, if applied,
it has exactly the same consequence a sharp writedown of impaired assets as
if fair valuing is applied.
So the argument is not about fair valuing as such, but whether true values
should be disguised, leaving governments and regulators to sort the problems out
Whether that is the best way to tackle the problem is the issue.
One aspect of the negative reaction to fair value is the impact of changes in
market value on the income statement.
Some years ago the International Accounting Standards Board proposed a matrix
approach, setting out all the changes in the shareholders funds (apart from
transactions with shareholders, such as rights issues) and splitting the
individual components into two the changes in value, whether upwards or
downwards, in one column, and all other items in another column.
Transparency was achieved by showing changes in value without suggesting that
profit in the ‘other’ column had been dramatically affected. There is indeed no
single figure to encapsulate the performance of a company, and trying to push
certain items into a single figure gives rise to many confusing changes in
‘profit’, as in the case of revaluations. I have never been able to understand
why this matrix approach met so much opposition.
One of the supporters of the matrix was the CFA Institute, which represents
tens of thousands of qualified analysts and investors worldwide. The institute
has also supported fair value accounting for many years. It’s views on the
development of financial reporting are set out in the Comprehensive business
reporting model, available on the institute’s website under the publications of
the CFA Centre.
Finally it might be added that the market for capital is well aware of the
elements of a crisis such as the one we see at the moment.
It is far more likely to react negatively if investors are deceived, or if
there is a lack of transparency.
The market needs outside regulation, but in addition, one of the best pillars
of regulation is the market itself.
David Damant is a member of the CFA Institute and
chairman of the consultative advisory group of the International Auditing and
Assurance Standards Board
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