Fair value accounting is a method of cost reporting. It is an objective estimate of the potential market price of a commodity.
The article attempts to explain the relationship between the concept of fair value accounting and the financial crisis witnessed in the United States from 2007 to date. The authors think that fair value accounting greatly contributed to the crisis. They also argue that the concept aggravated the situation (Trussel, 2009).
Some challenges arise from the use of fair value accounting. While the majority of these challenges can be avoided, some are so deeply rooted in the concept itself that they may be regarded as unavoidable. Bearing these challenges in mind, we can state that the concept of fair value accounting has been viewed as being responsible for the financial crisis. Support for this school of thought tends to be in the arguments that fair value accounting contributed to the severity of the crisis and that fair value accounting increased the leverage of banks in the property markets and substantially affected the market forces.
Fair value accounting aggravated the financial crisis in two ways. To begin with, it allowed banks to use the mark to market principle to their advantage. When the credit markets froze, the property markets suffered a major blow. The prices of properties held or financed by these banks went down owing to reducing demand. The banks panicked and lowered their property values trying to get rid of these properties fast. This move eventually contributed to the financial crisis. The resultant effect on the market was that of progressively falling property prices.
Secondly, having faced very low property prices, many small banks were forced to declare bankruptcy. In such circumstances, potential investors became fearful and the banks ended up remaining with bad properties. Therefore, fair value accounting substantially affected the market forces.
To help the economy recover from this crisis faster, there are a number of measures the Financial Accounting Standards Board can do. One is to change taxation rules (Hommedieu, 2012). The board should help the federal governments to come up with taxation rules and formulae that are balanced in nature. The tax levied on each individual tax-paying entity should be similar. The formulae used for tax calculation should be made in such a way that the percentage of income paid as tax is comparable. At the moment the high-income earners tend to have a smaller percentage of their income going to tax as compared to the small-income earners.
The financial accounting board should employ multiple approaches to financial reporting. They should allow the usage of both historical cost reporting and fair value accounting. Rules such as the one that allows banks to alter the value of bad properties should be discarded. When this rule is used, a false impression is created. The financial position of the bank looks better than it actually is. The overall picture tends to portray a false improvement in the economy. This may in turn scare away potential investors.
Emphasis should also be put on the individual households in order to help them to cope with the crisis. The focus should not be laid on assisting banks only. Helping the households will have an overall effect on the economy. The economic recovery measures will benefit a lot from this. If the household is empowered, its purchasing power improves. This will in turn spur economic growth.
References
Hommedieu, D. (2012). Who Benefits with FASB Accounting-rule Changes? Helium.com. Web.
Trussel, M., & Rose, L. (2009). Fair Value Accounting and the Current Economic Crisis. The CPA Journal. Web.