FV General Flashcards
What role does the “cultural authority” of financial economics play in the rise of fair value accounting (Power, 2010)?
Fair value accounting aligns with market-based valuation models, reflecting trust in the efficiency and objectivity of financial markets. The dominance of financial economics as a discipline lent credibility to FVA by emphasizing current market prices as the best representation of value. This perspective reshaped reliability to focus on confidence in market-derived prices rather than verifiability of historical transaction costs.
What is the fair value hierarchy introduced by IFRS 13, and why is it important (IFRS, 2018)?
The fair value hierarchy categorizes inputs into three levels: Level 1: Observable inputs (e.g., quoted market prices). Level 2: Inputs derived from observable data (e.g., market data for similar assets). Level 3: Unobservable inputs (e.g., valuation models). Importance: The hierarchy improves transparency by showing the reliability of inputs and the assumptions underlying fair value measurements.
How does the IFRS 13 post-implementation review evaluate the effectiveness of fair value standards (IFRS, 2018)?
Strengths: Enhanced disclosure usefulness through the fair value hierarchy. Better insight into valuation methods and assumptions. Weaknesses: High implementation costs for companies. Inconsistent application of Level 3 valuations across jurisdictions.
How does fair value accounting contribute to pro-cyclical economic behavior (Laux, 2009; Power, 2010)?
In Booms: Rising market values lead to increased asset valuations, boosting firm capital and encouraging further lending or risk-taking. In Busts: Falling prices force significant write-downs, leading to margin calls, asset fire sales, and liquidity shortages, creating a downward spiral.
Example: During the 2007–08 crisis, fair value write-downs of mortgage-backed securities amplified losses across financial institutions.
What reforms were introduced in IFRS 13 to address concerns about fair value during market volatility (IFRS, 2018)?
Clarification of Illiquid Market Treatment: Fair value should reflect orderly market conditions, not distressed or forced-sale prices. Additional Disclosures: Sensitivity analyses and detailed explanations of valuation methods for Level 3 inputs improve transparency. Fair Value Hierarchy: Provides clearer categorization of inputs to highlight areas of subjectivity or uncertainty.
How has the definition of reliability evolved in fair value accounting (Power, 2010)?
Traditional Definition: Reliability was linked to verifiable historical cost (certainty about transaction price). Modern Definition: Reliability in FVA depends on confidence in market prices or valuation models, even if these inputs are inherently uncertain or volatile.
