Reasons for the Popularity of Fair Value Accounting Prior to 2007–08 (10marks) Flashcards
What is fair value accounting (FVA)?
It’s the practice of measuring and reporting assets and liabilities at current market value (or an estimate thereof), rather than at historical cost. Under IFRS 13, fair value is defined as the price received to sell an asset (or paid to transfer a liability) in an orderly transaction between market participants at the measurement date.
Why did fair value accounting gain popularity prior to the 2007–08 financial crisis?
Market Efficiency Belief: A widespread assumption that market prices are the best reflections of underlying value.
Investor Demand: Investors sought more relevant, timely information compared to potentially outdated historical costs.
Financial Innovation: Growth in complex financial instruments (derivatives, securitized assets) that were difficult to measure using historical cost.
Regulatory and Standard-Setter Support: Standard setters (IASB, FASB) viewed fair value as a way to enhance transparency and comparability.
How did the rise of financial economics as a discipline influence FVA adoption?
Financial Economics Paradigm: Emphasized market-based measures and the idea that markets are efficient and rational.
Transformation of Reliability: “Reliability” shifted from verifiability of transaction price to confidence in market price as an objective measure. This shift paved the way for broader acceptance of fair values in accounting standards.
What was the role of IFRS 13 in solidifying fair value measurement practices?
IFRS 13 provided a uniform framework for measuring fair value and consistent disclosure requirements (e.g., fair value hierarchy).
It helped codify different levels of fair value inputs (Level 1, 2, 3), thus clarifying how to measure complex or illiquid assets.
Summarize the main reasons for FVA’s popularity pre-crisis in one short statement.
Perceived market efficiency, investor demand for relevance, complex instruments needing current valuation, and standard-setter endorsement all propelled FVA before 2007–08.
