Is there a viable alternative to fair-value accounting?

MANY culprits have been singled out to take the blame for the financial and economic crisis. Fair-value reporting too has been blamed for the depth of the crisis, where troubled companies claim that mark-to-market valuations are forcing them to declare declines in asset values that aren’t real, thereby worsening sentiment in jittery world markets.

Indeed, opponents of fair-value reporting argue that the information provided by fair-value financial statements can be unreliable and hence, financial decisions can be put at risk. But is there a viable alternative to fair value in this highly complex business world?

Although fair-value accounting may have gotten bad press as a result of the crisis, key producers and users of financial reports - such as chief financial officers and accountants - recognise the benefits of fair value.

In a recent survey done by CFO Research Services and ACCA, 128 CFOs stated that adopting global financial standards reporting - including mark-to-market valuations - will be good for their companies.

There are several reasons for their mindset. In this dynamic global environment where valuations can change in the blink of an eye, historical-cost financial statements may no longer be relevant because they are not able to give accurate information on current values.

Traditional accounting rules have not kept pace with sweeping reforms in regulations, customer sophistication, knowledge-based products and the evolving valuation methods of enterprises.

Value creation has also changed, and this has made reforms very necessary to the way we report, interpret and compare with a common set of acceptable standards to meet customers’ demands and protect public interest.

This is where fair value accounting - with its emphasis on mark-to-market valuations - is highly relevant. Historical-cost accounting methods may not work quite so well in measuring current values and in projecting future values.

It needs to be kept in mind that common double-entry accounting worked in systems based on transactions and are most relevant to economies based on buying and selling transactions.

Most sophisticated economies today have evolved beyond that to embrace dynamic value creation and there needs to be a means to reflect and measure this value.

For instance, intangibles including brand, patents, trademarks, intellectual property, and thought leadership towards corporate performance, has become a tremendous asset for the majority of companies, and a key element in valuations.

Most of the information metrics and reporting systems now appearing on the investment radar screen are designed to measure and report financial health, which are a challenge to their immediate users. Again, this is where the fair-value accounting framework comes in handy.

Many companies today also operate globally across many regimes and jurisdictions, thereby increasing the need for better quality disclosures and consistency in understanding and interpretation of complex financial and risk matters in order to better serve their investors and shareholders.

Delivering such quality and consistency is a key tenet of the international financial reporting standards, or IFRS, in which fair-value accounting is fundamental.

One of the biggest benefits of fair value accounting may also be that investors will have the opportunity to better manage the risk of investing in highly leveraged companies.

In other words, it enables investors to use their judgement to describe how to recognise real value.

Therefore, it can be argued that fair-value accounting best fits the bill in the demand for a robust new measurement and reporting framework that can serve the needs of business.

However, since fair-value accounting is a fairly new creature, there will be issues of interpretation and usage as it evolves.

Although the new financial reporting framework is here to stay, it will probably be tweaked to make it more relevant, user-friendly and palatable to all stakeholders in the financial value chain, as well as to critics like French President Nicholas Sarkozy who called for an overhaul of fair-value reporting as part of the solution to the current financial mess.

The International Accounting Standard Board - architect of the shift to fair-value accounting via the international financial reporting standards - has acknowledged that the global financial crisis underlined the importance and urgency of making financial reporting more transparent, comparable and clearer.

At the recent G20 summit, delegates agreed that immediate actions towards a more robust reporting and value measurement will be necessary as part of the global solutions towards addressing current financial woes.

Regardless, reforms must come with greater clarity, comparability and responsibility if the bitter lessons learnt from the current financial and economic crisis are to shape the world into a better place for everybody.
By TAY KAY LUAN at The Star Online