[ideaonly]The fair value debate from accounting utopia to financial realism

[ideaonly]The fair value debate from accounting utopia to financial realism

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Revue Trimestrielle de Droit Financier n°4 -2008 Jean-Florent Rérolle The fair value debate: from accounting utopia to financial realism Jean-Florent Rérolle 1 Managing Director Houlihan Lokey The aim of accounting is to reflect the financial position of a business as realistically as possible. Given the growing complexity of the economic world, the development and globalization of financial markets, and the expanding influence of the ideology of shareholder value, historical value accounting has become increasingly out of touch. To better align accounting with this new reality, accounting standard-setters have gradually replaced the historical cost principle with fair value. In the two key bodies of accounting standards (US GAAP and IFRS 2 ), the concept of fair value has become more and more predominant 3 . The merits of fair value have always prompted heated debate, particularly with regard to financial instruments. However, since the onset of the financial crisis, the controversy has intensified. It appears that the combination of the fair value principle and accounting-based capital adequacy rules for banks may have had a procyclical effect. Certain managers of banks and insurance firms have been falling over themselves to blame accounting standards 4 for the current predicament, along with credit rating agencies and hedge funds. Obviously, though, it’s much easier to criticize accounting standards than capital adequacy rules when you are under the watchful eye of banking supervisors. Importantly, however, the fair value principle did not take a hammering from leaders at the G20 summit on November 15, 2008. The statement published after the summit made no reference to fair value, although accounting authorities were asked to “work to enhance guidance for valuation for securities, also taking into account the valuation of complex, illiquid products, especially during times of stress”. Without going so far as to result in completely clear, workable solutions, one of the positive aspects of this crisis has been to shed light on the debate regarding two key issues that hail the end of a certain accounting utopia and the return to financial realism: - Conceptually speaking, preparing a balance sheet that can or even must give a realistic view of a company’s market value is too much to ask. The market is far too complex to be captured by an accounting system. 1 The opinions expressed in this article are those of the author only, and do not necessarily reflect the positions adopted by Houlihan Lokey. 2 International Financial Reporting Standards. 3 Fair value is mentioned 1,184 times in the European Commission’s November 3, 2008 Regulation on International Accounting Standards. 4
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[ideaonly]The fair value debate from accounting utopia to financial realism

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