Revue Trimestrielle de Droit Financier n°4 -2008
The fair value debate: from accounting utopia to financial realism
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
), the concept of fair
value has become more and more predominant
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
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
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.
The opinions expressed in this article are those of the author only, and do not necessarily reflect the positions
adopted by Houlihan Lokey.
International Financial Reporting Standards.
Fair value is mentioned 1,184 times in the European Commission’s November 3, 2008 Regulation on
International Accounting Standards.