Fair value accounting is a term that uses the agreed-upon purchase price between the buyer and seller, under the presumption that both sides entered into the contract arrangement without being coarse. Different investments have a different fair value, which is determined by the market on which securities are sold. The fair value also includes a measure of the value at which the subsidiary company’s assets and liabilities are consolidated with the main/headquarter company’s financial statements. The approach attempts to capture the change in the values of liabilities and properties over time. From the International Accounting Standards Board, it is explained as the value at which the assets and liabilities are changed between the willing and the knowledgeable parties in the length of an arms transaction (Laux, C., & Leuz, C., 2010). Assets and liabilities are valued differently in different periods of the resultant change affecting the net returns or the gains for the firm in the period. From this, the balance sheet is arrived at which reflects the present value of the liabilities and assets. The cost is mostly higher in volatility in the time reported performances which are caused by alterations in the fair value.
Fair value has been affected by the different situation of financial crisis. Changes in the prices of different products have been attributed to different time’s of financial crisis. Different factors have been reported to change the prices of goods in different countries and times. The factors include among other, government influence, political stability, social setting, and culture which affects the demand and supply of different products in the market (Laux, C., & Leuz, C., 2010).
Having the market becoming the main determiner of the prices of the products which are to be sold. It means that the prices of the prices are to set the accounting values. The change in inflation values is one of the factors which affect the market prices. The rate of inflation has a high capability of changing the market prices, it then means that the market prices and accounting values are dependent on each other. If the rate of inflation is high, the market prices will, therefore, be high which eventually affects the values to be accounted for. Accounting is recording the values according to how they reach to the selling point and the records of the all transaction in the company (Laux, C., & Leuz, C., 2010). It means that if the market prices change over time they the accounting values will always to alter in that order.
The issue of whether fair values accounting contributed to the financial crisis of 2007/08 is, yes, it had an impact. It is not only for that period but for all other periods which have reported financial crisis (Laux, C., & Leuz, C., 2010). Changing the mode of accounting from time to time with the rates which are in the market means that when the market is favorable, the accounting system will also show a favorable nature with the opposite being also correct. The use of both the GAAP and the IFRS rules and standards defines fair value as the current market values which hold for both the assets and liability (Laux, C., & Leuz, C., 2010). It usually comprises of the values estimated as the current values are mainly observed directly in the market for the liabilities and assets becoming illiquid. The Fair Value is higher than a mere technical measurements convention for the proponents and the representation of the changing process which is the world desires.
For the FVA the sales, assets, and liability are always changed to conform to the market prices. For the 2007/08 financial crisis, different companies suffered from the change in sales which went down. It meant that the companies would be forced to sell their assets to pay their debts which were also sold at a losing price. The liabilities rates of interests in the FVA are adjusted to conform to the market interests making it a loss to the companies (Laux, C., & Leuz, C., 2010). In the FVA accounting, the assets values are confirmed to the current market value which may be low in most cases making it hard for the company to survive if they resolve in selling the assets.
The financial crisis was brought about by the major economic downturn. The economic downturn was brought about by the forced sale and liquidity lowering. The asset values on the balance sheet were lowered making it a perpetual loss for the company which decided to sell its assets. The forced sales and liquidity reduction brought about descending effects on the capital which eventually brought about credit crunch deleveraging recapitalization (Laux, C., & Leuz, C., 2010). The FVA compiled the banks to have a report of the losses which show a decrease in the reported equity (Laux, C., & Leuz, C., 2010). In all these circumstances the losses in the financial instruments which were held by the financial institutions turned to increase or mostly decrease the equity to the stockholders which led to either rare improvement and more reported cases of deterioration in the capitalization. The liquidity crisis in the period brought was brought about the effects of fair values and the downward stress on the values which are effects of loss and profits on the equity.
All in all, the financial crisis in 2007/08 was brought about the by the fair value accounting nature of firms. The fair value model of accounting led to effects of economic crisis and the liquidity crisis. The sales and the market values of different products were altered making different companies run at losses. The value of assets and liabilities were made to conform to the market changing the equity values to the shareholders. The companies suffered high with their shareholders receiving a similar brow leading to a higher financial crisis.
Laux, C., & Leuz, C. (2010). Did fair-value accounting contribute to the financial crisis?. The
Journal of Economic Perspectives, 24(1), 93-118.