Fair Value Accounting
Fair value accounting is a model that allows the market forces of demand and supply between the involved parties to determine the value of the property. The problem emerged when the major funding institutions ran into extreme financial crisis which in effect resulted into more uncertainty in the mortgage backed instruments with close reference to the CDOs, the collateralized debt obligations (Novoa, Jodi and Juan, 16). This was aggravated by investors making attempts to dig deep into the financial instruments and who were further set back by the complex systems leading to more panic in the property and lending market.
In the event that the market prices are to adjust and that the investors are to obtain the property values, then only fair value could be used to determine the data and information which was hurriedly sought for. Therefore, it is clear that most of the financial difficulties witnessed in the property market at the time were as a result of combination of factors which included the pressure bestowed on the information by investors and extensive borrowing by the investors, beyond their reach and capabilities (Novoa, Jodi and Juan, 20). Fair value accounting offers an opportunity to outside market investors to get a clear picture of the market and be able to avoid the mostly hidden aspects of the other accounting structures which only protect the internal investors (Fick, 54). With the fair value where prices are determined based on the willingness of the financing institutions as well as the property developers, the difficulties that would be experienced by the new investors in the property mortgage will be reduced although this is considered a major setback to the more established internal investors in the subprime market.
Fair value ensures a stable market by providing equal benefits to the society, investors, managers and even the accountants. It helps level the interests of the stakeholders and harmonize them (Zack, 103). There could be greedy investors rushing to make high returns at the expense of the stability of the market and real value of the property while the banks, are interested in high amounts of interest on the other hand.
Historical costs appear to be the opposite idea to be used in determining mortgages as well as lending rates. This method considers the value of the property from the time of its purchase with rigid or pre set depreciation values. It is aimed at protecting the investors against unpredictable changes in the market (Zack, 163). This, appears to be one of the greatest factors that led to the subprime meltdown in the property market as the investors pushed on for loans from banks while not allowing the market forces to determine the cost of building and their property lending rates (Pounder, 40). The fear to lose investment ultimately resulted in the meltdown. It can be concluded that those against fair value are only looking to find where to rest blame on problems that resulted from the historical costs which were actually the dominating forces in determining the property values.
Fick, Kenneth F. Securitized Profits: Understanding gain on sale accounting, Journal of Accountancy (May, 2008): 54
Novoa, Alicia, Jodi G. Scarlata, and Juan Solé. Procyclicality and fair value accounting. Washington, D.C.: International Monetary Fund, 2009. Print.
Pounder, Bruce. Framing the Future: A first look at FASB’s GAAP codification, Journal of Accountancy (May, 2008): 40
Zack, Gerard M.. Fair value accounting fraud: new global risks and detection techniques. Hoboken, N.J.: John Wiley & Sons, 2009. Print.