Young and Invested

Being an accountant by trade, I’ve had some thoughts about how the recent spotlight on ‘fair-value’ accounting has been affecting the markets. Essentially, fair-value is a set of accounting principles that reflect financial statement items at current market prices rather than historical cost prices. The entire world’s accounting standards are moving towards fair-value presentation. The basis for this is that it provides more current figures and gives investors more transparency into the health of the company, while original prices may be outdated and no longer relevant for users.

They are right, and absolutely wrong.

Although fair-value accounting should be implemented for increased reliability in financial statements, there should be a limit to the pressure fair-value puts on companies. The perfect example is American International Group Inc (AIG). This American giant was forced to write down $4.88 BILLION worth of assets to then-current trading prices to accord to fair-value accounting. Not only did this massive write-down send the stock to the bottom of the ocean, it also cried out for a more reasonable approach.

Personally, I do believe that fair-value accounting should be implemented. It’s much more adapted to today’s dynamic business environment than historical-based accounting. However, when the markets are frozen and illiquid, writing assets down to fire-sale prices is completely ridiculous. Just because the assets may be worth pennies on the market does not mean they do not provide value to the firm itself. Especially with the newly found volatility we have been experiencing lately, these could just as well go back up in value once the economy recovers. Unfortunately, write-ups are practically never made in accounting, so AIG is likely stuck with its completely destroyed balance sheet.

My take on it: auditors and accountants that sign off on public statements should be given protection against being sued if the company goes bankrupt. It is rarely their fault, but signing off on written-down statements like AIG’s and causing a company bankruptcy can easily lead to the auditors carelessly being sued.

More importantly, FASB, AcSB and other accounting bodies have been too rigid in their fair-value accounting requirements, and although the rules will lead to new international standards, they need to be worked on to be more flexible.

Image credit: Jan Bakker

Last 3 posts by Daniel Eskin

• Google Boasts its Backbone - March 22nd, 2010
• Short-term Versus Long-term Investments - March 16th, 2010
• Expert Interview - Puru Saxena - March 9th, 2010