Question

Thoroughly explain..

How specifically, do gains and losses resulting from fair value adjustments to debt affect the financial statements?

What opportunities do you see for manipulation of the financial reporting of debt?

Do you see any ethical issues with regard to fair value accounting?

Answer 1

Debt Valuation Adjustment.

A Debt Valuation Adjustment (DVA) is an accounting valuation technique related to how a company handles changes in its issued fixed income securities. According to FASB 159 (adopted in 2007), firms can recognize market value declines in some debt instruments as earnings (income).

Effect

Fair value accounting uses current market values as the basis for recognizing certain assets and liabilities. Fair value is the estimated price at which an asset can be sold or a liability settled in an orderly transaction to a third party under current market conditions.

Using fair value accounting, when values of debt decrease, the company's calculated net income decreases, This is an advantage to companies because a lower net income results in lower taxes. These affects to assets also cause a decrease in the equity of the company.

Opportunities for Manipulation

Financial Statements are prone to manipulation due to the inflation or deflation in the fair value of the debt. Inflation in Fair value will result in the increase in the unrealised profits of the company and rise in the equity whereas deflation in the fair value of the debt will result the concealment of actual profits of the company.

Ethical Issue

Fair value Accounting involves the computation of actual value of the asset so that the company can calculate & book the estimated loss and know the real value of their assets.

Therefore, in my opinion there is no ethical issue involved with regard to fair value opinion.