Question

SFAS No. 159 (see FASB 825) allows companies to value financial liabilities at fair value. If not elected, financial liabilities will continue to be accounted for under the historical cost model.  In at least three paragraphs  

Position: Present arguments against measuring liabilities at fair value.

Answer 1

Fair value accounting is a financial reporting approach, also known as the “mark-to-market” accounting practice, under generally accepted accounting principles (GAAP) some of the major arguments against fair value accounting of liabilities are

Fair value accounting can present challenges to companies and users of reported financial information. Conditions of the markets in which certain liabilities are traded may fluctuate often and even become volatile at times. Applying fair value accounting, companies reevaluate the current value of certaina liabilities even in volatile market conditions, potentially creating large swings in the value of those liabilities. However, as markets stabilize, such value changes likely reverse back to previous normal levels, making any reported losses or gains temporary, which means fair value accounting may have provided misleading information at the time

There are several challenges for entities required to measure the fair value of liabilities. For one thing, its definition of fair value presumes that a liability would be transferred in a hypothetical orderly transaction between market participants. But in practice, liabilities are rarely transferred in the marketplace, mainly because of contractual restrictions that prevent such transfers.

Also, it requires that a liability’s fair value reflect nonperformance risk (including the reporting entity’s own credit risk) and that such risk be the same before and after a hypothetical transfer. But in the limited circumstances in which a liability is transferred to another party, it’s not unusual for the transferee’s nonperformance risk to be lower or higher than the transferor’s.