Question

Under current US GAAP, companies may opt to report financial assets and liabilities at fair value. In at least three paragraphs, support one of the positions presented below. You should use references to reference material, as necessary.

Position #1: Present arguments in favor of the fair value option for financial assets and liabilities.

Position #2: Present arguments against the fair value option for financial assets and liabilities.

Answer 1

Position #2: Present arguments against the fair value option for financial assets and liabilities.

The US GAAP, allows companies to report their financial assets and liabilities at fair value. Though fair-value accounting provides a way to evaluate the company’s assets and liabilities that appear on its financial statements consistent with its peers in the industry, it may affect its income, both positively and negatively.

Not all the business benefit from this method of fair-value accounting. The businesses whose assets fluctuate a lot during the year happen to report the changes in income that aren’t actual and accurate in the long-term perspective. This creates misleading gains or losses in the short-term. In addition, a reduction in income of one business due to asset loss has an impact on the whole industry due to the domino effect. This creates high volatility in the market.
Not every investor is well aware of the accounting approach the company follows. Any loss of value affecting net income will have an effect on investor's income which would hit their portfolio and further dissatisfy them. This would make the business less attractive to investors.

In an Illiquid market, there is a high risk of manipulation of the price within the firm in the process of obtaining a fair value, as a trading company can have an effect on both quoted and traded prices. Further, it loses the historical viewpoint. Sometimes assets may have a valued downwards in the year and reduced net profits, which can falsely lower the success that a business might have had in that year.

Sometimes the fair value of an asset in the market is not symbolic of its fundamental value. The market might be uneconomical and not replicate in its estimates all the information available in public. Additionally, there are other factors that could affect the deviation in market estimate like investor absurdity, behavioral prejudice or difficulties with arbitrage among others.