Question

Explain the arguments for and against market-value accounting. In your answer ensure that you clearly explain “real losses” and “paper losses” and the role of moral hazard in the application of market value accounting.

Answer 1

Market value accounting means how much the asset is of value in the real market or an investment value to an firm/equity.

To understand it in an easier way take an example where you are giving loan to one of your friend who wants to open up a business and needs inital investment. Now, you are not willing to lend him/her the money unless your friend gives you some assurance i.e some alternate way in which he/she will definetly pay you back the amount loaned. Now, let say he/she has said that I will sell my bike and return you the money.

Now, the market value would mean that if your friend goes to the market and sells the bike how much he/she will get for the bike. This value can be different or same as the book value of the bike depending choice of accounting method. Thus your decision of whether to lend money to your friend or not or how much should you lend, would depend on the value the bike would fetch if you aren't convinced with the business idea.

So, in order prepare an argument for for and against market value accounting one should study various asset classes and business scenarios to understand how asset value would affect and be significant in business and invetment decisions.

Sectors/Industries could be studied to understand the parameters for time- value of assets and investments in markets. Few parameters could be obsolescence, volatilty of percieved value of goods/services as per market sentiments etc.

Now, paper losses or gains are the gains or losses which are not yet realized i.e the investment is not yet closed or the asset is not yet sold etc.

In order to comment on the role of moral hazards of market value accounting one must study cases where price bubbles ws observed and how this led to mistrust and losses to the various stakeholders of economy. For example studying price bubbles in Real Estate sector leading to NPAs in Banks and NBFCs and consumer complaints can be studied.