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Bankers: Fair Value Is Like Throwing Gasoline on a Fire

Claiming a "mixed attribute" accounting model provides a better picture of a company's business and earnings engine, bank trade groups blast full fair value.

Marie Leone, | US
April 14, 2008

David Newman's idea

David Newman's idea of two columns, one for historical cost and another for fair value, is an excellent idea. Another idea is to use fair value for write downs of assets, but be slow about writing back up by straight lining the recovery over the period until maturity. Future fluctuations in fair value that did not breach the value reported the floor level reported in this method would be non-events for reporting purposes. Obviously this only works for assets that have a maturity. The same concept can be applied to liabilities.

Posted by Roland Cycan | April 17, 2008 05:49 pm

Mixed Models Financial Statements ? Historical Cost and Present Value

A truly mixed model would present one column at historical cost and another column at fair value all for the same assets, liabilities, and equity on the balance sheet, and the various elements and activities on the income statement, the retained earnings statement, and the cash flow statement. Then, differing shareholders (preferred and common), bondholders, creditors, managers, and labour could see the acquisition value and the liquidity value. The difference is the change over time due to inflation and also assessments of realizability relative to future cash inflows and outflows. Probably a better measure than fair value would be a present value model for all assets, liabilities, and equity. Assets and liabilities could be discounted at the weighted average cost of capital to present value given a combination of expected operating future cash flows and residual realizable value if sold during the asset or liability life (or even sold during the indefinite life of an intangible asset). The difference between the total assets present value and the total liabilities present value could then be considered as the net present value of equity (since A-L=E). The difference between present value and historical cost separate columns would be separately presented with those columns and the difference represents appreciation or depreciation in value relative to inflation and discounting interest rates. Discounting is appropriate and superior to fair value since it considers the time value of money and thus provides a standard basis comparison to historical cost of assets and liabilities that are purchased over time at various times. Thus, investment risk is represented considering inflation and discount rates by comparing historical cost, the present values, and the net present value. The main counter argument to present value is the possible unreliable nature of expected future cash flows as these are estimates into the future and also the discount rate chosen is relatively subjective. I would counter argue that most measurements in accounting are subjective and subject to estimates especially the complex assets and liabilities (at least those not considered in cash or under contracts which would use these elements as their measurement basis).

Posted by David Newman | April 14, 2008 04:25 pm

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