Fair value accounting – a brief summary
I read an article from the Guardian website last January, where a Bank of England official was suggesting that banks need to have separate accounting standards from other types of business. Some of the concerns mentioned were around the notion of fair value. This an extremely complex area, but I’ll try to summarise it here.
The basic idea of fair value is that certain types of assets and liabilities should be measured in the financial statements at a value which reflects what they could be sold for or settled for. In the main, the types of assets/liabilities concerned are referred to as financial instruments – e.g. debt, equities. There are two complex accounting standards which deal with how such instruments are measured according to fair value. IFRS 9 defines the what happens to the difference arising on fair value adjustment. Without going into too much detail, the fair value adjustment goes through the income statement/profit & loss account. As mentioned in the Guardian article, this is normally fine when markets are causing the value of the assets to increase, but it perhaps less popular when markets are falling. And, of course there is the problem of ascertaining what exactly is “fair value”. IFRS13 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”. It also describes a hierarchy of how to measure fair value and outlines detailed disclosures which must be made in the financial statements. Of course, all this presupposes there is a reasonable way to ascertain fair value based on a market price or equivalent market price. And, as we know from recent years, there have been plenty of media reports about the complex nature of some financial instruments. I’m sure the debate on whether or not fair value is right for the banking sector will continue.