1822-6515-2011-0014.pdf

ISSN 1822-6515 ISSN 1822-6515 

EKONOMIKA IR VADYBA: 2011. 16 ECONOMICS AND MANAGEMENT: 2011. 16 

FAIR VALUE ACCOUNTING AND THE REGULATION OF CORPORATE 

REPORTING 

Carmen Giorgiana Bonaci 1 , Jiří Strouhal 2 

1 Babes-Bolyai University Cluj Napoca, Romania, carmen.bonaci@econ.ubbcluj.ro 

2 University of Economics Prague, Czech Republic, strouhal@vse.cz 

Abstract 

Our paper approaches fair value accounting and its implications when considering the regulation of 

financial reporting. Analyzing and discussing such issues is important for all parties being involved and/or 

interested in the debate over the regulation of corporate reporting. Economic realities and current 

developments have made many of us wonder about whether corporate reporting should be led by markets or 

by regulators. Meanwhile, the concept of fair value and its implementation takes us even further into an area 

where management’s input and disclosure takes on added significance. The objective of the paper is therefore 

to continue and help develop discussions on the highly debated topic of fair value accounting, enhancing the 

necessity of bringing together the efforts and inputs of accounting professionals, accounting researchers, 

regulators and company managers. The employed research methodology refers to the review of the academic 

literature on the analyzed topic. 

Keywords: Corporate reporting, fair value accounting, corporate governance, regulatory intervention. 

JEL Classification: M41, G30. 

Introduction 

The impact of fair value accounting is essential for all users of financial accounting information, 

especially when considering investment and financial decisions, therefore becoming the centre of attraction 

for a significant number of researchers and policy applications, including corporate governance. Since the 

use of fair value often involves estimates, this can also be considered as increasing managers’ discretion and 

further impact its implementation through reporting discretion issues. In terms of risk management, the aim 

and the standard setting challenge is to arrive at mandated disclosures that provide knowledgeable users of 

financial reports with a clear picture of the reporting enterprise’s risk exposures and how those risk 

exposures (and concentrations) are shifting over time (Schipper, 2005). 

While being extremely appealing from a conceptual point of view, when considering fair value’s 

implementation a series of difficulties have occurred in time. We must mention subjective, entity specific 

estimates of future cash flows that might even generate a lack of comparability. Ohlson et al. (2010) consider 

that subjective assumptions about risks, transactions costs, and the performance of counterparties are 

fundamentally inconsistent with acceptable accounting standards. Even more important is the fact that these 

approaches tend to degenerate into easy-to-manipulate versions of mark-to-market accounting, as proven by 

recent history. On the other hand some consider that the concept of fair value, but not historical cost, 

provides the common denominator necessary for a meaningful comparison of accounting data, while acting 

as a catalyst in a harmonization cycle (Barlev & Haddad, 2007). More precisely, it is argued that fair value 

accounting propels international accounting harmonization and international accounting harmonization 

provides more relevant information that may foster the efficiency of global markets, which improves the 

quality of the fair value accounting figures. 

IFRS adoption within the European Union inevitably brought a move towards more fair value 

accounting, being considered one of the most dramatic shifts in European accounting. On the other hand, the 

consequences of the financial crisis brought a series of interventions asking for regulatory change. Under 

these circumstances special attention is necessary in order not vastly alter the regulation of financial markets, 

including the regulation of accounting standard-setting (Bushman & Landsman, 2010). Another aspect that 

requires serious consideration refers to the relationship between financial accounting and prudential 

regulation, while having in mind the main objective of financial accounting information in enhancing 

corporate transparency that would benefit market discipline and capital allocation. In this regards, literature 

underlines the danger of subordinating financial accounting to the demands of prudential regulation of 

financial institutions as caring significant danger of unintended consequences (Bushman & Landsman, 

2010). In other words, the necessity of analyzing the role that corporate reporting plays in the regulation of 

financial institutions is emphasized within literature. 

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Considering the above presented picture, fair value once again plays a central role, many considering 

that it exacerbated the crisis. The use of fair value for financial instruments received special attention in 

accounting research, some finding it documented outcomes motivated by some European governments' wish 

to see a solution that was consistent with their political goals rather than something which was actually in the 

public interest (Carsberg, 2010). A series of other current issues arising in the aftermath of the financial 

crisis, such as European Union's decision towards the acceptance of the International Financial Reporting 

Standard 9 and discussion in the US Congress to transfer oversight of accounting standards from the SEC to 

a systemic risk council charged with preserving the soundness of the banking system, for sure make us think 

twice about the impact crisis and scandals might have through regulatory intervention. This would be our 

main argument in developing an analysis that aims at offering a fair reflection of academic literature’s 

perception on fair value accounting, and its evolution in time, while considering different circumstances that 

might have impacted opinions being presented. 

We perform an analysis on the evolution of main considerations on fair value accounting as reflected 

through academic literature and focus on main conceptual underpinnings. Our analysis considers literature’s 

perception on such a debated concept which itself recorded an interesting evolution by rising despite a series 

of critiques and opponents to its application, therefore offering useful insights for the regulation of financial 

reporting. 

Research Methodology 

The analysis being developed in our paper relies on two main dimensions: accounting research 

literature on fair value and the accounting regulatory process. Accounting research literature on fair value is 

being analyzed by using literature review methodology, while focusing on study descriptions. The purpose of 

our focus is to help shape fair value debates that deal with fundamental implications for financial reporting. 

Due to the high number of studies dealing with fair value accounting, significant synthesis was necessary as 

well as strict selection criteria linked with the previously mentioned purpose of the study. 

The accounting regulatory process is only discussed in terms of its political implications due to the 

fact that fair value accounting was historically proven to be causing significant opportunities for those 

interested in transforming the accounting thing into a political thing (André et al., 2009). This also helped 

delimit our analysis when considering such a complex process. 

Accounting Research in Review 

If we are to review accounting research literature on fair value we must start with the 2008 issue of 

Abacus (Abacus, 44(2)) that reproduced papers from the September 2007 Siena Forum on Fair Value and the 

Conceptual Framework, covering the vexed question of fair value measurement (Dean, 2008), within the 

context of corresponding accounting regulatory initiatives, particularly the IASB and FASB’s efforts to 

develop a joint conceptual framework. McLeay (2008) synthesizes the main contributions brought through 

the papers being published within this special issue, as relevant and original approaches of the fair value 

concept. Whittington (2008) moulds IASB board members’ dissenting views into an overarching alternative 

to pure fair value accounting where financial reporting is based on entity specific measurements and is 

consistent with the stewardship requirements of current shareholders (McLeay, 2008). Discussant of 

Whittington’s paper, Bradbury (2008) argues in favour of fair value as the measurement objective, leaving 

open the choice of measurement methods (McLeay, 2008). Ronen (2008) also approaches fair value by 

considering the objectives of financial statements and the previously mentioned joint conceptual framework. 

He argues that the use of exit values in drawing financial statements should also impose presentation of 

information regarding cash flow expectations which would arise in case the entity’s resources continue to be 

used rather than sold, and of course regarding the realization of such expectations. Therefore, exist value 

accounting alone is considered to fail in adequately assessing the contribution made by managers to 

shareholder value (McLeay, 2008). As a discussant of Ronen’s paper, Turley (2008) questions the suitability 

of such proposals, which were design based on a context where investors’ interests are dominant, when 

considering other types of jurisdictions. 

Hitz (2007) develops a broad theoretical analysis of a fair value based reporting system focusing on 

the notion of decision usefulness, while evaluating the theoretical soundness of the arguments put forward 

by regulators and standard setting bodies. By considering the measurement or valuation perspective and the 

information perspective as approached to decision usefulness, his findings indicate that the decision 

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relevance of fair value measurement can be justified from both perspectives, yet the conceptual case is not 

strong. A major aspect emphasized by Hitz’s (2007) findings was that standard setters need to clarify the 

notion of accounting income, its presumed contribution to decision relevance and its disaggregation, as a 

must for further implementation of fair value accounting. Landsman (2005) approaches issues that bank 

regulators need to consider if they are to use fair value accounting for determining bank regulatory capital 

and when making regulatory decisions. A significant aspect that he emphasized as requiring regulators’ 

consideration questioned how to let managers reveal private information in their fair value estimates while 

minimizing strategic manipulation of model inputs to manage income and regulatory capital. Establishing 

how best to minimize measurement error in fair values so as to maximize their usefulness to investors and 

creditors as they make their investment decisions, and how best to ensure bank managers have incentives to 

select those investments that maximize economic efficiency of the banking system is considered equally 

important (Landsman, 2005). 

While fair value is mostly discussed in connection to financial instruments’ measurement, some 

studies also consider the use of fair value for non-financial items. An example in this regard would be 

Herrmann et al. (2006) who argue that fair value measures for property, plant, and equipment are superior to 

historical cost based on the characteristics of predictive value, feedback value, timeliness, neutrality, 

representational faithfulness, comparability, and consistency. This once again raises some conceptual 

implications in terms of the IASB/FASB joint conceptual framework since IFRSs are considered to be 

applying fair value more widely to non-financial assets than FASB standards do (Whittington, 2008). 

A very interesting approach to fair value accounting is that of Barlev & Haddad (2007) who analyze 

the concept within the broad context of international accounting harmonization. They present fair value as 

being suited to play the role of a common denominator that they consider necessary in order to complete our 

current understanding of international accounting harmonization systems. More precisely, they see this 

common denominator as helpful in measuring, recording and reporting business transactions, assets, 

liabilities and equities in a manner that would generate high quality comparability of accounting numbers. 

The idea of the common denominator clearly makes fair value accounting stand out in from of historical cost 

accounting, the first therefore offering feasibility to the idea of complete international accounting 

harmonization. Furthermore, since fair value accounting propels international accounting harmonization, the 

paradigm itself is seen as having the potential of acting as a catalyst in a harmonization cycle. International 

accounting harmonization is assumed to provide more relevant information which in turn should foster the 

efficiency of global markets and improve the quality of fair value accounting figures. The following figure 

synthesizes the idea of fair value accounting acting as a catalyst in a harmonization cycle: 

As previously mentioned, Barlev & Haddad (2007) analyze the paradigm of fair value accounting in 

relation to international accounting harmonization, therefore offering an original argument for an increased 

use of fair value measurements. Still, their paper relies on the assumption that a set of internationally 

implemented Generally Accepted Accounting Principles represents a must for a favorable process of 

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international accounting harmonization. Furthermore they argue how the set must be completed with the 

required common denominator that would serve the accounting concept of comparability which also 

represents the core idea of international accounting harmonization. While accounting systems evolve, reflect 

and reinforce the economic environment they serve (Radebaugh et al., 1997 quoted by Barlev & Haddad, 

2007), the international accounting system is an outcome of the globalization of financial markets and the 

international economic integration (Iqbal et al., 1997; Epstein & Mirza, 2000 quoted by Barlev & Haddad, 

2007). 

Meanwhile, some opinions within accounting literature consider that international accounting 

standards optimised for stock market based capitalism are not necessarily optimal for other forms of 

capitalism and, since stock market capitalism has lost credibility as a way of doing business, the world 

may be better served by encouraging alternative forms of capitalism to develop with accounting standards 

tailored to their needs (Walker, 2010). We have all been witnessing how excessive credit expansion 

generated worldwide recession, recent events raising a series of question marks and doubts regarding 

financial reporting in general and financial accounting standards in particular. Under these circumstances 

there are fundamental reasons for resisting the call for a single set of global standards, starting with the 

idea that the right to set the accounting standard for the entire world would represent a very significant 

monopoly power (Walker, 2010). Therefore both of the core elements mentioned by Barlev & Haddad 

(2007) as required for a complete harmonization, namely a set of internationally implemented Generally 

Accepted Accounting Principles and fair value accounting, were brought into question due to the 2007- 

2009 financial crisis. 

Previous to the financial crisis, accounting researchers and especially fair value supporters were 

arguing that accounting standard setting bodies will continue to use fair value as the means of ensuring that 

transactions are represented faithfully in the financial statements (Cairns, 2006) and some even argued for 

the extension of the use of fair value measurements. Meanwhile a series of conceptual underpinnings, as the 

ones discussed above, continue to be debated within research literature, while studies on the value relevance 

of fair value also seem to be generating mixed results (Hann et al., 2007). 

But, as we know it, it is turbulent times that test any concept, lieder or even standard setting body, 

considering our discussions. Therefore Enron offered the right setting for Gwilliam & Jackson’s (2008) 

analysis on the use of mark to market accounting in financial reporting by means of a case study-based 

examination. Setting their results in the context of historical developments in and theoretical discussion upon 

asset valuation and income measurement, Gwilliam & Jackson (2008) emphasize the ease with which Enron 

was able to ‘monetize’ physical assets so as to bring them within the remit of mark to market accounting; the 

unreliability of valuation estimates provided by independent third parties; and the asymmetry between 

management desire to recognise mark to market gains through the income statement in contrast to their 

desire to avoid recognising mark to market losses. 

It is naturally that such finding as Gwilliam & Jackson’s (2008) have the tendency of advising 

standard setters think twice before encouraging further moves toward more widespread use of mark to 

market accounting. In line with such situations emphasizing shortcomings and difficulties of mark to market 

accounting we must also mention the recent market conditions of the credit crunch and reduced market 

liquidity which brought significant challenges for users, preparers and auditors of financial statements, 

especially in terms of measurement issues. Even if a significant number of studies (see Veron, 2008; André 

et al., 2009) defend the concept of fair value in the context of the financial crisis, documenting how fair 

value ended up by being either the scapegoat or the shot messenger, it was the turbulent times of 2007-2009 

that brought a series of shortcomings of the concept even more into the spotlight. 

Such a conceptual implication is disused by Schmidt (2009) through an observation that might be 

considered trivial on first glance. Schmidt (2009) discusses the notion of fair value based on its 

definition in both IFRSs and US GAAP, while considering both a perfect market and an imperfect 

market setting. He documents that when considering a scenario that is characterized by low liquidity 

and/or high information asymmetry, which is broadly consistent with the recent credit crunch, the IFRS 

definition of fair value is not readily applicable. The following figures reflect his discussions in the 

context of an imperfect market. 

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Schmidt’s (2009) main reasoning is that in imperfect markets, buyer’s and seller’s marginal prices, at 

which they are rationally willing to transact, differ. On the other hand, the transaction price can be any 

amount within the range between those prices. Such a range is reflected in Figure 2. The problem appears 

for scenarios where no such range exists because the seller’s marginal price exceeds the buyer’s, as reflected 

in Figure 3. 

The Accounting Standard Setting’s Perspective and Political Implications 

A significant issue that is also emphasized through accounting research literature and whose importance 

was enhanced due to current turbulent times relates to having directly linked prudential requirements for equity 

capital to accounting rules. More precisely, this led to the banking sector arguing fair value’s pro-cyclical effect 

under crisis circumstances. In order to maintain their regulatory capital, financial institutions had to sell assets, 

therefore only enhancing the downward trend of the markets. This of course only generated further need to sell, 

therefore completing the pro-cyclical effect. This situation confronted us with a major dilemma: What is it that 

should be changed? The accounting model or the way regulators establish the required level of equity capital? 

Or maybe both? It is still for sure that we must therefore acknowledge the fundamental inconsistency between 

accounting measurement and prudential valuation (André et al., 2009). What mostly differentiate the two are 

precisely their objectives: while the first aims for financial-accounting information that is useful to stakeholders 

and particularly relevant to investors’ needs (Matherat, 2008 quoted by André et al., 2009), the latter ought to 

aim prudence from the regulator’s point of view. 

For sure we remember an extremely interesting situation that rose in the context of EU adopting IFRSs 

for consolidated financial statements of listed companies, starting with year 2005, through the so-called EU 

IAS Regulation (1606/2002). More precisely we refer to the European, especially French banks’ well-known 

opposition to carrying financial instruments at fair value. Furthermore, it was in 2003 that they actually 

convinced the then French president, Jacques Chirac, to write to the EC and complain that this would 

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destabilise the economy. After many months of negotiations, the compromise was reached through what we 

know as the IAS 39 carves out. This of course had direct impact on IASB and brought threats of carve outs 

elsewhere, but until nowadays IASB has only accepted the original carve out. Still, it was once again the 

2007-2009 financial crisis that nearly brought another carve out, once again required by EU and once again 

related to fair value of some financial instruments. This time it was based on the EU IAS Regulation that EU 

almost went for another carve out. The Regulation includes a requirement that IFRS endorsed by EU must 

not disadvantage European companies when compared with those in other major markets. This time it was 

President Nicolas Sarkozy that had to deal with French banks lobbying who were worried not to be 

disadvantaged in comparison with American banks. It was then found that an old US standard did not require 

property mortgages to be held at fair value and that SFAS 133 allowed available for sale financial 

instruments to be re-classified under rare circumstances. Since IAS 39 included a key anti-abuse requirement 

based on which entities determined at inception into which category each financial asset fell, without 

acceptance of subsequent re-classification, the reason was found to argue for another potential carve out. A 

compromise was found in October 13, 2008 through the amendment to IAS 39 for reclassifications of 

financial assets, allowing certain re-classifications (for more details see André et al., 2009). 

The risk of taking away all safeguards on manipulating the categories of financial instruments 

(referring to the possibility of transferring all loss making assets to amortised cost and profit making assets to 

fair value through profit and loss) was controlled. Unfortunately we cannot say the same thing about IASB’s 

credibility. 

Conclusions 

As Veron (2008) pointed out, a vigorous debate about fair value was made necessary by the recent 

financial disruption, which provides a real-world litmus test of accounting standards. As previously 

discussed, the standard setting process itself and standard setting bodies have been questioned and closely 

analyzed as a consequence of recent events that marked our history. The interesting times we are living 

clearly point to an extensive new agenda for predictive international accounting research (McLeay, 2008). 

The regulatory competition and the worldwide globalisation project were also for sure influenced by the 

circumstances and outcomes of the credit crunch, as even the new SEC chairperson, Mary Schapiro said that 

she thought a single set of global standards would be a very beneficial thing, but expressed doubts about the 

independence of IASB and declared she would not necessarily be bound by the proposed roadmap (World 

Accounting Report, February 2009 quoted by André et al., 2009). 

The concepts of fair value and fair value accounting for sure have their shortcomings and opponents 

that were even more encouraged through recent events, but we consider the most appropriate manner to 

handle the situation is to give it a fair trial. We consider initiatives such as that of Abacus special issue which 

we discussed to be useful in shifting the fair value debate towards greater recognition of the fundamental 

implications for institutions and markets (McLeay, 2008). As Bradbury (2008) concludes, it is possible that 

replacement cost is a better measurement method on some dimensions; deprival value is better on other 

dimensions; and even historical cost is better on certain dimensions; as well as it is still possible for fair 

value accounting to be, on average, the best. Being on the same page with André et al., (2009) who see fair 

value as the messenger being shot for the crisis, Veron (2008) considers it to be the financial accounting 

thermometer which would not help in improving the health of the patient if broken and tweaked, but would 

only make the doctors’ task that bit harder. 

Political implications that inevitably arise in the international accounting arena, as documented 

through our paper, should also be considered and dealt with, so that they don’t interfere with designing and 

implementing an adequate conceptual framework and accounting standards that aim for the quality of 

financial reports. Issues such as the measurement attribute of financial instruments being dictated through the 

four categories in IAS 39 used to be debated even before the crisis, but having the crisis as an excuse for 

their manipulation is not justified either. Meanwhile we will have to further debate these aspects with 

reference to the new IFRS 9 Financial Instruments, covering classification and measurement of financial 

assets, as the first part of IASB’s project to replace IAS 39. 

Acknowledgment 

This paper is part of the research project POSDRU/89/1.5/S/59184 ‘Performance and excellence in 

postdoctoral research within the field of economic sciences in Romania’, Babeş-Bolyai University, Cluj- 

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Napoca being a partner within the project and project GA403/11/0002 registered at Czech Science 

Foundation (GA ČR). 

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