Valuation for Financial Reporting - CMA Ankur Pandey

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Fair Value Measurementsand Financial Reporting 1Chapter 1Five years after Enron, corporate financial reporting stands at acrossroads. One route leads deep into the lightly charted terrain of‘‘principles-based’’ reporting, where thousands of rules and regulationswould be replaced by a relative handful of guiding precepts. The norm inEurope, this would be terra incognita of the most profound sort forAmerican companies. Proponents argue that the unceasing torrent ofnew standards and regulations is creating an unworkable system. Foescounter that if the existing rules failed to prevent corruption and providetransparency, a system based on vague pronouncements is doomed tofail. The alternative path entails a continuing series of changes to thestatus quo that would undoubtedly increase complexity even as theyattempt to improve transparency and accountability. No issueunderscores these concerns more dramatically than fair-valueaccounting, in which assets and liabilities are marked to market ratherthan recorded at historical cost. The degree to which fair-valueaccounting is embraced (or not) will have a major impact on thevery nature of corporate finance. In short, Sarbanes-Oxley was just awarm-up for what lies ahead.—Ronald Fink‘‘Think reporting has changed since Enron? Just wait.’’CFO Magazine, September 1, 2006OBJECTIVES OF FINANCIAL REPORTINGAND THE CURRENT ENVIRONMENTIn order to understand the historical and ongoing changes in generally acceptedaccounting principles (GAAP) surrounding fair value accounting and fair valuemeasurements, one needs to grasp the basic objectives of financial reporting.Accounting standard setters strive to meet these objectives in their pronouncements,which through the years have been consistent—to provide users of financial1
2 Valuation for Financial Reportingstatements the most meaningful information to inform their investment decisions. Asthe environment has changed, we have seen changes in the type of informationstandard setters consider most meaningful.One of the sources of U.S. accounting literature that discusses the objectives offinancial reporting is Statement of Financial Accounting Concepts No. 1, Objectivesof Financial Reporting by Business Enterprises, published by the Financial AccountingStandards Board (FASB) in 1978. Two key points are:1. Financial reporting is intended to provide information in making various types ofdecisions (e.g., investment, credit, resource allocation, management performance).2. The objectives of financial reporting are affected by the economic, legal, political,and social environment.The FASB and the London-based International Accounting Standards Board(IASB) are currently working on a joint initiative called the Conceptual Frameworkproject. The goal of this multiyear project is to provide a foundation for the futuredevelopment of accounting standards by the FASB and IASB. Both of these boardshave goals of developing accounting standards with the following attributes:Principles-basedInternally consistentInternationally convergedLead to financial reporting that provides the information needed for investment,credit, and similar decisions 2Phase A of the Conceptual Framework project is pending at the time of thiswriting, and the two boards have substantially completed their considerations of theobjectives of financial reporting. An interim report of this phase said the followingabout the objectives:In the Boards’ existing frameworks, the overriding objective is to provide informationthat is useful to present and potential investors and creditors and others in makinginvestment, credit, and similar resource allocation decisions. The Boards’ discussionsof the objectives of financial reporting and decisions reached to date are based on thatoverriding objective.The Boards made the following decisions about the objectives of financial reporting:As with the existing frameworks, the Boards’ converged framework should be concernedwith general purpose financial reports that focus on the common information needs ofexternal users. The framework should identify the primary users as present and potentialinvestors and creditors (and their advisors), rather than focus only on the informationneeds of existing common shareholders. Later in the project, the Boards will considerwhether financial reporting also should provide information to meet the informationneeds of particular types of users, such as different kinds of equity participants.General purpose financial reporting should provide information about the entity to theexternal users who lack the power to prescribe the information they require and
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210 IndexBusiness Enterprise Analys
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214 IndexLong-termcapital, 71debt,
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216 IndexSecurities and Exchange Co
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Valuation for Financial Reporting - CMA Ankur Pandey

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