Business
The practice on whether to use fair value (or current market value) versus historical costs in estimating the value of a firm’s assets and liabilities has always been a controversial issue. Since the beginning of capital markets, historical costs had been used. Over time however, the practice changed with the emergence of recent studies mainly, the market efficiency theory that rationalizes the use of “fair value” methodology. Adopting this principle in the standards set by Financial Accounting Standards Board (FASB) used by over 100 countries made this methodology even more popular. However, during market meltdowns such as the 1929 Wall Street Cash and even the latest 2008 financial crisis, this fair market valuation practice is pinpointed as the culprit that enables public companies to mislead investors on the true value of their business.
Despite these catastrophic financial crises, accounting standard setters and regulators namely FASB and Security and Exchange Commission (SEC) remain on the side of the “fair value” advocacy. In a study by Harvard Business School to determine the rationale for their support, it revealed that FASB’s preference for this methodology is driven by the growing number of financial services industry representative in the organization. These are the likes of investment bankers and managers from Goldman Sachs, Morgan Stanley, and Merrill Lynch who are the biggest name in syndicating mergers and acquisitions, as well as IPOs. Their biasness to this methodology is influenced by their day-to-day use of the system in reporting asset values in the balance sheets of the companies they handle. The system is also in alignment to GAAP rules in reporting income in current market prices that benefits corporate executives in terms of their bonuses, which eventually trickles down on these financial services’ business development.
On the side of historical costs arguments are the investors and privately held companies that call for conservatism and perhaps, to avoid another crippling financial downturn. As a result, a Private Company Council has been set up to establish this sector’s own accounting standards. At the end of the day however, the determining factor in choosing which practice to use is the simple rationale of what is the right methodology and what is truly fair for all stakeholders.
