Advantages of Fair Value Accounting

Fair value accounting offers several advantages that can provide more timely and relevant information to users of financial statements. Here are some of the key advantages:

1. Relevance and Timeliness: Fair value accounting provides current and up-to-date information on the value of assets and liabilities. This is especially important in rapidly changing markets where historical cost may not reflect current market conditions.

2. Transparency: Fair value accounting requires companies to disclose the methods and assumptions used in determining fair values. This promotes transparency and helps users of financial statements understand the basis for valuations.

3. Better Decision Making: Fair value accounting provides more accurate and current information to stakeholders, which aids in making informed decisions regarding investments, lending, and other financial activities.

4. Market-Based Information: It is based on market prices or observable market inputs, making it a more reliable measure of an asset or liability’s true value, especially for items like financial instruments.

5. Comparability: Fair value accounting allows for better comparability between companies, as it provides a common standard for valuing assets and liabilities. This facilitates easier benchmarking and analysis.

6. Risk Management: Fair value accounting helps in identifying and managing risks associated with market fluctuations. It provides a clearer picture of how market changes affect the financial position of a company.

7. Reflects Economic Reality: Fair value accounting is argued to provide a more accurate reflection of the economic reality, as it captures the actual market value rather than the historical cost.

8. Facilitates Mergers and Acquisitions: In cases of business combinations, fair value accounting is often used to allocate the purchase price to the acquired assets and liabilities. This can lead to a more accurate representation of the combined entity’s financial position.

9. Encourages Accountability: Companies are incentivized to continuously monitor and assess the fair values of their assets and liabilities, fostering a culture of accountability and diligence in financial reporting.

10. Encourages Active Management of Assets and Liabilities: Knowing that assets and liabilities will be valued at their fair value, companies may be more inclined to actively manage their portfolio to optimize their financial position.

11. Reduces Potential for Manipulation: Historical cost accounting can sometimes be subject to manipulation, as it relies on the initial acquisition cost. Fair value accounting, on the other hand, is based on observable market data, reducing the potential for manipulation.

12. Facilitates Reporting of Complex Financial Instruments: For complex financial instruments like derivatives, fair value accounting provides a more accurate representation of their current market value, which can be important for risk management and financial reporting.