Fair value accounting, by which debt and equity securities on a company's balance sheet are "marked to market" - written up or down to their market price - has been hyped by accountants and regulators as the epitome of modern financial reporting, enabling investors to gain a completely true picture of their investment's financial position.
Indeed, Gerald White of the Chartered Financial Analyst Institute, speaking at an American Enterprise Institute conference on Tuesday, believes it should be applied to all items on the balance sheet, not just financial instruments. There is just one problem: in the turbulence of the past nine months, it has completely failed to work and has indeed shown itself to be pro-cyclical, encouraging economically foolish behavior in both up and down cycles.
As someone who only thinks about accounting once a decade or so, I wasn't really aware that much had changed from my business school days in the early 1970s. At that time, the values of assets on the balance sheet didn't move much. Everything the company owned was dumped on the balance sheet at cost price and stayed there for decades while the world turned. The only exception was when the company held bonds or shares that had declined catastrophically in value (the occasional wobble was ignored) in which case they were declared "impaired" and their value written down.
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Indeed, Gerald White of the Chartered Financial Analyst Institute, speaking at an American Enterprise Institute conference on Tuesday, believes it should be applied to all items on the balance sheet, not just financial instruments. There is just one problem: in the turbulence of the past nine months, it has completely failed to work and has indeed shown itself to be pro-cyclical, encouraging economically foolish behavior in both up and down cycles.
As someone who only thinks about accounting once a decade or so, I wasn't really aware that much had changed from my business school days in the early 1970s. At that time, the values of assets on the balance sheet didn't move much. Everything the company owned was dumped on the balance sheet at cost price and stayed there for decades while the world turned. The only exception was when the company held bonds or shares that had declined catastrophically in value (the occasional wobble was ignored) in which case they were declared "impaired" and their value written down.
Read More Article....
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