Fair Value Accounting

Fair Value Accounting

1. current/market value is closer to present value of future cash flow

   • better than historical accounting

2. Reserve Recognition Accounting (RRA)

   • application of PV accounting when ideal conditions do not exist
   • not so reliable
     • info may differ from estimate due to timing
     • changes in price and cost estimates
     • lawsuit
       • FCF may not represent FV
         • mislead investors
   • recognizes revenue when it is PROVEN,
     • unlike HC
   • relevant
     • under certain assumptions
       • shows the PV of proven reserves
   • Ideal?
     • not reliable
       • relevant but doesn't matter anymore

3. Problem with Historical Accounting

   • TIMING of recognition

4. Fair Value VS Historical Accounting

   • FV/PV
     • measurement perspective
     • changes in PVs measured as they occur
     • Balance sheet focus
     • Income = net change in PV
     • attempt to measure total value of firms
   • HC
     • Information perspective
     • Only realised changes in value are recognised in income statement
     • income statement focused
     • uses matching principle
       • provides reliability
       • all rev matched against expenses
     • cash flows are smoothed by accruals
     • attempt to measure value added

5. Ideal Accounting not achievable

   • when OBJECTIVE state probabilities are lost
   • no cost effective way to achieve relevance without sacrificing reliabilty
   • what now?
     • focus on how financial accounting information is used in financial markets
       • understand how to make financial accounting information more decision useful