Academic journal article Accounting Historians Journal

The Crisis and Fair Values: Echoes of Early Twentieth Century Debates?

Academic journal article Accounting Historians Journal

The Crisis and Fair Values: Echoes of Early Twentieth Century Debates?

Article excerpt

Abstract: The recent global financial crisis has led to extensive criticism of the role of accounting and its use of fair value measurement in causing and spreading the crisis. This paper argues that the debate surrounding fair value vs. historic cost, and relevance versus reliability, is nothing new; it was at the center of early accounting discussions in the AAA (especially by A.C. Littleton and W.A. Paton), the AICPA (especially G.O. May), and the SEC. Although prominent accounting scholars and practitioners in postdepression 1929 focused on the use of historic cost, the paper discusses the decision of the IASB/FASB to move reliability to a secondary characteristic in its recent conceptual framework. This action ignores lessons learned from a century of research, teaching, and practice of accounting.

INTRODUCTION

The world is barely emerging from the most severe global economic downturn in living memory, a banking crisis that resulted from the collapse of the U.S. housing market in 2008 that subsequently spread to the rest of the world. Several contributory factors have been identified, of which the most widely accepted include unprecedented low long term real interest rates related to the excess supply of savings from Asian exporting economies [Wolf, 2009]; excessively lax monetary policy [Cooper, 2008]; the housing bubble and associated boom in consumer and other forms of credit, masking problems in loan quality [Demyanyk and Van Hemert, 2009]; undercapitalization of banks and excessive maturity mismatch [Brunnermeier, 2008]; an explosion of new structured instruments many of which were poorly understood, notably by rating agencies many of whose ratings now appear suspect [Gorton, 2008; Mason and Rosner, 2007]; and weaknesses in regulation and supervision that failed to prevent some individual institutions taking on extremely risky exposures [Brunnermeier et. al., 2009].

Given that accounting is critical for well-functioning capital markets, there has been extensive criticism of its role in the crisis. A large number of capital market participants, regulators, politicians, and media pundits have blamed the use of fair value accounting as a major cause of the crisis [Whalen, 2008; Forbes, 2009; Katz, 2008; Johnson and Leone, 2009]. (1) However, the accounting profession, most accounting academics, the Securities and Exchange Committee (SEC), and other commentators have consistently asserted that accounting should not be blamed [Badertscher et al., 2010; Barth and Landsman, 2010; Laux and Leuz, 2010; SEC, 2008; Turner, 2008; Veron, 2008]. Their position has been that the function of accounting is merely to record events and that the stability of financial markets rests on bank regulation, not accounting.

This criticism of accounting is the result of its intellectual trajectory in which the fair value paradigm replaced the historic cost paradigm [Bariev and Haddad, 2003]. Before the crisis, experts posited that fair value improved relevance and augmented the stewardship function of accounting numbers, reduced agency costs, and boosted managerial efficiency. This paper examines the role of fair value accounting in the economic crisis and argues that the debate of relevance (as in the usage of fair value) versus reliability (as it pertains to historic cost) is not new but reflects the discussions from the early part of the 20th century. Referring to the works of A.C. Littleton, W.A. Paton, and G.O. May, this paper highlights the implications of this ongoing debate for accounting. Moreover, it outlines current developments in the conceptual framework of the Financial Accounting Standards Board (FASB)/International Accounting Standards Board (IASB) that moved reliability to a secondary characteristic, giving more emphasis to relevance, and indirectly, to fair value. Thus, the current FASB/IASB framework ignores lessons learned from almost a century of accounting research and practice, including those from the Great Depression of 1929. …

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