Fair value accounting has received a significant amount of blame as the cause of the current financial crisis. Fair value accounting does not cause illiquidity or volatility in financial markets. Banks, rather than accounting, caused the existing crisis, ultimately through bad lending decisions and inadequate risk management. Accounting rules are designed to reveal the full extent of losses and future risks. This transparency would enable banks, regulators, and government to identify specific sources of the crisis and take steps toward recovery and future prevention. Shooting the accounting messenger is not a solution to the problem. Perhaps confusion exists regarding the conflict between transparency and financial stability. Transparency is an objective of accounting standards. Long term stability is best achieved by restoring investor confidence in financial markets and assets. Transparent accounting standards and sound auditing provide support for that confidence. Evidence from the recently released SEC study on mark-to-market accounting supports fair value as the most relevant measurement attribute for financial instruments. Suspension of fair value in favor of alternative cost-based measures would mask losses in value, mislead investors, and diminish investor confidence. From an ethical perspective, accounting has a responsibility to see that financial statements are fairly presented-reflect economic reality. Accountants and auditors are ethical detectives holding businesses to ethical standards of honesty, completeness, neutrality, and representational faithfulness. Accountants and auditors are bound by their professional code of conduct to protect the public interest. So grounded, accounting is the provider of one of the essential checks and balances on commerce.
Recently, there has been considerable media coverage on the subject of fair value accounting. While some commentators applaud the use of fair value accounting as a positive factor in promptly revealing the values of financial assets in today's troubled credit markets, others decry the use of fair value accounting as a negative factor exacerbating the problems in the credit markets.
Over the past 1 8 months, what some viewed as a subprime mortgage crisis has spread to the global economy. The National Bureau of Economic Research announced that the United States has been in a recession since December 2007 and is expected to "likely be the longest, and possibly one of the deepest, since WWII."
Some posit that the fair value accounting standards have contributed to or exacerbated the crisis in this illiquid market by requiring asset write downs below their underlying or intrinsic economic values. Critics assert that these write downs have triggered a downward market spiral, causing diminished investor confidence, further losses in value, and lessened liquidity. Fair value supporters counter that fair value reporting enhances transparency and, therefore, investor confidence. They argue that suspension of fair value reporting would decrease transparency, thereby, leading to greater uncertainty and instability in the market.
Our paper examines the current economic tsunami as it relates to fair value reporting and explores the role of accounting and auditing from an ethical perspective. We believe that accounting is applied ethics, and accountants and auditors are the gatekeepers of business ethics. Contemporary ethical models are applied to the accounting profession. Results of the recently released SEC study on mark-to-market accounting are considered and fair value reporting rules are evaluated from an ethical perspective.
THE FINANCIAL REPORTING FRAMEWORK AND BACKGROUND INFORMATION ON FAIR VALUE ACCOUNTING
SFAC No. 1 states that the objective of financial reporting is to provide information to investors and creditors that are useful in decision-making. SFAC No. 2 states that the two primary qualitative characteristics that provide decision-utility are relevance and reliability, with secondary qualities of comparability and consistency. …