This document discusses fair value accounting and myths about its role in the 2008 financial crisis. It presents perspectives from Steve Forbes, Brian Wesbury, and Lisa Koonce on whether fair value accounting caused the crisis. The document also outlines the differences between fair value accounting and historical cost accounting, identifies three myths about historical cost accounting, and recommends enhancing the credibility of fair value estimates calculated through models rather than market prices. The conclusion is that no single valuation method is best and fair value accounting did not solely cause the crisis, though misperceptions about standards may have exacerbated problems.

1. Prepared by :
Nitu Baral
Shreeza Tamrakar
Jeny Sherchan

2.  Introduction
 Myths about Accounting Methods
 Recommendations for Realistic Reporting
 Conclusion

3.  Fair Value accounting, also called mark to market
accounting, is the practice of valuing an asset every
period based on its fair market value, not what was
paid for it.
 A financial crisis can occur if institutions or assets
are over-valued, and it can be made worse by
irrational investors behaviour.

4.  Mark-to-market accounting was “the principal
reason” that the U.S financial system melted down in
2008, Steve Forbes, Chairman of Forbes media and
sometime political candidate

5.  Economist Brain Wesbury says:
 During the crash of 2008, value of any assets such as
corporate bonds and structured debts drop because
the market was frozen.
 This caused many banks to unload and sell assets at
fire-sale prices.
 This has lead to many European countries and US to
want to revert back to historical cost accounting
(valuing assets at purchase price).

6.  According to Lisa Koonce, an accounting professor
at University of Texas:
 Fair value accounting is not the cause of the current
crisis
 The main reason of crash is subprime loan
 Shareholders group even argue that fair value accounting
is crucial in the decision making process for investors.

7. Fair Value Accounting Historical Cost Accounting
Fair Value is the amount for which the
asset could be exchanged, or a liability
settled orderly among willing parties.
Historical Cost is based on the concept
that assets and liabilities are measured
and booked as per their original
acquisition price.
Focuses on the actual market values of
the asset.
Focuses on the cost distribution of the
asset.
More relevant to the intended users of
general purpose financial reports.
Doesn’t provide enough information
relevant to investors.
Contemporary and transparent. Conservative and easy to calculate.
Inaccurate when sharp, unpredictable
volatility in prices occurs.
Historical costs remain steady in the
long run.

8.  Myth 1: Historical Cost Accounting Has No Connection to
Current Market Value
 Myth 2: Most Assets of Financial Institutions Are Marked
to Market
 Myth 3: Assets Must Be Values at Current Market Prices
Even If the Market for Them Is Illiquid

9.  Historical Cost Accounting records assets at their
purchase price or original value
 Minor adjustments for depreciation and appreciation
 Ultimately must be marked down to the current value
on the Balance Sheet and the result recorded in the
Income Statement
 The only difference with respect to the Fair Value
Accounting is the duration and the amount in which
the market value can be reported

10.  Only 31% of bank assets were marked to market in the
late 2008
 Most bonds/loans were “held to maturity” subject to
historical accounting
 The gains were reflected under “other comprehensive
income”
 As a result, neither the net income nor the regulatory
capital were affected

11. “How Liquid Is That Asset?”
Level 1 Level 2 Level 3
Most Liquidity Moderate Liquidity Least Liquidity
Valued at direct
market prices, based
on active trading of
identical instruments
Valued using
observable marketing
inputs
Valued using a
financial model, such
as a discounted cash
flow model
Liquidity
Standard
Valuation
Method

12.  Enhance the credibility of Marking to Model
 Delink Accounting and Capital
Requirements
 Calculate EPS in both ways

13.  No single best way to value assets.
 Fair value accounting did not cause the
financial crisis.
 Misperceptions about accounting
standards may have aggravated the crisis.

14. THANK
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