Fair Value Accounting and Reliability

The Problem with Level 3 Estimates

Sung Gon Chung, PhD, Cheol Lee, PhD, and Santanu Mitra, PhD

FASB's efforts to expand the use of fair value accounting have rekindled the debate on the costs and benefits of the approach. Proponents argue that expanding fair value accounting rules will make financial reporting more relevant to users. In support of this view, the CFA Institute Center, which represents the views of investment professionals, argued in a 2010 comment letter to FASB that fair value is the appropriate basis for measuring all financial instruments (“Fair Value as the Measurement Basis for Financial Instruments,” September 2010, http://cfa.is/1Xw1LkH). Former SEC chairman Arthur Levitt also contended in an interview that fair value provides the kind of transparency essential to restore public confidence in U.S. markets (“U.S. Moves to Ease ‘Fair Value’ Accounting Rules,” The Globe and Mail, Apr. 3, 2009, http://bit.ly/1WsgEpZ). In contrast, opponents of fair value have raised concerns about the impaired reliability of reported financial information, arguing that fair value accounting often relies on subjectivity in the measurement of various financial statement items. In particular, when active markets do not exist for assets and liabilities, the business must estimate the fair value by applying present value techniques, which opens up the possibility of intentional or unintentional errors in accounting estimates. Recent research into fair value accounting and its effects on investor confidence sheds some light on this debate.