Dienstag, Juli 29, 2008

When Fair Value Isn't...

I've posted on IFRS and fair value before.

Today's FT - link here - has an article by three rather senior accountants that is spot-on.

The current world financial woes have been made worse by what is called "fair-market" valuation of assets, as opposed to purchased value or book value (i.e. depreciated). This "fair-market" valuation is pro-cyclical, increasing volatility, and is anything but fair: many, if not most, accountants have failed to understand what fair-market valuation is really all about.

First of all, it's not about assigning a value to an asset based on what that asset would currently bring in the market today. That is what many think it means, but that's a mistake: fair value is, instead, the value of an asset when that asset is purchased at a price that can be financed out of the cash flow of the asset. I worked for a while assessing the fair value of radio and TV stations, and while it is a simple concept, it's not one that can be simply assigned to various kinds of assets held by companies.

What the accountants wrote in the article I link to call for is, quasi, a mechanism where a sharp rise in the risk and discount rates would lead to a change in the way assets were valued.

While the idea has some merit, it ignores the fundamental fact that IFRS and the fair value concept ignores a fundamental concept of accounting: that the company for which the books are being prepared is an ongoing company and is not being liquidated. Fair value assumes the exact opposite, and remains a really bad idea.

For all the warts and bumps and problems that it has, the standard valuations of the past have one truly positive aspect: they don't force companies to write off billions in assets because there is a market downturn.

But the inmates appear to be firmly in control of the asylum, and it will take a monumental effort to break them. Shame that it will cost the world economy so much to do so.


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