Fair value accounting is a type of accounting in which companies measure and report certain assets and liabilities at prices equal to their fair value. Fair value means that assets are reported at the price the company would receive if they sold them and liabilities are reported at the value the company would receive if they were relieved of them. The purpose of this method is for creating realistic financial statements.
Reduced Net Income
Using fair value accounting, when values of assets decrease, the company's calculated net income decreases. When the company's value of liabilities increase, the company's calculated net income also decreases. Net income is the bottom line of a company's Income Statement. This amount reflects the amount the company pays taxes on. This is an advantage to companies because a lower net income results in lower taxes. These affects to assets and liabilities also cause a decrease in the equity of the company. A lower equity results in less money a company must decide what to do with. This usually results in less employee bonuses, which means more money in the company's pocket.
Realistic Financial Statements
Companies reporting under this method have financial statements that are more accurate than those not using this method. When assets and liabilities are reported for their actual value, it results in more realistic financial statements. When using this method, companies are required to disclose information regarding changes made on their financial statements. These disclosures are done in the form of footnotes. Companies have an opportunity for examining their financial statements with actual fair values, allowing them to make wise choices regarding future business operations.
Fair value accounting offers benefits for investors as well. Because fair value accounting lists assets and liabilities for their actual value, financial statements reflect a clearer picture of the company's heath. This allows investors to make wiser decisions regarding their investment options with the company. The required footnote disclosures allow investors a way of examining the effects of the changes in statements due to fair values of the assets and liabilities.