Fair value accounting: Current practice and perspectives for future research

• DOI: http://doi.org/10.1111/jbfa.12447
• Author: Ryan McDonough,Argyro Panaretou,Catherine Shakespeare
• Date: 01 March 2020
• Published date: 01 March 2020

DOI: 10.1111/jbfa.12447

Fair value accounting: Current practice and

perspectives for future research

Ryan McDonough1Argyro Panaretou2Catherine Shakespeare3

1Rutgers Business School, Rutgers University,

Piscataway,New Jersey, United States

2Management School, Lancaster University,

Lancaster, UK

3Ross School of Business, University of Michigan,

Ann Arbor, Michigan, United States

Correspondence

CatherineShakespeare, Ross School of Business,

Universityof Michigan, 701 TappanSt, Ann Arbor,

Michigan,United States.

Email:shakespe@umich.edu

Abstract

A fundamental issue debated in the accounting literature centres

on the appropriate basis for measuring firms’ assets and liabilities.

During the last several decades, scholars have generated a growing

body of important insights about the use of the fair value measure-

ment attribute in financial reports around the globe. In this paper,

we provide an overview of the institutional background of fair value

accounting and the associated accounting standards that prescribe

the use of fair value measurements under International Financial

Reporting Standards and Generally Accepted Accounting Principles

in the US. We discuss and document the extentto which firms across

differentindustries and accounting regimes recognize and disclose in

theirfinancial reports assets and liabilities measured at fair value and

we reflect on aspects of the fair value accounting literature. In doing

this, we identify several areas in which additional research can fur-

ther our understanding of fair value measurements and disclosures.

KEYWORDS

Fair value accounting, FASB,IASB

JEL CLASSIFICATION

G21, M40, M41, M48

1INTRODUCTION

Over the last several decades, fair value measurement has takencentre stage in international discussions concerning

the appropriate basis for measuring (and remeasuring) assets and liabilities. Academics, policymakers, and practition-

ers alike have sought to attribute both positive and negative capital marketoutcomes to fair value measurements in

corporate financial reports. Interest in this topic intensified because of the recent global financial crisis (e.g., Laux &

Leuz, 2009, 2010) and because of increasing reliance on fair value measurements that are inherently subject to bias

and measurement error. In this article, we contribute to the ongoing debate about fair value measurements in finan-

cial reports by providing an analysis of current practice and by discussing potentially fruitful avenuesof inquiry in the

context of the extantacademic literature related to fair value accounting.

In Section 2, we begin by discussing the historical development of fair value accounting. Notions of fair value

accounting in the academic literature can be traced to the discussions of W.A.Paton and A.C. Littleton, among others,

J Bus Fin Acc. 2020;47:303–332. wileyonlinelibrary.com/journal/jbfa c

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304 MCDONOUGH ET AL.

beginning around the 1930s. The concept ofan exit value in the context of fair value measurements has been attributed

to R.J.Chambers, whose work on this topic began in the 1950s. In Section 2, we also review the current definition of fair

value providedby the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board

(IASB), as well as the associated accounting standards that prescribe the use of fair value measurements. Although a

form of fair value accounting – current replacement cost – was initially introduced by both boards to deal with the

hyperinflationary environments of the 1970s, global accounting standards did not require or permit fair value mea-

surements until the issuance of the accounting rules for financial instruments, and this remains the area in which fair

value measurements havebeen most extensively required in practice. As we discuss in Section 2, fair value-related dis-

closure requirements emerged before US and international accounting standards required assets and liabilities to be

recognized at fair value in the financial statements.

To gain a deeper appreciation for the prevalence of fair value measurements in practice,in Section 3 we discuss

and document the extent to which firms across different industries and accounting regimes report assets and liabili-

ties measured at fair value in their financial statements. We also use a sample of US depository institutions to demon-

stratethe properties of fair value-related disclosures. It is critical to understand this information when making research

design choices and interpreting research findings.

After delineating the institutional landscape of fair value accounting around the globe, in Section 4 we review

research related to fair value measurements and disclosures in terms of their valuation and risk relevance. Our goal is

not to highlight every paper that has investigatedvarious aspects of fair value-related information in financial reports.

Instead,we aim to identify important aspects of the fair value measurement ‘black box’ about which additional research

can generate novelinsights. We provide concluding remarks in Section 5.

2INSTITUTIONAL BACKGROUND

2.1 Evolution of fair value accounting

One of the central functions of accounting is to record a firm’s transactions using an appropriate measurement basis.

Although historical cost accounting was the dominant measurement basis for much of the 20th century,there has been

an ongoing debate about the appropriate measurement basis to use in financial reporting since the very early days

of the accounting profession, and this debate continues today among academics, practitioners, standards setters and

policymakers.1The fundamental issue is whether an alternativemeasurement basis,such as fair value, should be used

instead of historical cost.

Discussionsabout the concept of value in the debates about measurement did not delve deeply into how value might

be defined other than as a market-based concept. For example,what is the value of a share of corporate stock that is

actively traded in a deep and liquid market? Should the value bethe bid price, the ask price,a quoted price during the

trading day (e.g., the high or low price)? Accounting measurements typically assume one of three measurement per-

spectives – that is, entry price, exitprice, or value in use.2An entry price is the price an investor would pay to purchase

an asset or would receiveto assume a liability. An exit price is the price an investor would receive for the sale of an asset

or would pay to transfera liability. In essence, the bid and ask prices for a share of stock are equivalent to the entry and

exit prices, respectively. As the term suggests, value in use is the value placed on an asset currently in use bya firm

and is defined by the FASB as ‘[t]he amount determined by discounting the future cash flows (including the ultimate

1Severalscholars have discussed in relatively recent studies the historical origins and development of the various measurement bases used or considered for

financialreporting in both the US and internationally. We refer readers to Georgiou and Jack (2011); Hodder,Hopkins, and Schipper (2014); Markarian (2014);

Zeff(1999) and Zeff (2007a).

2The International ValuationStandards (IVS) identify numerous bases of value (IVSC 2017, Section 104), including market value, investment value and liqui-

dation value. The standards describe the bases of value as the ‘fundamental premises on which the reported values will be based’ (IVSC 2017, Section 104,

paragraph 10.1). The basis of value may dictate ‘the methods, inputs and assumptions’ used to determine the amount (IVSC 2017, Section 104, paragraph

10.1).