Why fair value accounting can't work.

• Author: King, Alfred M.

Like it or not, we're inching toward a fair value accounting model. While the FASB and some academics have been beating the drums for fair value or current value accounting, financial executives and managers have been equally articulate on the other side. Their arguments seem to boil down to three points:

* "If it ain't busted, don't fix it." What we have today (historical cost) works, and people understand it. In short, leave well enough alone.

* If unrealized changes in values have to flow through the income statement each period, they'll distort the results of operations.

* Determining fair value is far from exact. It involves costs to develop the information. It requires imprecise estimates and is susceptible to manipulation.

Yet one characteristic of this controversy stands out. Never in my 30 years in the appraisal business has a client said, "I'm curious; I'd just like to know what my assets are worth." Always, in every assignment, there's been an actual or potential transaction that required information regarding FMV.

Unless a transaction is contemplated, or has been consummated, information on values is of no practical use. People do not pay, and should not pay, good money for useless information.

How Much Do You Want for That?

Fair value is never going to work in accounting for a good reason. The fact is, at any time, there's never a single value that's fair. Take an asset familiar to everyone, a private residence. What's the fair value, say, for a personal financial statement?

* Is the fair value the cost of reproduction, the amount you'd want to collect from your insurance carrier if the house were destroyed by fire?

* Is the fair value the amount you'd receive, after commissions and fix-up costs, if you were to sell the house on the open market?

* Is the fair value the amount you want the local property tax asses r to place on it for purposes of collecting ad valorem taxes?

* Is the fair value what a virtually identical house next door sold for last year - when interest rates were higher?

It's clear that these four values would be different - in some cases, markedly so. Each purpose for which value information is needed calls for a different answer. And utilizing the incorrect answer may lead to erroneous decisions or actions. For example, insuring the house at the amount you wish it were assessed at might cause you to under-insure it. Or, putting the assessed value on your financial statement might understate your net worth...