A question facing the accounting profession, particularly in light of the recent mortgage meltdown, is whether to use fair value or historical cost for the reporting of assets and liabilities. To be useful for decision making, accounting information should embody the two primary qualities of relevance and reliability. Neither fair value nor historical cost accounting on its own is likely to achieve both characteristics, and an integration of the two may be necessary. Fair value indeed provides relevant information for decisions when the information is also reliable. Reliability may be difficult to achieve when hypothetical transactions that are not objectively measurable are incorporated in the financial reporting process. The subprime lending crisis has revealed the potential risk in using fair value-based accounting, particularly when a market for fair valued assets is not stable. In such situations, operating cash flows, as a proxy for historical cost-based accounting for actual transactions, provides much more reliable information than fair value-based net income, which includes hypothetical transactions.
The Subprime Lending Crisis and Reliable Reporting Benjamin P Foster; Trimbak Shastri The CPA Journal; Apr 2010; 80, 4; Docsto
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