Reading Summary: Linsmeier 2011

Fair value measurement:

US Savings and Loan Crisis and Fair-Value Accounting

In the late 1980s and early 1990s, Savings and Loan Crisis observed a collapse of the U.S. thrift industry. Investors demanded for increased transparency, historical cost accounting was blamed for creating rooms for banks to underestimate their losses.

In 1991, the Government Accounting Office (GAO) issued a report which urged immediate adoption for both GAAP and regulatory reporting of mark-to-market accounting for all debt securities. It also suggested that a study be undertaken of the potential merits of a comprehensive market-value-based reporting system for banks.

As fair value was increasingly viewed as an important tool for valuation, a clear guidance is needed for better application. In 2006, FASB issued FAS 157, which provided a uniform definition of “fair value” and guidance for application.


Looking Forward: the Potential of Double-Presentation


To strike the balance between reliability and relevance, some scholars propose a double-disclosure--fair-value measurement backed up by historical cost figures: "The best way to ensure that regulators, investors, and the market at large have a full understanding of banks’ true financial conditions is to include changes in the value of financial instruments over time in financial statements, along with historical cost figures."

In fact, FASB is not planning to abandon historical cost accounting for financial instruments held for collection or payment of contractual cash flows, because it provides useful information about the potential cash flows associated with these financial instruments. Indeed, the difference between amortized cost and fair value captures the expected impact of current economic conditions on existing financial instruments. FASB is recommending for financial instruments held for collection or payment of contractual cash flows that amortized cost and fair value information be given equal prominence on the financial statements and, thus, that both measures be made available for these financial instruments in public releases of financial reporting information. This dual presentation in financial statements—which some investors have asked for—would ensure that both relevant measures are given adequate attention by banks and their auditors.


Reference: Financial Reporting and Financial Crises: The case for measuring financial instruments at fair value in the financial statements, Thomas J. Linsmeier, Accounting Horizons, Vol.25, No.2 2011 pp. 409-417

Our Personal Opinion to Add on the Double-Presentation:

It is good to have both sides of the story, one more relevent, one more reliable. Besides, the reconciled difference between the two measurements could serve as a early alarming of potential accounting frauds or request for necessary justifications and adjustments.It would significantly improve information transparency in financial accounting.
However, it might also cause confusion among unsophisticated investors and extra disclosing cost to issuers. Therefore,the balance between the cost and benefit should be carefully examined.
To add on the double-presentation proposal,I think: (1) it would be better to voluntary rather than mandatory if the proposal does get pass by SEC, because it would cause extra burden on both the management who prepare the financial filings and external auditors who reconcile and verify both. According to lemon-market theory, companies with higher profile and more competitiveness would be willing to disclose both sides of story if that could better distinguish themselves with "lemons". (2) A reconsiliation should be provided and explanation should be provided accordingly if there is material discrapency between the two measurements, so that investors wouldn't be confused of the differences and be able to make more rational decisions.