Question

One of the topics that is discussed in the first two chapters is the concept of fair value accounting (otherwise known as mark-to-market). This approach requires that all financial assets are to be held on the books at the end of a period at the current market value of these assets. This is quite different than the approach taken for assets such as buildings, which are held at historical value. What do you think about this approach? Does ot make sense?

Answer 1

Fair value or mark-to-market value of the assets is the value which a willing & knowledgable buyer ,will give for the same ,in the event of any arm's length transaction arising, between them.

Whereas,

Historical value of the assets is the value at which the asset is recorded in the books of accounts, on the date of its purchase.

Both the values are certainly relevant in a business environment.

Fair value helps in a variety of decision -making circumstances encountered by the management.It helps to know the exact cash /funds that will be available when the asset is sold in the market.

At times of mergers & take-overs of companies,the entire valuation of assets and liabilities are at fair value or exchange value only.

Accounting is more accurate in this method

Fair value gives more meaning , when compared & studied in the light of the historical values of the same asset/liability.

But

Normally accounting books & statements are required to be maintained in historical /book value of the assets & liabilities , for purposes reporting & calculation of tax on income.

Historical accounting also provides for current valuations by adopting techniques such as depreciation of assets , sinking fund for replacement of high-value assets,or amortisation of liabilities, so thatright amount of funds ,are available at the time of replacement .

Thus , both are equally important and neither can be overlooked for the sake of the other.

As said above,

Fair value gives more meaning , when compared & studied in the light of the historical values of the same asset/liability & vice-versa is also true.Both must be used complementarily , for efficiency and accuracy of the decisions made , about the assets & liabilities.