HOW FAIR IS THE FAIR VALUE ACCOUNTING ?

The U.S. financial market debacle has initiated a debate on weaknesses in U.S. GAAP and International Financial Reporting Standards (IFRS). The major debate is around Fair Value Accounting which permit business entities to account for financial instruments on the basis of their fair value. This concept enable accounting of mark to market profits as well as mark to market losses. The upsurge in market value of financial instruments based on fair value valuation techniques is recognized in accounts and even unrealized gains are considered in profitability and earnings besides assets and net worth. In terms of currently prevailing accounting standards in India, unrealized gains can not be considered as profits. In India, the fixed assets are accounted for on historical cost. The current assets are generally accounted for on cost or net realizable value whichever is lower. Except the investments held to maturity or as long term investments, the investment and derivatives are mark to market. The mark to market losses are accounted for and mark to market profit are not considered as income. The Indian Regulators including RBI, SEBI, IRDA and ICAI have been actively considering shifting over to fair value accounting shortly by implementing AS30, AS31 ad AS32 and adopting International Financial Reporting Standards. The crucial issue is how fair is the fair value estimation in the absence of a reliable and robust valuation, tremendous fluctuations and volatility even in the stock market and commodity market. The OTC (Over the Counter Market) in case of foreign exchange, unlisted securities and derivatives being non transparent and highly illiquid, the valuation of fair value of these financial instruments pose a major challenge to valuers. The credit ability of valuation is tested in times of falling financial market and may pose a greater risk. How to ensure fairness of fair value valuation? Should Indian accounting system allow mark to market profit accounting for financial asset/ financial liability valuation, recognitions, measurement and disclosure of profitability, net worth and assets besides for distribution of profits.

The Regulators need to openly debate as to how will they address risk of manipulation, Risk of error of judgement and resultant risk on liquidity & solvency of business Enterprises, banks, insurance companies, financial services sector and mutual funds Incase a debacle like U.S. hit the Indian Financial System.