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Finance: Fair value accounting during the financial crisis - Research Paper Example

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Finance: Fair value accounting during the financial crisis

The impact of the overall situation of financial crisis had a severe reaction on the social institutions as well, leading unemployment rate to increase since a large number of finnacinal institutions had to face failures and ultimately, bankruptcy. As a result, a number of debates have been observed between investigators that the credit crunch was due to the misinterpretation of assets and hedging strategies in the shape of subprime loans and mortgage backed securities (Deff and Phelps). The major concern of the debaters was the implication of fair value accounting systems which led to the situation where it has been blamed for facilitating the sustainment of the financial crisis which has led to massive government bailouts of financial institutions. As a result, it was marked that the Bush administration, FASB and SEC responded to the financial crisis with Acts and amendments to take a grasp of the situation (Twaronite and Levine). The aim of this paper is to critically evaluate the role of the fair value accounting’s role in the financial crisis. This will be done by carefully taking an in-depth analysis of the accounting systems and alternatives. Also, different factors such as subprime loans, mortgage backed securities etc, have led the fair accounting system to affect the financial turmoil. Furthermore, theoretical background of different cases of failure and bankruptcy will be created to prove the role of fair value accounting in magnifying and prolonging financial crisis of 2007. Part 2: Background to Accounting Systems: 2.1 Historical Cost Accounting: It is imperative to understand the historical cost accounting in order to assess the role that fair value and other relevant factors have played in the recent financial crisis. As evident from the term, the historical cost accounting is basically an accounting system which records the assets at the point of their historical cost (Casabona and Shoaf). It should be noted that the recording of assets with a historical cost (the value at which it is purchased at the first place; this equates the fair value accounting and historical accounting) is merely done in order to provide impairments. The market value of the assets is never recorded when balance sheets are prepared by using historical cost accounting. This means that in case there are fluctuations in the market regarding the market value of the asset then under the historical cost accounting, it will not be presented in the balance sheet (Guni and Negurita). In simpler words, it can be said that the historical accounting records assets on the historical cost because it will not increase the asset value for amortization. The reason behind observation of impairment is because the assets at their fair value would decrease to the point of amortization (Fitzsimons, Satenstein and Silliman). As a matter of fact, there is a point where both the fair value accounting and historical cost accounting becomes equal. That point is when the asset reduces its values to a high extent allowing impairment to become evident (Christian and Christian). The comparison between the fair value accounting and the historical cost accounting has been made on the basis of manipulation. Both the systems have been applied to record the assets purchase’s loss and gain. The fact remains that the historical cost accounting does not allow manipulation as compared to fair value accoun ...Show more

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[Name of Student] [Name of Instructor] [Name of Course] [Date] Fair Value Accounting During the Financial Crisis Part 1: Introduction: The financial crisis of 2007 has been a basis of a number of problems being faced by the international business and accounting profession in particular…
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