The Economic Consequences of Fair Value Accounting

Yuan Mingzhe and Liu Huifeng
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Yuan Mingzhe: Shandong University
Liu Huifeng: Shandong University

Accounting, Economics, and Law: A Convivium, 2011, vol. 1, issue 2, 44

Abstract: Two fatal intrinsic flaws of fair-value accounting are found and mathematically proved by this paper. One flaw concerns its non-complete existence, that is, the required fair value may not exist under certain conditions. One direct consequence of the flaw is that a huge fair value trap may be created by fair-value accounting when the fair value does not exist. Another flaw of fair-value accounting is its self-expansion, that is, the fair-value accounting acts as a share price bubble maker based upon the normal net incomes from the operations of listed firms. The bubble may then expand much larger than the original incomes.For a single firm, it is possible to sell out its assets at their “fair value,” but it is usually impossible for all firms to sell out their assets at the same market price within a short period of time. From the standpoint of the whole market, fair-value accounting acts then like a numbers game, while its book values lose any connections with cash flows.All these flaws of fair-value accounting can bring risks to investors in financial markets, and finally provoke financial crises.

Keywords: fair value; marked-to-market; financial crisis; bubble; self-expansion (search for similar items in EconPapers)
Date: 2011
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DOI: 10.2202/2152-2820.1010

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