September 28, 2008

The Perils of Fair Value Accounting

Filed under: Business,Economics — Bottom's Up @ 12:40 pm
Tags: , ,

Any new student of accounting gets bewildered by the historical cost concept. The premise of this being that long term assets should be reported on the books at the value that they were bought at (apart from depreciation etc). The most commonly used example is that of land – land is usually reported on the books in the US system at the cost at which it was bought at. Land being such, usually appreciates and thus in the course of time, the value on the books ends up being being below the market value and firms are forced to report less assets than they have.

However, in recent years, firms have been allowed to report financial assets at market values instead of historical costs. For sometime this was considered a good idea, but in recent months has become the cause of much debate thanks to the credit crisis. The Economist last week had a great article on problems related to the same. An interesting point that the Economist brought out and which this writer was not aware of was

Today the treatment of a financial asset is determined by the intention of the company. If it is to be traded actively, its market value must be used. If it is only “available for sale” it is marked to market on the balance sheet, but losses are not recognised in the income statement. If it is to be “held to maturity”, or is a traditional loan, it can be carried at cost, subject to impairment. This is a dog’s breakfast. Different banks can hold the same asset at different values.

Noe this is indeed terrible. A big part of the problem recently has been one of the adverse selection problem. The only way around adverse selection problems is to reduce the level of assymetric information when it comes to dodgy products. Of course, this is easier said than done.

UPDATE: Justin Fox of Time has an interesting update on what’s happening on this front currently.


June 4, 2008


Filed under: Business — Bottom's Up @ 11:07 pm

Recently I have found myself spending a little more time in front of the boob tube – either watching some elections coverage or the ever occurring comedy in the financial world on CNBC. A hallmark of the commercials on both CNN and CNBC it seems are ads by companies that everyone likes to hate. Thus you have DOW of Bhopal and Agent Orange fame telling us how they care about the Human element (BTW, the Human element ads are beautiful ads, just that they promote DOWs BS), the oil companies talking about how wonderful they are and helping the world meet its dual challenges of energy production and protecting the environment (they never address how they help protect the environment), the big Pharma companies advertising about their bus that goes to various small towns helping people and giving free medicine and the coal guys talking about how coal is the energy of the future and clean as hell (clean burning smoking hell indeed!!). Turns out they even have a term for this – Greenwashing. And they are now indexing such corporate gems and more.

Some corporation watching guys also have a good article on the new hype in the business world about marketing everything as green (they are of course giving the market what it wants). Of course, when it comes to BS commercials, my favorite are the Budweiser commercials where the dude goes on and on about how they use they best ingredients and processes to create the beer – if it sucks so bad after all this, wonder what would have happened if the best material was not used. And of the Budweiser (or was it Miller) commercial about how they recycle more cans than they produce – how come they do not talk about the grains that go in making beer which would have been used to feed someone in the times of the food crisis.

UPDATE : Found this on NPR.

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