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An Examination Of The Efficiency Of Fair Market Accounting: An Analysis Of Sfas No. 115 And Sfas 157

1992 words - 8 pages

Throughout the last few decades, a greater emphasis has been placed on fair value accounting rather than employing the lower-of-cost-or-market (LCM) method as a result of issues related to the 1980s Savings and Loan Crisis. Its prominence has been especially pressed in the financial industry including, but not limited to, those employed for banking purposes. Selected occurrences that sparked this marked increase in the fair value approach include accusations that the historical cost method has failed to accurately illustrate financial institutions’ sustainability and health. Additionally, the historical cost based financial statements do not illustrate these institutions’ lack of feasible ...view middle of the document...

However, this method was criticized because of its connections to the 1980s Savings and Loan Crisis. Therefore, the FASB developed SFAS No. 115 within a three-step project in order to incorporate market values into the valuation of financial instruments. The first step focused on disclosing the fair value of financial instruments and was completed in December 1991 through the issuance of SFAS No. 107, Disclosure About Fair Value of Financial Instruments, requiring all organizations for fiscal years ending after December 15, 1993, to disclose the fair values of their financial instruments, either in the financial statements themselves or in the footnotes. The second phase of the FASB’s project addressed the dilemma regarding whether the market value is an accurate measure of financial instruments’ value, and additionally, for recognition purposes. Therefore, the FASB issued in November 1991 a Discussion Memorandum titled, Recognition and Measurement of Financial Instruments, to outline issues related to the recognition and measurement of financial instruments with attention on financial institutions (Cornett, Rezaee, and Tehranian 121-122). The final step focused on fair value accounting pertaining to debt and equity securities, which then directed the creation of SFAS No. 115, which identifies accounting standards regarding equity securities not covered under the equity method, with easily determinable fair values and all debt securities (Cornett, Rezaee, and Tehranian 122-123). Therefore, through the development of SFAS No. 115, financial statements would not be historically cost based, but instead, partially constructed on fair values.
SFAS No. 115 specifically addresses investments in equity securities that have “readily determinable” fair values and all investments in debt securities. They are defined within three categories: held-to-maturity; trading; and available-for-sale securities.
Institutions that have the “positive intent and ability” to hold their debt securities, consider their securities as held-to-maturity securities, and therefore, are required to report the value of their securities using the amortized cost method (“Statement of Financial Accounting Standards No. 115” 6). Consequently, the FASB outlines circumstances in which these securities would not be considered held-to-maturity in detail. Secondly, securities are considered trading securities if an institution purchases and holds them for sales purposes. Accordingly, these securities are reported at their fair values and the unrealized gains and losses are included in earnings. Finally, if debt and equity securities are not classified as held-to-maturity or trading securities, they are considered as available-for-sale securities and are consequently, reported at fair value, with unrealized gains and losses reported in a separate section of shareholders equity (“Statement of Financial Accounting Standards No. 115” 8).
Moreover, SFAS No. 115 had associated...

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