CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
According to FAS 157 define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This definition of fair value reflects an ideal “exit value” notion in which firms exit the positions they currently hold through orderly transactions with market participants at the measurement date, not through fire sales. At the measurement date means that fair value should reflect the conditions that exist at the balance sheet date. Barlevy (2007) noted that if markets are liquid and credit risk premium are at unusually high levels at that date, then fair values should reflect those conditions. In particular, firms should not incorporate their expectations of market liquidity and credit risk premium returning to normal over some horizon, regardless of what historical experience, statistical models, or expert opinion indicates. To enhance performance and determine the magnitude of measurement, the usefulness of accounting information about an enterprise increases greatly if it can be compared with similar information about other enterprises and with similar information about the same enterprise for some period or some other point in time (FASB, 1980).
Comparability addresses comparing information among different entities while consistency addresses comparing information over time for the same entity. Different firms may use different accounting principles making comparison among firms, even within the industry, difficult at best. Fair Value Accounting (FVA) does not ease the comparability problem and likely exacerbates it. Fair Value Accounting (FVA) also has a significant impact upon consistency. When the market financial assets declined precipitously and the valuation inputs change overnight, it is impossible for the information to be consistent. Fair Value Accounting (FVA) seems to result in a situation where comparability and consistency are more compromised than in the traditional accounting model. An “orderly transaction” is one that is unforced and unhurried. The firm is expected to conduct usual and customary marketing activities to identify potential purchasers of assets and assumers of liabilities, and these parties are expected to conduct usual and customary due diligence. However, since the major objective of any business (manufacturing companies) organization is to make profit and continue in business, what they face in the course of doing their business and the method of accounting they use in reporting their profit may make this noble objective to be unrealistic particularly during inflationary period.
1.2 STATEMENT OF THE PROBLEM
Recent market price conditions have resulted in large write-downs through the application of fair value measurements. Most of the charges have occurred within the manufacturing companies and other industries. Companies providing credit protection through credit default swaps on the underlying asset, as opposed to insurance contracts, have been impacted by fair value measurements. Even though the default that would trigger protection may not have occurred, companies are required to recognize unrealized losses on the contract when the fair value of the underlying assets has significantly decreased. Also affected have been some corporations with investments in auction rate securities which suffered declines. The requirements to use fair value measurements have been criticized for producing inaccurate results in the unusual market conditions recently experienced. Such results, it is argued, hurt the company in the long run.
If a company must record losses in such an environment, critics claim, it signals bad news to investors that may ultimately be misleading. Therefore, they say, it is preferable to record only realized gains and losses. In considering this controversy, it is important to recognize that accounting principles such as fair value are developed with the objective of providing information that will best serve the interests of investors, businesses and policy makers over the long term. This study tries to investigate whether fair value accounting is an appropriate tool used in measuring market value for manufacturing companies in Nigeria.