Fairness in Modifications for Disabled Students
Generally accepted accounting principles (GAAP), have gained popularity in preparation, presenting and reporting of financial statements. According to Aizenman and Pinto, (12-16), they are accounting rules that are used in many organizations, such as those private held, or publicly traded companies, governments and non-government organizations. GAAP generally includes local Accounting Standard, Accounting Framework, and the related accounting rules and laws.
In the United States, the government leaves setting of accounting standards to the private sector, since it believes that it has more resources and knowledge, and therefore it does not appear in law. However, the United States Securities and Exchange Commission, has requirements that publicly-traded companies follow these regulations when reporting financial statements. FAS 157 relates to fair value measurement and was issued by the Financial Accounting Standards Board, in November 2007, as a means of correcting shortfalls attributed to the system of reporting financial statements, then.
FAS 157 gives a new definition of fair value as the price realized when transferring or selling assets and liabilities, between market participants, in orderly transactions at a given date. FAS 157 uses models to come up with a hierarchy that ranks various information sources, used in fair value measurement. The prices quoted from the stock exchange are perceived to be the most reliable and are thus at the top of the hierarchy, while the prices obtained from unobservable data are perceived to be least reliable and are therefore at the bottom of the hierarchy.
Why it was necessary to change to FAS 157, from historical cost as standard of reporting Historical cost has long been used as a standard of reporting. This is attributed to the benefits of using this approach, which include the ease of use, its simplicity, and verifiability. Under this approach, recording of values of liabilities and assets, assumes the value they had when they were initially acquired. After the valuation, the values are not adjusted for subsequent change of value.
When dealing with inventory under this method, the lower of net realizable value and cost is used, such that decrease in inventory value realized below cost, is immediately recognized, and increase in inventory value realized, is only recognized after the sale of inventory. When dealing with property, equipment and plant, purchase price is used, in addition to any other cost incurred in transporting the assets to the location, and making them operational. Such costs include installation costs, handling and delivery costs, testing, assembly, labor and any other relevant costs.
Cost is then subject to depreciation charges throughout its lifetime, mostly using the straight line method, which depreciates the asset equally, throughout its lifetime. According to Jaffee (21-33), one benefit of this method is the ease of valuation, since historical costs are easily accessible. Another benefit is that increase in value of the assets is recognized after disposal, thus following the prudence concept of accounting. Finally, the wide use of historical costs makes them more convenient to use.
However, this approach has major weaknesses that have necessitated the movement from historical approach to fair value reporting (FAS 157). According to Plantin (27-35), one major weakness is that this approach does not give an accurate valuation of the current worth of assets. This is because there are many factors that affect the value of assets, and the historical approach does not recognize them. Such factors include inflation, political instability, market speculation among others.
This makes the approach inaccurate, and therefore a misrepresentation of the current value of assets, is likely. Due to this weakness, businesses are unable to calculate opportunity costs of various projects, since their valuation is inaccurate. An illustration of this weakness is given as follows; Assume a company buys an asset for $1000, and the market value of the asset is $1,200 after the end of the first year. Further assume that the asset is sold during the second year for $1,300.
When using the historical method of valuation, at the end of the first year, the value of the asset will be recognized in the balance sheet as $1000, since that was the initial value. This is obviously inaccurate, since the asset has appreciated by $200. The true value is only recognized after disposal, since the $300 profit is recorded then. This weakness may seem insignificant, in this example, but it is very significant, especially when dealing with assets with high value, or large businesses, which have to calculate opportunity costs in their daily operations.
This is what necessitated the movement to Fair Value Reporting (FAS 157), which presents a more accurate picture of the current values of assets and liabilities. Evaluation of FAS 157, with respect to fair value reporting and historical cost. FAS 157 creates a movement from historical cost to fair value. This is in line with its new definition of fair value that presents an accurate value of the prices at the current date. Unlike the historical cost, which bases costs on the initial purchase value of assets, FAS 157 tries to present the accurate current market value of such assets and liabilities.
This is done by having a hierarchy that classifies the prices used in determination of fair values, according to their reliability and quality of their sources. As previously seen, prices from the stock exchange stand at the top of the hierarchy, since they are primary sources, direct from the market. Such prices are therefore seen to be very reliable in giving the fair values of assets and liabilities. Prices obtained from unobserved data are seen to be at the bottom of the hierarchy, since they are secondary sources, and may prove to be unreliable.
Securities and mutual funds have for long recorded their liabilities and assets at fair value, according to the regulations that govern them. This has also applied to commercial banks and other firms that offer financial services, when dealing with marketable equities. However, the movement from the historical cost approach, to the fair value approach introduced by FAS 157, has largely depended on the function that assets serve to firms. According to Plantin ( 56-63), firms that hold assets for investment purposes are more likely to use the historical approach in valuation of their assets.
However, those that hold assets for active trading, are more likely to use fair value reporting, in this case FAS 157, since their profits are dependent on the accuracy of current asset prices and calculation of opportunity costs, based on these prices. Subprime mortgages, fair value reporting and their impact on financial institutions Subprime mortgages gained popularity after lenders realized that there was demand for loans by customers, who were perceived not to be ideal.
These are the customers who have higher likelihood of defaulting on the loan, for instance those with previous records of bankruptcy and loan default or delinquency. Generally, these are loans or mortgages that are granted to customers who have credit scores below certain levels. Credit scores are scores in hierarchical charts constructed by banks, that measure the probability of customers to default on loans granted, based on previous experience, and characteristics of the study group. The subprime mortgage crisis currently facing the U. S.
, can be partly attributed to the predatory lending practices by lenders. These include targeting clients who are not aware of their loan terms, or lending others who the bank or financial institution knows will not afford the interests, in the long-run. These lenders included hidden conditions and terms, charged exorbitant interest rates, in a bid to seize the collateral. The homeowners could not be able to finance their housing needs since interest rates were rising, and the value of houses was falling. This led to large scale seizure of collateral by lenders and foreclosure of housing properties.
This negatively affected both the lenders and the homeowners, since lenders could not be able to get customers, leading to collapse of their businesses, and home owners were not able to build their houses. According to Nelson (44-47), the concept of fair value reporting (FAS 157) gained popularity during the mortgage crisis, making bankers change their approach to valuation of assets. Some bankers are of the opinion that fair value reporting made them dispose of securities, since the prices that they fetch at current market rates were too low.
However, the large investors were of the opinion that the economic volatility exposed by the concept of fair value reporting, already existed in the market. Fair value reporting has nevertheless helped mitigate the risk that lenders face, since they are now able to get accurate values of assets, in this time of crisis. It has also helped home owners get insights into proper valuation of their collateral, since previously, some lenders and brokers were collaborating in fleecing the home owners, by valuing the collateral, at rates lower than the market rates.
It is however difficult to apply the concept of fair value in the current market, according to Gongloff (11), since value of assets are difficult to ascertain. This is blamed on the current mortgage crisis, which makes trading inactive, since investors are using a ‘wait and see’ attitude. It presents further risks to financial institutions that continue using unobservable inputs in setting the asset prices. This makes companies pay auditors to work longer hours in order to use the FAS 157 standards of valuing assets and liabilities. Conclusion.
Fair value reporting has changed the way assets and liabilities are valued, and provides a more reliable value. The introduction of FAS 157 has made companies rely on more accurate data, such as the stock exchange, when valuing assets and liabilities. This has made them experience lower risks and also take advantage of opportunities, through computation of accurate opportunity costs, during their operations. The U. S. mortgage crisis was partly caused by unfair practices by banks, and they too became victims of their own circumstances.
Banks failed to realize that by making homeowners bankrupt, they too would be affected, since they depend on the homeowners for their operations. The fair value reporting is helping mitigate the risks, though it is facing challenges from limited information on the market, due to low volumes of trading. Investors are waiting to see whether the $700 billion injected to the economy will turn things around. Works cited. Aizenman, Joshua Pinto, Brian, Managing Economic Volatility and Crises: A Practitioner’s Guide.
London: Cambridge University Press, 2005. Gongloff, Mark, A FAS 157 Primer, Wall Street journal, 15 November, 2007. Jaffee, David, The US subprime mortgage crisis: Issues raised and lessons learned. Retrieved on October 23, 2008 from <growthcommission. org>, 2008. Nelson, King, Fair value accounting for commercial banks. Accounting review. JSTOR, 2008. Plantin, Grace, Fair value accounting and financial stability. Journal of financial accounting. Retrieved on October 23, 2008 from <papers. ssrn. com>, 2007.Sample Essay of Custom-Writing