The Importance of Fair Value Accounting Knowledge for Accounting Students

By Thomas J. Frecka, Vincent and Rose Lizzadro, Professor of Accountancy, University of Notre Dame
The comments in this article do not necessarily reflect the position of Ernst & Young LLP.

Accounting standard-setters 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” (ASC 820-10-20 Glossary). As applied to financial assets and financial liabilities, fair value measurement has become more important in recent years due to its ability to provide more relevant information, without sacrificing faithful representation, as the result of widespread availability of market prices and the development of valuation models that provide sufficiently accurate estimates of fair value. The most common application areas are accounting for investments and accounting for derivative financial instruments. Other important contexts in which fair value concepts are applied include impairment accounting, accounting for loans held for sale, securitization (including the valuation of retained interests), and the various fair value option applications. Fair value accounting is particularly important for financial institutions whose balance sheets consist mostly of financial assets and financial liabilities. Knowledge of fair value accounting issues is also important for accounting professionals as various parties debate the economic consequences of such measures and work to assure consistent and appropriate application of the rules.

Understanding the challenges, pitfalls and nuances of fair value accounting requires an understanding of capital markets and valuation theory. Valuation theory includes both income (discounted cash flow or residual income) and market (comparable firm/comparable asset) approaches for estimating intrinsic value. Unfortunately, this type of material is not included on the CPA exam, causing some students to discount its importance.

I teach a Financial Instruments and Fair Value Accounting course for MBA students. We recently revised our curriculum to allow for full course coverage of this material in our MBA program. Given its importance, we have also expanded the coverage in our undergraduate and MS in Accounting programs. Students and I have found the Ernst &Young Academic Resource Center fair value accounting financial reporting and auditing materials extremely useful. Examples are very clear and relevant. A limitation of most accounting textbooks’ fair value problems is that the fair values are usually “given” and students do not have to struggle with practical measurement issues. I look forward to using the newly released fair value advanced materials where these issues will be addressed.

Students find the applications of fair value accounting extremely interesting. Again, concepts learned in financial statement analysis and valuation courses can be brought into the discussion. Examples like Enron, where fair value measurement was abused, and examples involving financial institutions and the 2008 financial meltdown, can all be used to enrich the discussion and to enhance learning.

I predict that fair value measurement in accounting will become even more important in the future. Fair value measurement is one the most intellectually challenging areas of accounting and it should serve as a catalyst for attracting outstanding students to accounting.

Ernst & Young Academic Resource Center (EYARC) curriculum resources

EYARC resources are freely available to you through a private portal and are collaboratively developed by professionals and faculty. To obtain an account, contact Catherine Banks, EYARC Program Director. If you already have an EYARC account, be sure to check the site regularly as materials frequently are updated for currency and new offerings are made available, including the recent release of the Fair value advanced module. An overview of fair value curriculum resources include:

Fair value basics
This module provides an overview of the definition of fair value according to ASC 820 (converged with IFRS 13), fair value concepts and a fair value framework. A history of the development of fair value is also included.
The module includes lecture notes, examples, slides, disclosures, homework problems, behind the scenes and a case study.
Click here for more information in the user guide.

Fair value advanced
This module includes eight sections. It provides a more extensive overview of fair value concepts, models and frameworks and a step-by-step approach to the valuation process. Additionally, it includes coverage of the fair value hierarchy and disclosures as well as additional ASC 820 special topics not covered in the Fair value basics module.
This module includes lecture notes, examples, slides, disclosures, homework problems and case studies.
Click here for more information in the user guide.

Auditing fair value measures
This module focuses on the basics of auditing fair value measures as derived from AU Section 328, Auditing Fair Value Measures and Disclosures.
The module includes lecture notes, slides, homework problems and case studies.
Click here for more information in the user guide.

Additional Ernst & Young thought leadership is also available on the EYARC site related to this topic.

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