Fair-Value Accounting: Defective Concepts, Wrong Methods and Serious Economic Consequences

Abstract

Two fatal inherent defects of fair-value accounting are proved mathematically in the paper. One defect of fair-value accounting is its non-complete existence, that is to say, the available fair value may not exist under certain conditions. One direct consequence of the defect is that a huge fair value trap may be created by fair-value accounting. The other defect of fair-value accounting is its self-expanding, that is to say, the fair-value accounting is a bubble maker. It could derive a huge bubble in stock market from the normal net incomes in the operating activities of listed firms. The bubble may be much larger than the original incomes. For a single firm, it may be possible to sell out the assets at their fair value, but it may be impossible for all firms to sell out their assets at the same time in the same market. From the standpoint of whole market, fair-value accounting becomes a numbers game because it loses the internal relations between cash flows and book values. All those defects of fair-value accounting would bring risks to investors in capital markets, and finally cause financial crisis. The inherent defects of fair-value accounting determine it can not be taken as the base of accounting measurement.