Though mark- to market process or so-called fair value accounting was considered as necessary to capture the risk, however, it seems to have worked like a double sword wherein a potentially small problem was turned into a bigger one because asset values were down due to market freeze despite the fact that most of the firms managing such assets were performing well. (Pozen, 2009)
What contributed towards the development of fair value accounting and under what conditions it was advocated is one of the most important debates in the current accounting and finance literature. The theoretical contributions that have been made in the recent past for the development of fair value accounting largely viewed this issue from a different perspective. The fair value accounting advocates, therefore, focused on the development of a comprehensive accounting framework which can cater to the needs for properly recording those assets and liabilities whose values change with the changes in the market fundamentals or for any other reasons.
This paper will, therefore, provide a comprehensive review and critical analysis of the role, if any, played by the accounting and finance theory in the development and implementation of fair value accounting by FASB.
Before discussing the role that theory has played in the development and implementation of fair value accounting, It is important that a comprehensive understanding of the term fair accounting is developed and why it was advocated to be implemented.
According to generally accepted accounting practices, the fair value of the asset is the current value at which an asset can be sold in the market between two parties under an arms-length transaction. Generally, accounting practices or standards advocated the use of historical cost in recording the assets and liabilities in the balance sheet, however, as the financial products became more complex and financial innovation took place, the real value of the assets does not necessarily reflect the cost only. Complex derivative transactions with no downside risk protection can cause their value to decline significantly hence they may not represent the correct assessment of the value of the assets. (Ryan, 2008)