Accg308

Cost of adopting Fair Value for financial reporting

Fair values measurement error

By adopting fair value accounting for financial reporting, an obvious and significant issue bank regulator would comfort is that estimating fair value of bank assets and liabilities, which are primarily financial instruments, probably involves measurement error. According to Wayne (2006, p. 10), if the investment securities are generalized to other bank assets and liabilities, recognition of financial instruments at fair value by adopting full fair value model could receive unrecognized gains or losses which could result in that earnings and regulatory capital becoming more volatile than earning and regulatory capital in historical cost model. This would occur specifically when measurement error in bank assets could not fully offset by measurement error in bank liabilities at fair value.

Definitely, measurement error could not cause all earnings or regulatory capital volatility by adoption of fair value accounting. According to Wayne (2006, p. 10), an observation of there main sources of “extra” volatility in associating with fair value accounting amounts are under historical cost. First of all, the changes in bank assets and liabilities at fair value demonstrates the underlying economic volatility. Secondly, the measurement error in estimating assets’ and liabilities’ fair value changes reflect volatility. Thirdly, if all instruments are recognized at fair value, the entity adopting mixed-attribute model would induce volatility and the volatility would be less concern. Therefore, the primary aim for regulator is to design a framework of measuring financial instruments’ fair value in order to maximize additional volatility in bank earnings by adopting fair value accounting other than historical cost to additional volatility induced by measurement error in fair value estimates.

Significantly, bank regulators should also notice that although estimating bank assets and...