Thursday, February 5, 2009

Fair Value Accounting Securities

What is fair value accounting and how is this topic related accounting systems for trading securities on a public market? 

In accounting, relevance and reliability, as outlined in the FASB are key to success. In a financial reporting context this means fair value (FMV) vs. historical costs of an asset. On many physical assets that a company owns, GAAP is recording on the balance sheet at historical costs. This is generally easy for the accountant because they can find records indicating exactly what the fair market value of an asset is to a company when it was purchased.

However, on trading securities and many other intangible assets, its irrelevant to record them at historical costs because these values change frequently. Companies follow a fair value hierarchy (FMV), when reporting  these costs on the balance sheet.

Furthermore, in the futures market, fair value (FMV) is equal to the equilibrium price for a futures contract. This price is equal to the spot price after taking into account compounded interest over a certain period of time (usually one year). If the futures are above fair value  FMV, then the Wall Street traders are betting the market index will go higher, the opposite is true if futures are below their FMV.

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