Fair Value Accounting and Implications for the Auditing Profession: Historical Overview

Abstract

This paper explores the link between the introduction of fair value measurements (FVM) and the development of the Global Financial Crisis (GFC) in 2008-9. The paper aims to provide an historical analysis of the development of the Enron scandal with a focus on fair value accounting (FVA) and provides a narrative literature review of the subsequent economic downturn, its effect on the auditing profession and audit fees arrangements, implications for FVA, and response of global institutions and standard setters. It provides a theoretical explanation of the underlying antecedents using existing accounting theories. For each reviewed stream of research, the paper establishes the theoretical underpinning and discusses its application supported by the context. The content analysis using NVivo software was employed to analyse existing research and available published information. Based on the comprehensive literature review, the study arrives at two main findings. First, the paper concludes with the controversial use of FVM and establishes a direct connection between Enron’s collapse, the GFC, and improper FVM practices. Secondly, the study identifies the current pricing strategy for audit as an industry response to the abuse of external audit arrangements regarding FVA. Supported by the literature review findings, the paper contributes to the audit research by providing deep insights into the connection between FVA practices, the GFC and development of the audit profession. The paper addresses the lack of foundational research in FVA and establishes a solid background for further studies on FVA and audit profession development in general.

Fair value accounting and audit fees: The moderating effect of the global financial crisis in Jordan

“…The application of FVA prescribed in IFRS can be investigated through the lens of the agency, stakeholder and signalling theories since the ideologies it embodies operate as principles prevailing in the current organisational environment (i.e., signalling and stakeholder theories). The organisational environment makes this adaptation more problematic given the fair valuation's complex and uncertain estimates, i.e., agency theory (Alharasis et al, 2020). Agency and signalling theories are commonly employed to explain the choice of accounting methods (Khlif & Achek, 2016;Samaha & Khlif, 2016).…”

“…While the overall aim of disclosure is captured by the stakeholder theory, signalling theory suggests a motivation for subjective judgements in FVMs. (Alharasis et al, 2020;An et al, 2011)…”

“…A fresh concern about FVMs emerged in the aftermath of the GFC of 2008-2009 due to higher managerial assumptions being utilised to prepare fair values especially in the case of absent active markets (Alexeyeva & Svanström, 2015;Demartini & Trucco, 2017;Huang et al, 2020;Zaman et al, 2017). Two controversial views regarding the alleged role of FVA in the GFC were provided recently (Alharasis et al, 2020). Some commentators felt that fair value implementation was not responsible for the crisis and there is no solid evidence which supports this claim against FVA (Barth & Landsman, 2010;Laux & Leuz, 2010;Plantin & Tirole, 2018;Pozen, 2009).…”

“…The GFC revealed FVA-related abuses and fraud in firms' financial performance (de Jager, 2014), price bubbles in finance-related statements (Penman, 2007) and greater market volatility (Allen & Carletti, 2008b;Magnan, 2009). Higher risk for Level 2 and Level 3 fair value inputs (Bratten et al, 2013) resulted in putting more burdens on auditors and rising audit prices (Xu et al, 2013;Alharasis et al, 2020). In Jordan's case, FVA is aggressively used by companies due to the growing reliance of Jordan's economy on external exports which has increased the use of financial assets by domestic companies (Abdullatif, 2016).…”