An Experiment in Fair Value Accounting: UK Investment Vehicles
Abstract
We use the British real estate and investment fund industries as experimental settings where historic cost (HC) and fair value accounting (FVA) can be compared. Both industries have a substantial part of their assets marked to market and hence the difference between the two accounting systems is profound. However, as the valuation of real estate is more subjective than that of investment funds, we are able to contrast fair accounting in a near ideal setting with one where it remains important, but where valuation difficulties may permit bias.
We find that fair value income is considerably more value relevant than historic cost income. However, in the presence of changes in FVA balance sheet values, income measures become largely irrelevant. FVA for our real estate sample is considerably less value relevant than for the investment companies and exhibit biases consistent with earnings management. We interpret these results as confirming that fair values are highly relevant and unbiased where the values are unambiguous. Where valuation is ambiguous, which will normally be the case, value relevance will be lower and biased accounting may be revealed.
Contact information
Paolo Perego
Anna Nöteberg
