In the midst of Covid-19, why fair value matters

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Robert Morgan

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It is hard to argue against Warren Buffet’s common sense investment approach and performance

One of Buffet’s premises is that we should take a long-term view to investing. In this, I completely agree. But this year’s Buffet letter (source: Economic Times, 23 Feb 2020) starts with a rejection of reporting unrealised gains in the market price of shares as inappropriate accounting. What he is referring to is ‘fair value accounting’.

Always a contrarian, I would like to point out that the CFA Institute, not exactly an intellectual lightweight, took a completely opposite position in 2009 in their ‘Comprehensive Business Reporting Model’. Both unrealised gains and losses must be reported to get a full picture of financial performance.

The importance of getting a full picture is all the more relevant now. The impacts of Covid-19 are real, even if not yet realised for accounting. Lloyd’s of London has reported they expect to pay out up to $4.3 billion in Covid-19-related losses, making the pandemic one of the largest loss events in Lloyd’s history. 

Reporting earnings on the basis of historical costs rather than current values, as suggested by many, is potentially misleading. What if an institution succumbed to temptation and improved results by selling winners and keeping losers? The current value of winning assets could be brought out by selling them while the current value of losing assets could be kept hidden behind historical costs. Such a company could misleadingly appear more attractive or less risky to investors than it is.

Fair value accounting doesn’t increase the volatility of the underlying earnings. On the contrary, it reveals the risk that was always present, but not previously reported (and what we are seeing now with the market impacts of Covid-19 is a good example of this).  To be fair, how to communicate the volatility for long-term assets and assets traded infrequently needs more thought. But this does not mean that financial reporting needs to differ for income derived from actual (realised) transactions versus income derived from changes in the market value of unsold assets. 

Sorry and respectfully, Mr. Buffet, but fair value better illustrates the risks taken behind your legendary performance.

Robert Morgan has served on a number of International Accounting Standards Board (IASB) committees, various CFA Institute standard setting committees and is a past Board Member of the Accounting Standards Board of Canada. He has chaired CRUF Canada since 2010.

Disclaimer: The views expressed in the blog are those of the author(s) and do not necessarily represent the views of all CRUF participants. To read more about the CRUF’s views on this and other topics, please visit the comment letters section of the CRUF website.

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