It is a measure of the cost of the asset based on its original price when it was acquired. Under U.S. GAAP regulations, few assets are not recorded using their historical values, such as marketable securities. While, most of the assets are recorded using their historical cost, although their value may have changed over time. For instance, a building may have been acquired for $50,000 in 1900, and although its value today is $1’000,000, it is still recorded on the balance sheet at $50,000. It means that it has not been adjusted for inflation since the asset was acquired by the company. Using historical values of assets for valuation purposes may not give investors a current and accurate idea of the value of the asset today, because the purchase power of a U.S. dollar today is greater than the purchase power of a U.S. dollar ten years ago. The same effect could be applicable to other currencies. Therefore, investments with a shorter maturity period may be preferable for some investors because the value of the money over time may not have an effect on the nominal return of the investment. Otherwise, investor can calculate the present value of the return in a future period. In order to calculate the present value of the return in a future period, the investor will need to use the corresponding consumer price index. The calculation of the present value will provide valuable information to the investor, given the fact that if the present value of the return is negative then it will signal the investor that it is not a good investment, while if the present value is positive then it will signal the investor that it may be good investment. The Bureau of Labor Statistics of the U.S. Department of Labor publishes consumer price indexes for different types of activities, industries and assets. They have five major databases: All Urban Consumers, Urban Wage Earners and Clerical Workers, All Urban Consumers-Chained CPI (C-CPI-U), Average Price Data, and Department Store Inventory Price Index. The All Urban Consumer price index is different than the All Urban Consumers-Chained CPI on the fact that the C-CPI-U is calculated based on a Tornqvist formula using several consecutive periods that take into account spending data from adjacent periods in order to control for substitutions that consumers may have incurred in those periods. The chained CPI is a relative new technique designed to provide a better “cost-of- living” index estimation. Monthly averages, semiannual averages, and annual averages of consumer price indexes are available from The Bureau of Labor Statistics of the U.S. Department of Labor. Another definition that it is linked to business-decision making is sunk cost. Sunk cost is defined as a cost that has been incurred and cannot be recovered in the future. The calculation of sunk cost is based on historical values and not on current market values.
Published in Chapter:
Accounting Standards in the U.S. Banking Industry during the Financial Crisis
Copyright: © 2016
|Pages: 14
DOI: 10.4018/978-1-4666-9484-2.ch007
Abstract
The global financial crisis became evident when U.S. house prices fell related to the subprime mortgage-backed securities crisis. In the years preceding the financial crisis of 2008, there was a real estate bubble that pushed U.S. real estate prices to high levels, and at the same time financial institutions were holding large amounts of subprime mortgage-backed securities. Fair value accounting (FVA) and its link to the recent global financial crisis has been a focus of discussion and interest for accounting researchers, financial analyst and policy makers. During the financial crisis, a large percentage of assets in the balance sheets of banks were calculated using fair value. The main concern was that those assets were calculated using mark-to-model accounting (Goh, Ng, & Yong 2009). There are still contradictory conclusions on the implications of fair value accounting and the global financial crisis (Laux & Leuz, 2009). The main objective of this chapter is to provide a better understanding of the global financial crisis and of the mechanisms of fair value accounting.