Fair Value Accounting From the Mouths of Babes Students: Zoe-Vonna Palmrose’s 2005 AAA Address
A few weeks ago, in a post entitled “Why Do Standard Setters Make Such Awful Decisions?,” I cited Zoe-Vonna Palmrose as one of several academics who think that the FASB’s embrace of fair-value accounting is so obviously mistaken that even children could see it. Bill Kinney pointed out that my recollection of Zoe-Vonna’s 2005 presentation to the AAA was not quite right: Zoe-Vonna’s point was that the FASB is so obviously mistaken that even accounting students could see it.
To set the record straight, Zoe-Vonna has generously provided her prepared remarks from the talk in question: A panel discussion entitled “The FASB’s Move Toward Fair Value in Accounting: Is it Auditable?” You can download her complete prepared remarks here. The panel was moderated by Bill Kinney, and also featured Ross Watts and Katherine Schipper. Zoe-Vonna opened her talk with this:
I would like to begin by asking you to consider two questions. The initial question is one you might pose to your students at the start of their first accounting course. The question is as follows. Suppose you had the choice of preparing or using financial statements based on: (1) actual transactions, (2) expected transactions, or (3) hypothetical transactions. Which seems to make the most sense to you? Which makes the least sense? Which would you choose?
For the second question, instead of an accounting class, suppose you are teaching an introductory auditing class. You have explained that auditors provide assurances that GAAP financial statements are free of misstatement. Of course, your students also know that auditors can get sued, disciplined, penalized, and otherwise punished if the financial statements are alleged to be misstated. So, what do you think? If auditors could choose, would it be to audit: (1) actual transactions, (2) expected transactions, or (3) hypothetical transactions?
Zoe-Vonna then walks through a hypothetical class discussion illuminating the dangers of relying on hypothetical transactions.
While my specific recollection of the talk was flawed — criticism of FASB flowed from the mouths of students, not babes — Zoe-Vonna is clearly arguing that FASB’s embrace of Fair Value is so mistaken that it is obvious even to students. As she says, “I suspect both groups of students would be dumbfounded when you tell them that their intuition and common sense do not apply here, because the standard setters are embracing hypotheticals in their push for fair value financial reporting” [emphasis mine].
So I repeat my question from the prior post, which I ask in all sincerity: Why do standard setters make such awful decisions? They don’t seem to be bending to political pressures, which tend to push them away from fair value. A misguided ivory tower view? That would cast academics as the bastion of practicality. Or it is just mistaken or misapplied theory?