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    Sub-Prime Crisis and Fair-Value Accounting

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    Consider the article "Subprime Crisis and Fair-Value Accounting" (Healy, Palepu, & Serafeim, 2009) from the perspective of an accounting regulator (e.g., the FASB). Next, using outside sources that you may seek and your professional experience, develop and write a 3- to 4-page paper concisely answering the following questions:

    - If you were a FASB researcher, what specifically would be the relevant accounting research question with respect to the subprime crisis and fair-value accounting? Propose a research question spanning multiple areas of an organization's financial statements.

    - What accounting standards exist that already effect banks involved in the crisis?

    - What must be known, estimated, and assumed to answer the research question?

    - What would your recommendations be with respect to fair-value accounting standards for banks? Outline the basis of your recommendation.

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    Solution Preview

    Step 1
    The relevant accounting research question is:
    Was fair value accounting responsible for the sub-prime crisis?

    Step 2
    The accounting standards that already existed, under FAS 115, the reporting for financial instruments depended on the intentions of the management. If the instruments were intended to be held to maturity, the accounts reported these at amortized costs. Under FAS 115 if the securities were available for sale these were recorded at fair value. The cash flow hedge derivatives under FAS 133 were also recorded at fair value on the balance sheet. Those securities which were held to maturity were put to impairment tests and if there was a permanent decline in value, these securities were written down to fair value. If securities were available for sale, any unrealized gains and losses were recorded in accumulated other comprehensive income. These were not included in the net income.
    Banks involved in crisis were directly affected by FAS 157. Under this standard the Fair value was the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurable date. FAS 157 created a hierarchy of into fair-value measurements. Its first level inputs were unadjusted quoted market prices in active markets; its second level was that it directly ...

    Solution Summary

    This solution explains the role of fair value accounting in sub-prime crisis. The sources used are also included in the solution.