Fair Value's Affect on Accounting's Ability to Predict Future Cash Flows: A Glance Back and a Look at the Potential Impact of Reaching the Goal

35 Pages Posted: 15 Sep 2006

See all articles by Keji Chen

Keji Chen

University of Alabama - Culverhouse School of Accountancy

Gregory A. Sommers

Southern Methodist University (SMU) - Accounting Department

Gary K. Taylor

University of Alabama - Culverhouse College of Commerce & Business Administration

Date Written: September 14, 2006

Abstract

As the FASB implements accounting standards with fair value accounting components, discussions have centered around relevance and reliability of the reported values. Discussions primarily focus on potentially increased relevance weighed against issues of reliability rather than considering the potential impact on the predictive objective of accounting. The current study instead frames the issue based on financial reporting objectives as stated in SFAC No. 1. We show that, even with recent standard's fair value requirements, correlations between current accounting numbers and current market data have not improved through time, nor have correlations between current accounting numbers and future cash flows improved. Most importantly, we find that correlations between market data (in essence, fair values) and future cash flows are significantly lower than correlations between current accounting and future cash flows. That is, achieving fair value accounting would reduce the predictive ability of financial reporting for future cash flows.

Keywords: fair value accounting, predictive ability of accounting, objectives of financial reporting

JEL Classification: M41, M44

Suggested Citation

Chen, Keji and Sommers, Gregory A. and Taylor, Gary Kenneth, Fair Value's Affect on Accounting's Ability to Predict Future Cash Flows: A Glance Back and a Look at the Potential Impact of Reaching the Goal (September 14, 2006). Available at SSRN: https://ssrn.com/abstract=930702 or http://dx.doi.org/10.2139/ssrn.930702

Keji Chen

University of Alabama - Culverhouse School of Accountancy ( email )

Tuscaloosa, AL 35487
United States

Gregory A. Sommers (Contact Author)

Southern Methodist University (SMU) - Accounting Department ( email )

United States
214-768-1188 (Phone)
214-768-4099 (Fax)

Gary Kenneth Taylor

University of Alabama - Culverhouse College of Commerce & Business Administration ( email )

Box 870223
Dept. of Accounting
Tuscaloosa, AL 35487-0223
United States

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