It's the beginning of the school year and we're seeking relief from a deadline by reprising a column that appeared in November 2008. Back then, we provided this conceptual primer to show that market value reporting could not be legitimately blamed for the credit crisis, and that it actually offers major advantages over the existing reporting model that enabled the credit crisis to go undetected for so long and to be so serious when ultimately revealed.

As we fast-forward to today, Congress has passed its financial reform legislation that will surely add to the federal bureaucracy and bolster reporting requirements. Thus, we think it is timely to remind everyone that more extensive reporting of market values is what is really needed. For anyone who continues to scoff at the merits of market value reporting, we suggest you carefully read what follows.

One (and possibly the only) positive result of the [2008] financial crisis is that market value accounting has been brought to the public's attention. Unfortunately, most discussions of this issue have generated much more heat than light. For instance, we've noted that many who criticize value-based accounting don't begin to understand its advantages over other asset and liability measures. We want to explain the theory behind it, which is how we came to be convinced that all the trouble of switching to values would be worthwhile. This perspective has helped us see that most criticisms of market value are transparent attempts to deflect blame away from managers who made poor investment decisions.


To begin at the beginning, measurement is the process of providing additional useful information about objects or events by assigning quantities to them. It's one thing, for example, to say a building is "tall," and quite another to say it has 58 floors or is 650 feet high. It's also possible to say that a building cost $346 million or that it could be sold for $780 million. To produce useful results, four things must be established:

Purpose: Measurers can produce useful measures only if they know what the results are to be used for.

Phenomena: Useful measures occur only if measurers understand what relevant objects, or phenomena, to describe.

Attribute: Phenomena can be measured in many different ways, including their weight, height, density, thickness, cost or value. The choice of which characteristic, or attribute, to use is driven by its relevance to the purpose.

Method: The measurers' chosen method should provide reliable results that faithfully represent the real magnitude of the relevant phenomena's relevant attribute.


Different objectives have been identified for financial reporting, but we see no reason to disagree with the Financial Accounting Standards Board's Conceptual Framework, which says its purpose is to provide useful information that helps users make rational decisions. Specifically, the CFW asserts that users assess the amount, timing and uncertainty of future cash flows from the reporting entity's resources and obligations.

This means that financial reporting is not intended to promote higher or more stable stock prices by painting pretty pictures that don't reflect reality. It is also not intended to make auditors safe against recrimination. Useful information promotes productive analyses of future cash flows, warts and all.


The CFW broke new ground when it determined that assets and liabilities are the relevant objects to be measured, not periodic earnings. Many mistakenly assert that FASB is so focused on the balance sheet that it doesn't care about earnings. They're wrong, of course, in confusing the board's initial measurement focus with its sense of what is important. Using asset and liability changes to define earnings doesn't diminish that number's importance at all. Instead, the earnings measure is strengthened because it is achieved by observing real events and real amounts, instead of making simplistic, hopelessly optimistic or downright manipulative assumptions.


In 1982, when the CFW project reached the question of which attribute of assets and liabilities is relevant, the working consensus among the seven FASB members came apart like a cheap suit. Three wanted to report market values, three wanted to protect the status quo, and the chair wanted to publish a unanimous statement. None of them got their wish, because Concepts Statement 5 was passed by a 6-1 vote and mostly describes existing practices without prescribing improvements other than possibly including more market values in financial statements. The attribute issue has remained officially unresolved ever since. The recent mark-to-market debates show that it's still unresolved for many accountants and managers.

However, we've determined that the issue actually was resolved, even though no one noticed. Further, FASB's discussions and others since then have been misdirected. This audacious statement begs explanation.

What we see is that the CFW objective defines the relevant attribute as an asset's or liability's ability to affect the amount, timing and uncertainty of future cash flows, or AAATUC. To a large extent, an entity's ability to generate cash flows depends on the aggregate AAATUC of its assets and liabilities; therefore, financial reporting should provide information that enables insights into that capability.


Because AAATUC is an abstract economic quality, its magnitude cannot be directly measured; however, it can be inferred indirectly from other attributes. (By analogy, electricity can't be measured directly either, but results can be obtained by measuring what it does to other things, such as magnetic fields.) Thus, the search is for the most reliable method of depicting AAATUC's magnitude.

We repeat: The goal is the most reliable depiction.

In addition, because AAATUC is forward-looking, it only makes sense that financial statements should describe current measures, rather than old or otherwise outdated amounts.

One possible attribute (for assets) is historical cost. Obviously, it cannot be reliable for predicting future cash flows because it is obsolete; that is, its amount was shaped by economic factors that may no longer affect future cash flow potential. Because historical cost doesn't change, it cannot help users know what AAATUC is today. In addition, a cost comes from a single transaction, and samples of one observation are inherently invalid. Cost must be rejected as unreliable.

Book value is an offshoot of historical cost. No one claims that systematic depreciation reflects actual changes in assets; rather, it's merely an allocation of original costs (or initial values) over predicted periods. The rampant uncertainties about that process mean that book value cannot possibly describe current AAATUC except by freakish coincidence. Therefore, it is unreliable and not useful.

Lower of cost or market is unreliable because it's clearly biased to report only losses while excluding gains. This bias causes LCM measures to lack reliability and usefulness.

Present values of future cash flows were often praised as alternatives during recent debates because managers wanted higher imaginary "economic values" based on their predictions of future cash flows and an arbitrary discount rate. Because predictions are unverifiable and subject to great bias, present values cannot reliably estimate AAATUC.

However, market values offer distinct advantages over the others we've rejected. For one thing, they're rooted in current up-to-date conditions and events. This timeliness makes them more useful than past numbers. In addition, market values are strongly correlated with AAATUC. That is, preferences exist for assets that produce cash flows sooner, in greater amounts, and with greater certainty. These preferences are expressed in higher values. The huge advantage is that market values respond very quickly to market participants' perceived changes in AAATUC, thus causing market values to reflect new events and conditions. Ironically, this responsiveness is criticized by mark-to-market opponents as a disadvantage of market values.

In conclusion, we advocate values because they are more reliable than the other reasonable alternatives.


When we refer to market values, we're talking about amounts actually observed in sufficiently large populations of transactions in orderly markets.

In other words, one-time transactions don't produce valid market values. We also look askance at thin markets with few transactions, or at values of surrogate assets that are not essentially the same as the one being measured.

In these circumstances, which exist for a great many financial instruments in these chaotic times, we admit it can be really difficult to determine what sort of value to put on assets and liabilities. Therefore, we sympathize with those who say mark-to-market may not be feasible in all situations.

However, and it's a big however, the lack of ready evidence about some market values does not justify retreating to other numbers just because they're handy or because someone prefers how they affect companies' financial statements. Rather, the need for useful information should drive wise managers to find other ways to estimate market values.


Here is our caveat to those who would ban mark-to-market: Security prices won't be favorably impacted by reporting less reliable measures. Instead, substituting non-market values creates more uncertainty for financial statement users. That uncertainty increases risk, which in turn makes them discount financial instruments.

Contrary to what bankers and others wanted, retreating from or eliminating mark-to-market accounting would not have produced more price stability and higher stock prices. Just the opposite would have happened.

What's really irrational about the debate is the underlying assumption that markets respond only to financial statement information, instead of what's actually happening. There's no reason to expect them to believe obviously biased information, much less rely on it. Finally, we doubt the ethics of public policy-makers who would create misleading financial statements and call them good for the economy.

There really should be no debate on mark-to-market, except for how quickly it can be applied to all assets and liabilities.

To their credit, both FASB and the International Accounting Standards Board are calling for increased use of market value reporting, but both are moving at a snail's pace.

You can read more about AAATUC in the upcoming September 2010 issue of Accounting Horizons, which will present our paper titled, "Continuing the Normative Dialog: Illuminating the Asset/Liability Theory."

Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors’ views are not necessarily those of their institutions. Reach them at

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