The US and International Financial Accounting Standards Boards (FASB and IASB) have been moving towards replacing historical cost with fair value accounting. In general, fair values have been limited to financial assets and liabilities, at least in the financial statements proper.1 A Proposed Statement of Financial Accounting Standards, Fair Value Measurements (FASB, 2004: 5), specifies a ‘fair value hierarchy’. Level 1 bases fair values on ‘quoted prices for identical assets and liabilities in active reference markets whenever that information is available’. If such prices are not available, level 2 would prevail, for which ‘quoted prices on similar assets and liabilities in active markets, adjusted as appropriate for differences’ would be used (ibid.: 6). Level 3 estimates ‘require judgment in the selection and application of valuation techniques and relevant inputs’. The exposure draft discusses measurement problems that complicate application of all three levels. For example, with respect to levels 1 and 2, how should prices that vary by quantity purchased or sold be applied and, where transactions costs are significant, should entry or exit prices be used? As difficult as these problems are, at least many independent public

accountants and auditors have dealt with them extensively and are aware of measurement and verification pitfalls. However, company accountants and external auditors have had less experience with the third level (at least for external reporting), which use estimates based on discounted cash flows and other valuation techniques produced by company managers rather than by reference to market prices.