In recent years, there has been push towards the financial reporting that is based on fair value as indicated by headlines made by accountants. There has been increase in the use of fair value measurements with the regulations and rules that are being formulated by the International accounting standard board (IASB) and Financial accounting standard board (FASB). A crying foul in relation to this particular accounting concept is marked by some recent development in market with some subprime market meltdown and failures of bank attributable to the fair value accounting concept. Fair value accounting concept is has been preferred as an alternative to modified historical cost as appeared in many standards and the topic is considered as ubiquitous. In practice, fair value is considered as nuanced despite its prevalence in accounting standard. This creates difficulties son part of users to interpret, operationalise and leaving a wide scope for financial statement manipulation for achieving political and financial ends by using valuation that is not appropriate. In addition to this, there also exists complication concerning the term of fair value that there has been different definition or indeed no definition in the standard creation process. Financial reporting has become unnecessarily perplexing due to this inconsistency in guidance regarding the fair value accounting.
For the purpose of analysis, five journal articles have been selected on the chosen research topic. The journal article named “Auditing challenging fair value measurements: Evidence from” field have been selected that raises concerns about effective auditing related to fair value measurement. Another article titled “Changes in the measurement of fair value: Implications for accounting earnings” by Fargher and Ziyang Zhang has been selected. An article named “Effect of IFRS 13 on the fair value relevance adjusted by credit risk” by Mariano has been selected that analyzes the impact of fair value on financial leverage, credit risk of financial institution and own probability default. Another article that has been chosen for analysis is titled “Fair value accounting: information or confusion for financial markets that examines how the ability of financial analysts to forecast earnings is influenced by fair value measurement. Another article titled” Fair value accounting and its usefulness to users of financial statement” by Vera Palea has been selected conducts empirical research and raises concerns on reliability of fair value.
Fair value measurement is the price that is involved in orderly transactions between the participants of market for making payment to transfer a liability or to sell an asset at the measurement date. Concerns have been raised and addressed regarding this traditional definition of fair value measurement as indicated by number of key parts to the definition. A strong part is played by debate surrounding around the concept of fair value accounting impacting the relevance and reliability. It has been argued that new accounting standard has favored the concept of relevance over reliability and this distinction has been reinforced by the concept of fair value accounting. Valuing the financial instruments at fair value or amortized cost is determined by the development of accounting standard IFRS 9 . In regard to the financial crisis, role of fair value accounting was questioned for exacerbating or causing such crisis. Although the policy makers have widely supported the concept of fair value accounting, it is certain that the perceptions of users of financial reporting have changed due to question on fair value standard and recent discussions.
The bottom line of concept of fair value accounting comprise of treating income as residual, liability and assets recognition and expectation that the market valuation of company is equal to the sum of balance sheet values. Fair value accounting has some direct issues associated with it such as relevance, recognition and measurement. Companies are able to record and recognize economic events with the evolution of capital markets. Fair value can be most appropriate if the main intention of management is to increase the potential value of financial instruments by holding it.
It is stated by paragraph 11 of IFRS13/AASB 13 measurement using fair value is for particular liability or asset. Therefore, it is required by entity to account for the characteristics of liabilities or assets when measuring fair value if such characteristics are taken into account by market participants while pricing liabilities and assets at measurement date. For instance, such characteristics involve restriction on sale or use of assets and location or condition of assets. The fair value is affected by each type of liability and assets that have their own set of characteristics. Accounting for valuing such issues requires entity to make identification of adjustments and characteristics. If the restrictions are considered by market participants at measurement date when pricing the assets, it is required to account for any restriction on disposal and use of assets.
In this particular section, the main focus is on valuing the assets. In many ways, assets are considered easier to fair value on theoretical basis as it would more likely provide an active market for exchange of assets. On other hand, liabilities tend to remain to the transaction with original party. It is stated by the paragraph 34 of IFRS 33/AASB 33 there is assumption involved in the fair value measurement that at the measurement date, instrument of own equity, financial and non financial liability is transferred to market participants . Following are the assumptions regarding equity owned instruments or transfer of liabilities and they are as follows:
The paragraph 61 of IFRS 13/AASAB 13 outlines the core principles that is applied when measuring the fair value. Such valuation techniques should be used by reporting entity for which there is availability of sufficient data for measuring fair value and are appropriate for the circumstances. There are three approaches that forms the part of valuation technique of fair value.
Income approach- The basis of income approach is to convert the future expense or cash flow or income into a single present value. This would require using models of discounted cash flow and other approach of options pricing. For the items under consideration, there is a close relationship between expected future economic benefit and market price.
Market approach- This approach is based on market identification ability for a comparable or identical liabilities and assets. There is a direct relationship between the standard and this particular approach. Any existing transactions can be adjusted for depending upon the nature of market.
Cost approach- The estimated cost of replacing the asset service capacity under consideration forms the basis of this approach. Computation of cost is done on assets that can be substituted for deriving comparable benefits while accounting for current assets obsolescence.
The valuation of liabilities and assets using the fair value accounting intends to create large variations and swings and such variations do not benefit many different enterprises and business organization. Companies that do not benefit from such accounting concepts are the ones that have investment in assets whose value fluctuate many times and by huge amount during any particular financial year . The changes in income of company are triggered by such volatile assets and in relation to long term financial assets, they are not considered accurate.
The two crucial concepts that revolve around the concept of fair value are issues related to reliability and relevance. Reliability is defined as information quality assuring that there is faithful representation of financial information and they are reasonably free from bias and errors. When the market is well established, then using fair value as an estimate of exit value is non controversial and is well defined. In event of absence of such liquid market, it would be required by entities to select appropriate discounting rates and make prediction of future cash flow. Such prediction might lead to intentional manipulation and miscalculation of the numbers that makes the errors in measurement.
The accounting standard IFRS 13 has been implemented for reducing the complexities and eliminating inconsistencies in the measurements of fair value. This led to formulation of more specific definition of fair value. The assets and liabilities explained in the definition put forward by this particular standard are elaborated that has initiated a debate against the standard. However, the requirements of this particular disclosure are not followed by many entities in different countries at its entirety. For instance, the level of hierarchy at which the measurements of fair value is computed is not stated by certain real estate companies and the standard mandates entity to specify the hierarchy level. It is therefore indicated that the investors have been provided with misleading information. Moreover, the accounting policies and requirements of new disclosures pertaining to the fair value are not well understood by auditors in practice. It is therefore required in this context that there is a need to have enough knowledge about fair value along with its disclosure to provide investors with trusted audited financial statements.
Fair value accounting has been argued to be an ambiguous and complex system and its actual implementation is faced with considerable issues. Such complexities have been identified in terms of active market where the identification of fair value of liabilities and assets are emphasized using the approach of estimation. However, the harmonization of accounting practices is affected by this procedure and the convergence between the local standards and IFRS has been delayed. Arguments have also been presented in terms of definition of fair value as all the factors cannot be met at the same time. In addition to this, the comparability of financial instruments is also affected by lack of complete information relating to fair value.
It is difficult to make effective measurement of fair value resulting from ambiguous details in the three levels of hierarchy of fair value. Ambiguity of fair value hierarchy has been strongly criticized where it is difficult to ascertain the active market in practice.
Due to continuous impairing and adjusting of values of liabilities and assets, the comparability between the financial instruments would diminish that is presented as one of the major negative arguments. For example, for determining the worth of financial instruments, one company may continue to use historical cost while other company would opt to use the fair value accounting. Furthermore, the measurement of fair value faces earnings volatility and the impact of such valuation on liabilities appear to be counterintuitive. This can be explained with the help of an example, say if a considerable financial difficulty is encountered by company, there exist a risk that the financial liability or any outstanding debt would be paid by company. Hence, it is required to make the settlement of note or bond at the price that is below the par values of liabilities before maturity. This leads to potential increase in earnings due to increase in default risk resulting from decrease in value of liabilities.
There exist many influential voices to oppose the concept of fair value accounting along with many advocates for adoption of same. Several issues have been identified that underpins the arguments which the fair value supports. The explanatory and predictive power requiring accounting information is not provided by relevant accounting. Secondly, some factors are omitted due to argue presented by the relevance value measures and they are significantly important for making assessment whether the information are useful.
One of the loudest opposition to fair value accounting has come from insurance companies, dealers, brokers, insurance companies, investment companies, mortgage writers and specialty lenders. There practical problems were cites by the economists regarding the fair value accounting and it includes problems valuing the securities at level three, circuit between capital adequacy of bank and stock price and inconsistencies treating liabilities and assets. In case of defined benefit scheme and pension funding, a short term visibility is created by the fair value accounting concept. It is further argued generally by the critics that pro cyclicality of fair values are demonstrated by financial crisis when the liquid assets market is more than unreliability of marking to model and when the accounting is related to the prudential system of regulations . The impact of fair value accounting can also be seen in terms of debt covenants that are more demanding, lending practices that are restrictive and higher prices as required economically. Moreover, the predictions of earnings based on fair value cannot be done in the same way due to occurrence of some unseen future events. However, if the earnings report any changes in fair value due to induced volatility of earnings attributable from fair value accounting, it is believed that the performance of management might not be related to earnings volatility. This in turn would make difficult for entities to predict their future performance. Since, it is possible to measure the fair values reliably; the case presented above cannot be reliably measured. Some of the concerns of fair value accounting opponents can be addressed by requiring the information of fair value as supplemental disclosures rather than recognizing the financial statements. A factor of non performance risk is included in the computation of liability fair value and any perceived chance that such liability will not be paid by entity would impact the valuation of liability. The measurement of fair value liabilities would lead to some outcomes that are counterintuitive. Opposition of fair value measurement has also been witnessed in terms of financial reporting quality being adversely affected. It has been ascertained that measurement of fair value has increasingly relied on the assumptions of managers. The discretion of management regarding using fair value is associated with lower earnings informativeness and higher probability of earnings management.
Some of the arguments that have been presented calling for change in fair value accounting are as follows:
Some of the points summarizing the proponent’s argument regarding the fair value accounting are as follows:
It is required by fair value measurement to report all the financial liabilities and assets in order to provide investors with relevant financial information. Market players and regulators have taken efforts together for securing the rights of investors in gathering reliable and comparable information irrespective of keeping or suspending fair value accounting . Before the efforts are taken to shift to recognition of full fair value, it is required to have disclosure of full fair value. It has been ascertained that the choice of fair value accounting is influenced by fundamental accounting goals and this call for reducing the bias of management in relation to such accounting concepts.
Conclusion:
The appropriateness of fair value accounting in valuing the distressed assets and derivative financial instruments has been criticized. Present research that have accounted for various issues pertaining to fair value accounting would form the basis of future research. There are numerous issues surrounding the fair value and its implementation is opposed by many powerful forces. In light of identified controversies concerning around such accounting concept, the attempt of future research would be to find an alternative to fair value accounting. The relevant accounting standards are studies by Securities and Exchange Commission that provide with the recommendation of making changes in for improving its practice and related application. Nevertheless, the arguments coming from opponents of fair value concepts might be putting forward some of the valuable arguments, there will be further expansion of such accounting concept. It is likely that there will be continued expansion of fair value concept if the gap continues to get narrow between international standards and General accepted accounting principles.
Like any other accounting rules, the concept of fair value accounting and rules pertaining to fair value accounting are the products that have been produced from compromising practicality or theoretical correctness reflecting the perceived benefits or needs of different types of business. It is required by standard setters or regulators to find a better alternative to the fair value accounting if the same has to be abandoned that would help inn serving the interest of investors. Any such accounting rules should provide regulatory authorities with the sufficient resources that would help in meeting the obligations and a reliable estimate relating to obligations of future. It should further be mentioned that rules of accounting should not serve as tool that would mislead investors or users with unreliable information or conceal any financial problems.
References list:
Ball, Ray, Xi Li, and Lakshmanan Shivakumar. “Contractibility and transparency of financial statement information prepared under IFRS: Evidence from debt contracts around IFRS adoption.” Journal of Accounting Research 53.5 (2015): 915-963.
Bamber, Matthew, and Kevin McMeeking. “An examination of international accounting standard-setting due process and the implications for legitimacy.” The British Accounting Review48.1 (2016): 59-73.
Blackburn, Nivea, et al. “Stakeholder engagement in corporate reporting: towards building a strong reputation.” Marketing Intelligence & Planning 36.4 (2018): 484-497.
Cannon, Nathan H., and Jean C. Bedard. “Auditing challenging fair value measurements: Evidence from the field.” The Accounting Review 92.4 (2016): 81-114.
https://aaajournals.org/doi/10.2308/accr-51569?code=aaan-site
Christensen, Hans B., et al. “Incentives or standards: What determines accounting quality changes around IFRS adoption?.” European Accounting Review 24.1 (2015): 31-61.
Christensen, Hans B., Valeri V. Nikolaev, and R. E. G. I. N. A. WITTENBERG?MOERMAN. “Accounting information in financial contracting: The incomplete contract theory perspective.” Journal of accounting research 54.2 (2016): 397-435.
Dignah, Ashwag, et al. “Fair Value Accounting and the Cost of Equity Capital: The Moderating Effect of Risk Disclosure.” SHS Web of Conferences. Vol. 34. EDP Sciences, 2017.
Fargher, Neil, and John Ziyang Zhang. “Changes in the measurement of fair value: Implications for accounting earnings.” Accounting forum. Vol. 38. No. 3. Elsevier, 2014.
https://www.sciencedirect.com/science/article/pii/S0155998214000295
Florou, Annita, Urska Kosi, and Peter F. Pope. “Are international accounting standards more credit relevant than domestic standards?.” Accounting and Business Research47.1 (2017): 1-29.
Glover, Steven M., Mark H. Taylor, and Yi-Jing Wu. “Current practices and challenges in auditing fair value measurements and complex estimates: Implications for auditing standards and the academy.” Auditing: A Journal of Practice & Theory36.1 (2016): 63-84.
Goh, Beng Wee, et al. “Market pricing of banks’ fair value assets reported under SFAS 157 since the 2008 financial crisis.” Journal of Accounting and Public Policy 34.2 (2015): 129-145.
González-Sánchez, Mariano. “Effects of IFRS-13 on the relevance of fair value adjusted by credit risk: Evidence from Europe.” Advances in Accounting 40 (2018): 89-97.
https://www.sciencedirect.com/science/article/pii/S088261101730144X
Griffin, Jeremy B. “The effects of uncertainty and disclosure on auditors’ fair value materiality decisions.” Journal of Accounting Research 52.5 (2014): 1165-1193.
Griffith, Emily E., Jacqueline S. Hammersley, and Kathryn Kadous. “Audits of complex estimates as verification of management numbers: How institutional pressures shape practice.” Contemporary Accounting Research 32.3 (2015): 833-863.
Heald, David, and Ron Hodges. “Accounting for government guarantees: perspectives on fiscal transparency from four modes of accounting.” Accounting and Business Research(2018): 1-23.
Israeli, Doron. “Recognition versus disclosure: evidence from fair value of investment property.” Review of Accounting Studies 20.4 (2015): 1457-1503.
Kanodia, Chandra, and Haresh Sapra. “A real effects perspective to accounting measurement and disclosure: Implications and insights for future research.” Journal of Accounting Research 54.2 (2016): 623-676.
Kemp, William C. An Introduction to Case Reports: The Fundamentals of Accounting. Diss. The University of Mississippi, 2018.
Magnan, Michel, Andrea Menini, and Antonio Parbonetti. “Fair value accounting: information or confusion for financial markets?.” Review of Accounting Studies 20.1 (2015): 559-591.
https://link.springer.com/article/10.1007/s11142-014-9306-7
Miller, Anthony D., and David Oldroyd. “An Economics Perspective on Financial Reporting Objectives.” Australian Accounting Review 28.1 (2018): 104-108.
Nobes, Christopher. “Accounting for capital: the evolution of an idea.” Accounting and Business Research 45.4 (2015): 413-441.
Palea, Vera. “Fair value accounting and its usefulness to financial statement users.” Journal of Financial Reporting and Accounting 12.2 (2014): 102-116.
https://www.emeraldinsight.com/doi/abs/10.1108/JFRA-04-2013-0021
Stent, Warwick, and Tuyana Dowler. “Early assessments of the gap between integrated reporting and current corporate reporting.” Meditari Accountancy Research 23.1 (2015): 92-117.
Vergauwe, Skrålan, and Ann Gaeremynck. “Do measurement-related fair value disclosures affect information asymmetry?.” Accounting and Business Research (2018): 1-27.
Essay Writing Service Features
Our Experience
No matter how complex your assignment is, we can find the right professional for your specific task. Contact Essay is an essay writing company that hires only the smartest minds to help you with your projects. Our expertise allows us to provide students with high-quality academic writing, editing & proofreading services.
Free Features
Free revision policy
$10Free bibliography & reference
$8Free title page
$8Free formatting
$8How Our Essay Writing Service Works
First, you will need to complete an order form. It's not difficult but, in case there is anything you find not to be clear, you may always call us so that we can guide you through it. On the order form, you will need to include some basic information concerning your order: subject, topic, number of pages, etc. We also encourage our clients to upload any relevant information or sources that will help.
Complete the order form
Once we have all the information and instructions that we need, we select the most suitable writer for your assignment. While everything seems to be clear, the writer, who has complete knowledge of the subject, may need clarification from you. It is at that point that you would receive a call or email from us.
Writer’s assignment
As soon as the writer has finished, it will be delivered both to the website and to your email address so that you will not miss it. If your deadline is close at hand, we will place a call to you to make sure that you receive the paper on time.
Completing the order and download