Accountants play a vital role in the measurement practice while evaluating the value of assets and liabilities before the preparation of an entity’s financial statements for different institutions in the world. The current accounting practice is very dynamic. This calls upon accountants to be put in place fair value measurement technique, provide superior transparency, equality and appropriateness when compared to the use of historical cost.
Fair value accounting can be described as the projection of value estimates of a company if decides to sell its assets or exchange a liability using the prevailing market prices. This approach is used in the valuation of assets or liabilities in the balance sheet. The fair value of accounting can also be used to describe the prices of futures contracts which are at equilibrium (Laux and Leuz, 2009, pp.830)
Fair value accounting according to Cheng, groups estimates into three categories. The first level groups valuation basing on the market quoted prices and this applies to match assets and liabilities in a given market. The second level includes estimates basing on marketplace observables, examples are products which are the same but are not alike (Lodh, 2018, NP.). The third level comprises of items which require a particular valuation approach and are unobservable in the marketplace.
The significance of assets and liabilities evaluation using the fair value is to assist in providing relevance to the users of the financial statement for example lenders, creditors and investors. When information is prepared using the fair value method it assists the investors and other external users to make useful financial decisions and consequently, they are able to make correct investment decisions. Fair value measurements provide investors with very appropriate information that helps them visualize the true picture and accounting realities of financial statements of different companies and institutions. Fair market value helps create a very transparent environment for the external users of the financial statements, Bragg and Bragg (2018)
Fair value measurements enable the external users of the financial statements to be able to evaluate the growth of an entity, evaluate the expectations of an entity and therefore be able to make suitable financial decisions (Lu and Mande, 2014, pp.95). Different investors look at the financial statements using an international perspective and due to this, it is significant for companies to utilize the fair value measurement approach which is widely used and accepted.
Fair value measurement technique acts as a good mechanism for investment attraction. This technique helps the accountants to take care of other financial statement users’ needs industrially and technologically. If the financial statement users find the financial statement information to be useful and faithfully represented then they are able to invest in their organization s, Cairns (2006).
Fair value reporting makes the information to be consistent, comparable with those of other firms, makes the information convenience and increases its reliability, Herman and Thomas, (2006). The financial statement users are able to compare the financial information of the different company and due to this, they come up with good financial decisions.
Fair value measurements of accounts make the information of the financial statements to be represented faithfully, have impartiality and also be easily verifiable. It also makes the external users be able to look at the economic problems that the company may face and the risks that might arise if they invest in the organization (Cheng, 2012, pp.535)
Reporting the financial statements in which the assets and liabilities have been measured using their fair value provides realistic and suitable information to the external users of financial statements. This is because the financial statements reflect the business performance in the current market and also the accounting realities of an organization.
Fair market value is widely used by private and public sector organizations. The portfolio and derivatives are reported using the fair market value in the public sector using the current market quoted prices. The private sector and public sector organizations are required to produce financial results on yearly basis and the financial statements should be reported and presented according to the accounting standards. Their financial statements should show consistency, be comparable, be represented faithfully and also be accurate so as to benefit the external users of those financial statements in making useful financial decisions. In order to achieve these qualities, the public sector and private sector organizations have to evaluate their assets and liabilities using the fair value method.
Due to the emergence of the public sector and private sector organizations, there has been an increase in demand for production of financial statements which enable the users to make good financial decisions globally. Fair market value enables organizations to produce high-quality information in their financial statements (Whittington, 2008, pp.140).
The fair value measurement contributed to the subprime crisis. It is believed that the fair value evaluation technique produced difficulties to the subprime accountants while evaluating the subprime value positions. The fair value accounting is alleged to have culminated to the excessive leverage which was employed by banks during the time of boom which in return brought about a downward spiral all through the bust era (Njima and Zouari, 2015, p.275). This act strained banks to measure their assets using the fire sale market prices and consequently, the assets of subprime were valued at a very low value which made their business endangered and resulted to the subprime crisis.
Fair value froze the subprime markets and the bonds traded at lower market value than their true face value. Fair value is alleged to have undermined the financial reporting foundations for instance in terms of reliability and variableness hence it made the financial statements users make a poor investment and economic decisions in terms of loans and this culminated to the subprime crisis (Durguner, 2012, np.).
Fair value approach contributed to other crisis in the world in cases where the approach was not well used or where the valuation brought about difficulties in the calculation. Many companies which used this approach especially in the mark to market accounting ended up in crisis (Xu, 2009, p.216). A good example is Enron Company. The start of the use of fair value method in mark to market accounting was the start of the fall of the company and the creation of many scandals.
To sum up it evident that the use of fair value measurement technique provides more convenient results than the other methods such as the historical cost; this is because the information provided by use of this method is much updated and it reflects the prevailing market rates and hence improves transparency (Ifrs.org, 2018, np.). It is, therefore, true to say that over-reliance on the use of fair value technique does not provide useful data that help in stewardship and consequently the evaluation of assets and liabilities should be done by use of both the historical cost and fair value method in order to give complete, accurate information and faithfully represented information to the external users of the financial information.
The two selected companies are the Commercial bank for Australia (CBA) and Australia and New Zealand bank (ANZ).
ANZ bank and CBA bank both reported their assets and liabilities using the fair value method. Both banks estimated their fair value prices using the quoted market prices which prevailed in the market (Commbank.com.au, 2018; Anz.com.au, 2018, np.). They also used other valuation techniques which were appropriate and applicable in cases where the financial instruments were non-market quoted.
Both banks valued their non-market quoted financial instruments using other valuation methods which are accepted in measuring the fair value.
Both banks report their financial liabilities using the fair market value except for CBA bank which has reported other liabilities at amortized cost.
In both ANZ and CBA banks, the changes that resulted due to fair value measurements were reported as profit and loss in the statement of income.
ANZ measured some of its assets and liabilities using the fair value evaluation technique. The items that were measured comprise of the following: the derivative financial instruments, assets classified as available for sale, the financial instruments held by the bank for trading and other financial instruments which are designated using fair value by loss and profits. On the other hand, in CBA the items that were measured using fair value plus the transaction cost, those items include loans and receivables, the derivatives assets and the goods available for sale.
The financial assets and liabilities of ANZ were evaluated using the fair value method. They were evaluated using the profits and loss. The trading securities of the bank were evaluated and then presented in the statement of financial position with their values of revaluation using the profits or loss. On the other hand, in CBA bank the assets were reported in the income statement using the fair value at the date of measurement or at the date of the transaction.
ANZ hedging of fair value was prepared on acknowledged assets and liabilities and the resulting changes were reported as profits or losses. When ANZ sold any of its hedged items, the adjustment of fair value was reported without amortization. On the contrary, CBA the hedges were recorded in the income statement in addition to the changes which aroused due to fair value. The fair value of the hedged asset was adjusted using the carrying value of the asset which was hedged
The deposits and borrowings at ANZ were supposed to be designated using the fair value and the amounts reported as either loss or profits in the statement of comprehensive income. Some of the unsubordinated debts were measured using the fair value. On the contrary, the liabilities of CBA were reported in the income statement using the fair value (Plamrose, 2009, p.279) Other financial liabilities in CBA bank like interest expense was not reported using the fair market value method they were reported at amortized costs.
ANZ measured its financial instruments using the fair value. The bank used the quoted market prices in evaluating fair market values. It also used the present value technique and other valuation methods of estimating values which are recognized in accounting. On the contrary, CBA bank, on the other hand, reported their financial instrument using the transaction prices. The transaction prices were to act as fair value.
The fair market value of ANZ was measured using the quoted price or other accepted valuation methods while the fair value estimation of CBA is done using the quoted prices and other dealer prices in the market.
Both assets and liabilities of ANZ were evaluated using the quoted market price or the recognized valuation method while in CBA only the noncurrent assets and long-term liabilities were measured using the quoted market price. Short-term liabilities and current assets of CBA were measured using the asking price.
ANZ generalized the assets that were measured using the fair value while CBA bank went further to categorize those assets measured at fair value into three categories. The first category consisted of trading, the second category was the insurance category and the last category was the others.
References
Anz.com.au. (2018). ANZ Personal Banking | Accounts, credit cards, loans, insurance | ANZ. [online] Available at: https://www.anz.com.au/personal/ [Accessed 24 Sep. 2018].
Cheng, K. (2012). Accounting Discretion and Fair Value Reporting: A Study of US Banks’ Fair Value Reporting of Mortgage-Backed-Securities. Journal of Business Finance & Accounting, 39(5-6), pp.531-566.
Commbank.com.au. (2018). [online] Available at: https://www.commbank.com.au/content/dam/commbank/about-us/shareholders/pdfs/2017-asx/Annual_Report_2017_14_Aug_2017.pdf [Accessed 24 Sep. 2018].
Durguner, S. (2012). The 2007 Subprime Mortgage Crisis: Changing Characteristics of Lending to Subprime Households. SSRN Electronic Journal.
Laux, C. and Leuz, C. (2009). The crisis of fair-value accounting: Making sense of the recent debate. Accounting, Organizations and Society, 34(6-7), pp.826-834.
Lodh, S. (2018). Conventional accounting in determining an enterprise’s wealth: Sign or referent a theoretical discourse for augmentation’,. [online] International Journal of Critical Accounting. Available at: https://www.xcdsystem.com/APIRA2016/program/index.cfm [Accessed 24 Sep. 2018].
Lu, H. and Mande, V. (2014). Does disaggregation of fair value information increase the value relevance of the fair value hierarchy?. Research in Accounting Regulation, 26(1), pp.90-97.
Njima, N. and Zouari, S. (2015). The subprime crisis and the impact of accounting standards/fair value accounting: the case of European and North African countries. African J. of Accounting, Auditing and Finance, 4(4), p.273.
Plamrose, Z, V., 2009, ‘Science, politics, and accounting: A view from the Potomac’, The Accounting Review, Vol.84, No 2, pp.281-297.
Whittington, G., 2008, ‘Fair value and the IASB/FASB conceptual framework project: an alternative view’, ABACUS, Vol. 44, No. 2, pp139-168
Xu, Y. (2009). The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It20091Robert J. Shiller. The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It. Oxford: Princeton University Press 2008. Journal of Property Investment & Finance, 27(2), pp.215-216.
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