Contemporary Issues in Accounting - Essay Example

?Introduction The aim of this report is to evaluate and issue an opinion to the International Accounting Standards Board (IASB) on whether IFRS 13 onFair value measurement which was drafted in May 2011. The standard sets out a single framework for fair value measurement and guidance on how to measure assets and liabilities, whether financial or non-financial. The evaluation is based on the discussions of technical matters such as comparability, relevance, reliability and understandability. A brief background of the standard will be discussed to determine the reasons that lead to its issue and the changes made thereof after convergence. The executive summary section will give a summary of the benefits and costs of the standard which will determine whether there is a balance between the two. The report will also discuss the relevant theories in relation to the standard and the entities which are more likely to be affected by the standard. It is evident that fair value is affected by the type of industry and thus may concern will be the most affected entities. Part F of the report evaluates the standard by highlighting the advantages and disadvantages of the standard. Conclusions and recommendations reached are also based on these criterions which are required in making economic decisions. ). The conclusion is based on the discussions of technical matters such as comparability, relevance, reliability and understandability. These are the four main criterions which have been designed for application in determining whether the standard meets the expectations of IASB and the users generally. Executive summary IFRS 13 defines fair value and provides a framework on how to determine fair value for financial reporting purposes. The definition of fair value is not different from the one contained in previous IFRS. IFRS 13 defines fair value as the amount which would have been received when an asset is sold or paid if a liability is transferred between parties in an arm’s length transaction (Rankin et al 2012). The application of IFRS 13 requires significant judgment and use of core concepts for fair value measurements. It provides a common objective when it permits or requires a measurement of fair value irrespective of the asset or liability type the entity holds or being measured. The benefit of adopting IFRS 13 is that it satisfies the criteria of comparability, relevance, reliability and understandability (Rankin et al 2012). IFRS 13 is intended to make users understand the measurements of fair value and enhance consistency in the application of fair value measuring in the financial statements. By having a single framework, conflicts are eliminated since the objectives of fair value measurements remain the same regardless of the reasons behind fair value measurement or the information available to support the measurement. Fair value considers the prevailing market conditions existing at a certain measurement date and this conveys the current value of an asset or liability. This brings out the aspect of relevance since the potential future value of the asset or liability is not considered. In addition, the management’s intention to dispose an asset or transfer a liability at the measurement date is not considered. Instead, the standard represents a market-based measurement that reflects a hypothetical transaction among market participants at the measurement date. The standard also requires that inputs used in measuring fair value be prioritized based on reliability. The nature of these inputs whether observable or non-observable, does not adversely affect the intentions of the standard which is an advantage. This means that the requirements of an exit price are not relaxed because a current market condition prevails at the measurement date. Apart from this four criteria’s, IFRS 13 does not lead to incremental costs for users in incorporating the new requirements. The standard requires more extensive disclosures and thus users have to perform a detailed analysis which requires a lot of time. Background of the standard AASB13: Fair Value Measurement Most International Financial Reporting Standards (IFRS) require entities to measure and disclose the fair value of assets, liabilities and equity instruments. However, until recently there were conflicts and limited guidance in IFRS with regard to measurement of fair value. Therefore, a situation of decreased comparability of the financial statements and the quality was being experienced and thus the two bodies decided to merge the requirements on fair value measurements into a single standard. To resolve this issue the International Accounting Standards Board (IASB) set out and issued IFRS 13, a standard on Fair Value Measurement. The standard was issued in May 2011, and it was to be effective for annual periods on or after January 1st 2013. The adoption and restructuring of the accounting standard was as a result of the increasing global pressure due the changing global needs and attitudes. The recent global financial crisis also emphasized on the importance of improving guidance on measuring fair value and relevant disclosures. The standard defines fair value, gives guidance on the measurement of fair value and provides relevant information on the fair value to be disclosed (Christian and Denbach 2013). . The standard satisfies the criteria of understandability, consistency, reliability and relevance. The standards intention is to provide a framework of reducing inconsistency in fair value measurement and not to remove the judgment involved in estimating fair value measurement. This means that the standard does not also reflect which asset and liabilities are to be measures at fair value or the measurements to be performed. It does not provide guidance on when to apply fair value but on the measurement of fair value for both the non-financial and financial assets and liabilities. IFRS 13 is based on the principle that fair value is only an exit price and gives priority to market information. The requirement to use bid and ask prices for actively quoted assets and liabilities has been removed and replaced by exit price. Therefore, an entity must use or rely on other standards as this is only a framework. it also focuses on market participants who hold assets or owe liabilities at the measurement date and not on the entity itself. IFRS 13 applies to all fair value measurements when fair value is permitted by IFRS but with some exceptions. IFRS 13 also applies to measurements such as fair value fewer costs to sale which are based on fair value. However, it does not apply to similar measurements such as the value in use. The standard also introduces new disclosure requirements on fair value such as hierarchy disclosures on non-financial items, more extensive disclosures when unobservable inputs are used in the measurement of fair value and more detailed information in interim financial reports. Fair value measurement changes and the extent of such changes are influenced by the type of asset or liability being measures or by the prior fair value measurement requirements. The effect of the standard also may differ by sector or industry. The application of IFRS 13 requires significant judgment and use of core concepts for fair value measurements. Part B: Theories relevant to standard: The basic theories in which are applicable to all standards alike are held together within the conceptual framework of accounting, which essentially is a normative theory. That is, the theoretical underpinnings of financial accounting principles and concepts are able to be determined via the framework. Primarily, the theories I thought applicable to standard: Normative theory of recognition criteria: That is, probability of future inflows and as the ability to measure values reliably in order to report on various elements within the financial statements. Normative theories of qualitative characteristics: These include the two primary characteristics being relevance and faithful representation. The secondary characteristics that in theory are important to fair value measurement include comparability, verifiability, timeliness and understand ability. Positive theory of accounting policy choice: This relates to the choices managers and alike make based on the theory that if a benefit of the individual is based on company profitability, the valuation measurement method that nets the highest reported income will be selected. Part C: Research relevant to standard: Research can be defined as the diligent and systematic enquiry or investigation into a subject in order to discover facts or principles. Research within AASB13: Fair Value Measurement accounting standard essentially associates with both normative and positive theories. It is this research that allows the in depth analysis and resulting evolving nature of current accounting principles and theory. Primarily, the research I though applicable to standard: Normative research on the usefulness of fair value measurement in comparison to historical costs Managerial accounting policy choice – Positive research on why managers make the decisions they do on asset and liability measurement. Capital market research – Positive research of market behaviour and the affect accounting information (in this case asset/liability measurement) has on them. Normative research on the ineffectiveness of fair value measurement when an active market does not exist Positive research of accounting information processing Part D: the reporting entities most affected by Fair Value In financial reporting, the accounting standard of fair value keeps a popular topic at least two decades. The reporting entities with fair value are to provide the information about the amount of exchanging the financial instruments (such as assets and liabilities) in the market by a firm or an organization (PriceWaterhouseCoopers[PWC], 2008). The standard of fair value has significant effects on the reporting entities. The main influences as follows: Firstly, reporting entities are related to the change and mutability which is created by their financial reports of reporting fair value. Hence, numerous reporting entities consider that it becomes harder and more complex for the users of their accounts to make a distinction between the influence which is made by the variation of fair value and the financial performance which is created by their main business activities and operations (PWC, 2008). If reporting entities make a choice to invest in terms which within volatile fair value and if these items are required to be measured at fair value by the accounting standards and if the volatiles of fair value are needed to report in profit or loss, the net income or loss of the reporting entities could become more instable and volatile over time when contrast to the entities which applying the cost-based approach. Nevertheless, it needs to be noticed that this volatility could reflect the volatility of the economic environment very sufficiently (United Nation Conference on Trade and Development, 2006). Secondly, the updating and amendments of the accounting standard of fair value also will affect on the reporting entities. There is not a common and accepted set of fair value accounting of measuring assets and liabilities in the international financial system currently (Lefebvre, Simonova &Scarlat, 2009). The objective of updating the accounting standard of fair value is to realize the common requirements of providing and disclosing more useful information of the fair value measurements for the reporting entities to satisfy the investors’ requirements and needs, which is under International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP) (Briggs & Waterman, 2011). For example, the accounting standard of fair value has been developed under IFRS 13. In IFRS 13, the measurement of fair value requires the reporting entities to consider and decide all the situations: the specific liability or asset which is the subject in the fair value measurement (with its account’s unit congruously); the premise of assessment and valuation that is suited for the measurement for a non-financial asset; the primary (or the most favorable) market for the liability or asset; and the technique of evaluation is appropriated to the fair value measurement, and also have to consider the data’s validity and significance with that to improve the inputs which stand for the assumptions that the participators in the market would utilize when setting a price of the asset of liability and the standard of the fair value hierarchy within which categorizes the inputs (IASPlus, 2013). Hence, it indicates that the reporting entities have to follow and comply with the requirements of IFRS 13 in the measurement of fair value. Furthermore, the reporting entities are most influenced by the accounting standard of fair value. Part E: Identification of parties who gain from the standard as well as parties who lose from standard: Investors gain on the insight provided by fair value measurement in regards to market values, as well as current financial instruments. Investors have a clearer picture a company’s health through fair value measurement. Companies lose out on reported earnings when using fair value measurement when the economic period is illiquid or weak. Fair value measurement has been said to be subjective and arbitrary at times, increasing volatility of reported earnings. This causes investors to lose out on the misleading information. A flow on affect being inaccurate long term value measurements causing increased transparency for both companies and investors. Companies are required to spend more capital on the costing of fair value measurements, in turn reducing spending in other areas. Governments too, face this problem. Fair value measurement represents the value of assets/liabilities to its “truest” form. This benefiting companies as they have a better grasp at the values of their assets and liabilities. Reduces net income for companies which effectively also decreases taxes payable. Part F: An evaluation of the standard Some advantages and disadvantages of using fair value would be addressed in this part to evaluate fair value accounting. In accordance to AASB 13, as it has shown above, “the objective of a fair value measurement is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions” (“Fair Value Measurement”, 2011a). The most distinctive advantage of fair value is relevance. Fair value provides more reliable value of assets and liabilities comparing to values based on historical cost method. As fair value reflects ongoing market conditions, it also affords comparability of the value of financial instruments that accepted at different times. Moreover, reflecting underlying market conditions enables fair value measurement to provide accuracy. In spite of the benefit of relevance, it has been claimed against fair value that it is less reliable. Fair value measurement has some probability of providing management the opportunity to manipulate the bottom line by producing inaccurate results in the unusual market conditions (Rebecca Toppe Shortridege, 2006). By using fair value measurement, for instance, accounting costs are anticipated to be increased which could be question of financial statement users as the use of independent values are not required (Alfred, 2005). In the definition of fair value accounting, it has been mentioned ‘active market’ either ‘active markets’. The relevance linked to the availability of market data. More specific, some assets and liabilities that are traded considerably frequently can be valued accurately, since they the value is publicly available. However, there are also other elements in the balance sheet that rarely traded and unique. In the absence of active markets, therefore, fair value estimate reliability tends to be uneven at best. Additionally, another argument confronting fair value is that it could bring volatility into financial statement by measuring market movements’ effect (S.S.C. Ting Tieng, Meng, 2005). Conclusion IFRS13 results to relevance, consistency, reliability and understanding. Information is relevant if it influences the decision making process of users. The information should have predicative value and confirmatory value to help users evaluate past, present and future events. The new guidance in IFRS 13 results to the provision or omission of relevant information on those assets, liabilities and equity instruments owned by users. Information is highly reliable if it is free of material error or bias, complete and contains faithful representation. There are no significant issues concerning material errors and bias to the standard. IFRS 13 gives guidance on fair value measurements when the level of activity for a particular asset or liability has decreased significantly . There have been arguments that it is impossible to produce fair value information where activity level reduces. However, the standard gives guidance with this regard. Some arguments indicate that information may not be reliable if entities operate in the same market and arrive at different conclusions on whether there has been significant decrease in the level of activity. Additionally, the new changes made on fair value measurement mainly impact comparability and relevance of information but no significant effect on reliability (Rankin et al 2012). However, the standard does not lead to significant issues regarding to the reliability of information of assets and liabilities subject to disclosure requirements and fair value measurements. Information is comparable if like items and events have been accounted for in a consistent manner through time and by different entities and when unlike items or events are accounted for differently. IFRS 13 provides a single source of guidance for measuring fair value thus satisfying the criterion of comparability. Finally, the notion of understandability requires that the information provided to users to be easily comprehended. IFRS 13 satisfies this notion. Based on these arguments, IFRS 13 satisfies the four technical criterions and the costs involved offset with its benefits bringing in a balance. Therefore, the standard should be applied without doubt though from time to time the IASB should evaluate to give room to changes if need be. References Christian, D. and Denbach, N., 2013. IFRS Essentials. Wiley Publishers Rankin, M., Stanton, P, McGowan, S, Ferlauto K and Tilling M, 2012, Contemporary Issues in Accounting. John Wiley & Sons. Read More