Disclosure of Fair Value Information - Essay Example

DISCLOSURE OF FAIR VALUE INFORMATION IN THE CORPORATE ANNUAL REPORT Word Count: 2,597 Introduction Disclosure of fair value information differs from company to company. Provided that companies are obligated to provide stakeholders with insight of how much they are valued and how much of the returns come from non-obvious sources. Based on the IFRS accounting system, companies are required to value their worth accurately by considering the fair value hierarchy method as it ensures that a company’s sources of revenue are considered from all levels, 1 to 3. This paper provides an insight into how fair value information is treated under the UK context taking into consideration the inclusion of such information in Weir Group’s financial statement. Assessment of UK’s Regulations and Standards The manner in which businesses are run in the UK markets is monitored and controlled through policies that touch on ethical business relationships, fair representation of financial statements, and fair valuation of company’s worth. While corporate operations are regulated in order to attain an ethical business environment, various other regulations are conducted to ensure that financial and accounting approaches of the business are transparent to attract genuine interest from investors and other stakeholders (Martinière, 2007). Within the UK marketplace, IFRS 13 is considered the law governing fair value information which is a vital set if information required to value a business entity. The IFRS 13 is responsible for fair value measurement and provided guidelines on how companies should measure their fair value (Deloitte UK, 2013). However, since the financial and accounting field has various approaches to valuing assets and business’s net worth, the IFRS 13 considers fair value at the exit price and makes use of fair value hierarchy to value an entity. Valuation using the fair value hierarchy is market-based and is not entity-specific (Demski, Lin, & Sappington, 2008). Entity specific measures tend to consider the type of business and the owner of the business. However, fair value hierarchy makes use of market-based approach to value assets and business’s worth. Additionally, the approach of considering the exit price aims at showing how much the business entity or company would be worth in its current market if were to close at the moment of valuation (Song, Thomas, & Yi, 2010). Under the UK regulations, fair value is defined as the prices acquired from an asset sale or in transfer of liability in a systematic transaction among market participants at the date of measurement. Based on the market value, fair value considers active markets which are defines as markets where transactions for an asset or liability takes place with respect to regular frequency and volume to facilitate pricing information on a gradual basis (Muller, Riedl, & Sellhorn, 2011). Since the IFRS 13 is only applicable in situations where other IFRS requirements permit fair value measurement, its approach of using the exit price intends to value an asset or a liability with respect to the price that would be received or taken to sell or buy an asset or a liability respectively. In the valuation process, the IFRS 13 considers highest and best use as factors that determine whether a non-financial asset can increase the value of assets or liabilities. Most advantageous market is another factor considered within the UK’s fair value measurement and its role is to set the price for selling an asset or the amount paid to transfer a liability. Lastly, the IFRS 13 under the UK’s context considers principal market as a factor in the valuation process. The principal market is considered as the busiest market in the sale of assets or transfer of liabilities (Saudagaran, 2009). The IFRS 13 makes use of the fair value hierarchy which is used to rank and prioritize inputs. Under the UK’s IFRS 13 requirements, the fair value hierarchy provides room for three levels of input. These include level 1, level 2, and level 3 inputs. Level 1 inputs comprise of quoted or unadjusted prices within an active market for identical assets and/or liabilities at the date of measurement. Under IFRS 13:77, a quoted price is the most reliable measure of fair value at the time of measurement as it requires no adjustment and no exceptions as well. Level 2 inputs under IFRS 13:81 are other inputs besides unadjusted prices falling under level 1 (Chen, Tan, & Wang, 2013). Level 2 inputs cover quoted prices for similar or identical assets and liabilities, unquoted prices for identical assets and liabilities, and observable prices other than quoted for the asset or liability. Finally, level 3 inputs are defined under IFRS 13:87-89 as the unobservable inputs with available best information. IFRS 13’s objective in fair value measurement is to estimate the price of an asset or a liability at the time of sale or transfer within a market under its current conditions (Deming, 2006). The requirements of the fair value measurement include the determination of the particular liability or asset, the use of highest and best use factors to value non-financial inputs, the principal market, and the consideration of valuation techniques; under IFRS 13, fair value hierarchy is the applied technique (Saudagaran, 2009). On the aspect of disclosure, the measurement of fair value has to be purposeful. The objective of fair value disclosure is to assist the users of a company/business’s financial statements with understanding the assets and liabilities measured at fair value, the measurement technique applied, and the inputs used to determine the value of the assets and liabilities. Additionally, fair value disclosure seeks to identify the effect on profits and loss level 3 inputs have on the value of the company (Greenberg, Helland, Clancy, & Dertouzos, 2013). However, the fair value disclosure has exemptions including IAS’s employee benefits, retirement benefit investments, and assets covered under the IAS impairment of assets. IFRS 13 has development over a period of 8 years but with remarkable changes occurring between 2005 and 2013. In 2005, the IFRS 13’s project on fair value measurement was included in IASB’s agenda while in 2006 a discussion paper, Fair Value Measurement, was published. In May 2009 an exposure draft, Fair Value Measurement was published. In 2010, a staff draft of IFRS on fair value measurement was released. In 2011, IFRS 13 was issued to be on effect from January 1, 2013. In December 2012, the IFRS 13 was amended to reflect annual improvements on IFRSs cycle of 2010-2012. Suggested Improvements With reference to the levels of input considered through the use of the fair value hierarchy technique, the measurement for level 3 inputs falls short in determining how to value unobservable inputs (Hodder, Hopkins, & Wahlen, 2006). For instance, companies that provide added benefits to employees such as allowing them to work overtime on projects, cannot value the overtime effect on operations and company’s profit or loss. Hence, while factors under level 3 inputs have high chances of not being measured, it is recommended that IFRS 13 measurement approach be altered in a manner that it can quantify unobserved inputs. For instance, companies that sell information to other companies as an additional service may not value their assets and liabilities properly if sensitivity of traded data is a factor of consideration. In addition, assuming that a company indents to acquire another company, the liabilities of the acquired company may not be accurately valued if market volatility is considered. Additionally, if the acquired company has a potential and stability within its market, the factors such as goodwill with be considered with respect to averaged concerns (Hirst, Hopkins, & Wahlen, 2004). The interests of the buyer and the seller may conflict in the valuation of goodwill especially for companies with financial issues adjusted in their financial statements (a company with internal problems and good market reputation). Company Analysis Weir Group PLC is listed within the UK’s FSTE stock exchange. The company’s adherence to disclosure policies and the set of policies it has set on the same matter differ in some areas. With reference to the operations in gas and oil, Weir Group Plc has a number of inputs that do not fall under any specific category within the company’s financial statements. For instance, the company has incurred various impairments and gains from intangible assets. With reference to the company’s financial statement, it reports that due to infrequency and size of some inputs, these are not referred to in the financial statement and instead these are reported separately outside the balance sheet or the financial statement. On the other hand, the company reports that its reporting period is after 52 weeks which end on the 2nd day of January. In the financial statement, the company’s take is that it does not include the Group’s statutory financial statements. In its reporting criteria, Weir Group Plc indicates that its financial reporting policies state that the statements are in Sterling Pound and figures are rounded off to one decimal place. Regardless of whether the figures are accurately rounded off, the fair value of the group cannot be established with reference to the error margin accommodated in the rounded figures. On the aspect of disclosure, the company has two approached of reporting. Firstly, the company reports profit before the inclusion of exceptional items and intangible assets. Secondly, the company states that it considers the effect of exceptional items and intangibles. Under the reporting policy, Weir Group Plc defines exceptional items as items of expense or income accounted separately as they do not feature the major operations of the company. The company’s classification of exceptional items considers nature, size, value, and frequency of events leading to transactions. Among the items included under the exceptional items include profits and losses incurred in business closures, investments made in the optimization of processes, losses incurred under impairment of intangible assets, and adjustment of fair value for acquisition items (Perrera, 2012). Based on the IFRS 13 fair value measurement, the Weir Group included intangible assets amortization as a factor for reporting exceptional assets separately. As auditing agents may not pay close attention to level 3 inputs under the fair value hierarchy, it is also possible that increased acquisition of intangible assets can lead to a gap in the reporting approach. Thus, in order to provide relevant and reliable data on its assets, the company considers intangible assets business inputs that may not be valued if placed under investments. Thus, following the separation of exceptional items from tangible assets and the major operations of the company, the existence of intellectual assets provides the company with an upper hand of monitoring level 3 inputs and reporting on their effect over the financial year. Based on Weir Group’s operations in gas and oil, the company does not have products different from those of competitors (Funds Library, 2015). However, in order to be efficient in acquiring the raw products and refining them within the least budget, the company has to design and implement innovations that contribute to its competitive advantage. Innovations in processes are considered intangible assets and in most cases are patented over years to prevent rivals from imitating them. However, patents have life spans and when they expire, other companies can develop the innovations and use them in their processes as well. However, in the disclosure of financial assets such as the innovation developments and their effect on business, the company has considered the least of inputs which contribute to the optimization of processes. In its annual report, Weir Group indicates that policy guidelines under IFRS 10 to 12 have not contributed to any changes or inclusions within the financial statement (Funds Library, 2015). In relation to disclosure of fair value information, IFRS 10 to 12, indicate that consolidated financial statements develop on existing principles, joint arrangement require disclosure of areas of common interest, and disclosure interests build on obligations for liabilities of the respective arrangement (Funds Library, 2015). Combined, the Group’s take on the three IFRS caps indicate that the arrangements between the group and other stakeholders influence how much information on fair value can be disclosed. The company’s statement that the provisions of IFRS 10, 11, and 12 do not influence change in its financial annual report shows that the company either obliges to the requirements of disclosure or it does not have to comply with the provisions of the regulatory (Funds Library, 2015). Considering that under the UK disclosure law, IFRS 13 was developed to guide business on the approaches they should adapt to measure fair value. IFRS 10 to 12 indicate that disclosures are obligations based on the amount of information owed to the audience or users. For instance, the partnership between any two or more companies may require the financial statement to show all information agreed upon at the date of partnering or amendment of the primary arrangement. Additionally, the IFRS caps 10 to 12 indicate that a company can choose to or not to disclose fair value information if it is not required by obligation to provide that information. This shows that a company’s fair value information can include every detail within its annual report if stakeholders such as shareholders, business associates, and others require the information as an important factor of making business adjustments. However, the provisions of IFRS 10 t0 12 do not conflict with those if IFRS 13. Under the first set of regulations, IFRS 10 to 12 require Weir Group to disclose as much fair value information as it is obligated to provide. On the other hand, IFRS 13 provided guidelines on how to measure fair value. The difference between measurement and disclosure is that the initial exercise requires the consideration of all internal operations leading to spending or generating revenue of any magnitude. On the other hand, disclosure involves the provision of the valuing results to stakeholders who require it. In this case, Weir Group is justified to argue that the requirements of IFRS 10 to 12 have not influenced the compilation of the annual report of the company. Additionally, based on the requirements of IFRS 13, the company’s consideration of level 3 inputs shows that it practices a rather transparent reporting approach. Company’s Fair Value Information Disclosure Practices vs. UK’s standards Under IFRS 13:77, a quoted price is the most reliable measure of fair value at the time of measurement as it requires no adjustment and no exceptions as well. Level 2 inputs under IFRS 13:81 are other inputs besides unadjusted prices falling under level 1. However, when considering that Weir Group only considers the effect of all items and adds another set of exceptional items, it is observed that the company is not capable of quoting the price of the effects of intangible assets and intangible asset amortization. However, under IFRS 13:77, no exceptions are considered meaning that an effect brought forth by investment on innovative solutions should be quantified and accounted for. IFRS 13’s objective in fair value measurement is to estimate the price of an asset or a liability at the time of sale or transfer within a market under its current conditions. Since Weir Group has not provided a criteria of valuing intellectual property and other categories of assets such as exceptional items, it is difficulty for the company to provide users of its annual reports with reliable fair value information. Under the Weir Group’s disclosure policy, included are accounts of accumulated investments in intellectual property that reflect changes in the balance sheet but cannot be accurately measured or included. However, the company’s attempt to present as much data as possible regarding its varying levels of inputs shows the company’s attention to adhering to best practices. The objective of fair value disclosure is to assist the users of a company/business’s financial statements with understanding the assets and liabilities measured at fair value, the measurement technique applied, and the inputs used to determine the value of the assets and liabilities. Suggested Improvements The factors under level 3 inputs have high chances of not being measured under Weir Group’s case. However, it is recommended that IFRS 13 measurement approach be altered in a manner that it can quantify unobserved inputs (Meyer, 2005). Although IFRS 10 to 12 relate to the obligation of disclosure, the guidelines on IFRS 13 require more accurate measure of fair value regardless of whether companies are obligated to disclose that information or not (Chen, Tan, & Wang, 2013). Conclusion Based on IFRS 10 to 12, companies should ensure that their worth is accurately measured by considering all sources of income as well as expenditures. Such requirements can be facilitated by employing fair value hierarchy method of fair value measurement. IFRS 13 on the other hand, requires companies to provide fair value information if only the company is obligated by contract or terms of business to produce such information. Considering the case study at hand, it is observed that Weir Group Limited considers the guidelines of IFRS 10 to 12 but point out in its financial statement that the conditions/requirements stated under the IFRS caps have no influence in the compilation of the Group’s annual financial statement. References Chen, W., Tan, H., & Wang, E. (2013). Fair Value Accounting and Managers Hedging Decisions. Journal of Accounting Research, Vol. 51, No. 1; pp. 67-103 Deloitte UK. (2013). IFRS 13 – Fair Value Measurement. Accessed online on April 14, 2015 from http://www.iasplus.com/en-gb/standards/ifrs13 Deming, S. (2006). International Accounting Standards. The International Lawyer, Vol. 40, No. 2. 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Value Relevance of FAS No. 157 Fair Value Hierarchy Information and the Impact of Corporate Governance Mechanisms. The Accounting Review, Vol. 85, No. 4; pp. 1375-1410 Read More