British Telecommunications Approach to Fair Value Measurement - Case Study Example

British Telecommunication’s approach to fair value measurement Task Introduction This essay presents the financial activities of the British Telecommunication in the year 2013. The primary data supporting the essay will be obtained from the company’s 2013 annual report. The main issues that will be focused on are the types of non-current assets – both tangible and intangible – owned by the company, the problems the company is likely to deal with in the attempt to ascertain the fair value of the types the non-current assets. In addition, it will also be determined whether the IASB’s fair value measurement approach is practical for companies owning non-current assets that are not actively traded on broad and deep markets. Financial reports The preparation of financial statement is an obligation to every organization, both for profit and not for profit. The International Financial Reporting Standards (IFRS) has set rules and regulations to converge and govern the approach used in the preparation of the financial statements. Users of the financial statement are as follows: investors, lenders, employees, customers, government and their agencies and suppliers. The following are the importance of objectivity and integrity in the preparation of financial statement: first, it provides useful information for the current and potential investors, creditors and other users of the named above. The preparation of the financial statements based on the objectivity and integrity ensures the provision of clear and useful information that help the users in decision-making (Gibson 2012, p. 1-3). Second, the financial statements provide potential investors with reliable information to help them assess the amount, time and risks of the prospective return on investment. The ability of an enterprise to generate enough cash to meet its obligation may be affected by investor’s and creditor’s the perception of a company. This may eventually influence market prices and enterprise security (Lee, Financial reporting and corporate governance, pp. 113-139). The role of accounting and reporting standards In light of the varying accounting practices in different countries, the International Finance and Reporting Standards has established guiding principles to facilitate the convergence of the international accounting practices and to improve the quality of the information presented to different users (Barth 2007, p. 3-5). In the attempt to achieve the convergence in accounting practices, the IFRS has established the following principles: information relevance, information reliability (faithful presentation, neutrality, complete and free from material error and prudence), comparability (consistency and disclosure of accounting policies), understandability and materiality. In addition, the IFRS has also provided a standard definition and guides in recognition of various elements of the financial statements such as revenue recognition, definition of various assets and liabilities (Accounting Standards Board 1999, pp. 38-47). Different users of the financial statements The first category of people who use financial information is investors. Investors who provide capital to a company are concerned about the levels of risk, and return from their investments. They need financial information to help them decide whether they should buy or sell shares of a particular company. They are also interested in information that enables them to assess the ability of a company to pay cash dividend. The second category of people is employees. Employees need to know whether their employer is financially stable. They use this data to evaluate the employer’s ability to implement a fair remuneration package, provide retirement benefits and be able to offer employment chances (Lasher 2008, pp. 64). Lenders use financial information to access the ability of a company to promptly pay both the principal and interest on loans (Saudagaran 2009, pp. 51-56). Suppliers and other trade creditors are interested in financial information to enable them to determine whether the amount owed to them will be paid without default. Customers are interested in financial information to determine the life span of an enterprise, especially when they have a long-term association with an enterprise such as the presenting solutions to both short and long-term problems. Government and their agencies use the financial information to regulate the activities of an enterprise and to determine tax policies. They also use the information to compute national income. Lastly, the public use financial information to determine the trends and recent development activities of an enterprise to help them assess the possibility of a major economic contribution by an organization (Saudagaran 2009, pp. 51-56). Varying information needs of different user groups The following are the users of the financial statement and their varying needs: first, present and potential investors’ information needs are to aid the assessment of risk and return on investment and the capacity of a company to pay dividends. Second, the employees’ information need is to assess the financial stability of the employer and the quality of employees’ remuneration package. Third, the lenders need financial information to assess the possibility that a company will pay the principal and interest on loan (Sinha & Sinha 2009, p. 5-7). Fourth, suppliers and other trade creditors are interested in the financial information to help them assess the possibility of being paid when due. Fifth, customers use the financial information to determine whether a company has either continued or limited existence. Sixth, the government and their agencies use need the information to assess an entity’s activity, determine tax liability and prepare information for national purpose. Lastly, the public need the information to assess the trends in a company’s performance and the possibility of making a positive economic impact (Conceptual and regulatory framework, n.d., pp. 7-9). The benefits of preparing the financial statements The following are the benefits of preparing the financial statement: first, the users of the financial statements such as the investors benefit by obtaining important information about an organization, which facilitates informed decision making. That is whether to buy or sell stocks of a company. Second, companies benefit by attracting new investors, lenders and employees. The financial statements provide a basis for assessing an organization’s financial condition (Kwok 2005, p. 95-97). Third, the preparation of such statements is in compliance with the requirements of the government and their agencies, thus eliminates the legal consequences of violating such regulations. Lastly, by preparing such information, an organization creates a healthy association with the stakeholders, which creates goodwill for that particular organization (Saudagaran, 2009, pp. 150-155). The British Telecommunications The British Telecommunications, a wholly owned subsidiary of the British Telecommunications group plc, is the principal operating subsidiary though the management responsibilities of the company are borne by the Board, which is in charge of the financial performance of the group. In addition, it is the board’s duty to ensure effective management of the groups operating activities and customer service delivery. The main purpose of the company is to channel the power of communication towards the achievement of a better world by converging the finest network and technology. British Telecommunications fully understands that an effective communication system is one of the keys to transforming the world. The company has its head office in England, the United Kingdom and several other subsidiaries in the international markets. In order to achieve its goals, the company has responded to the market needs by selling various products and services to a wide range of customers and small and medium-sized enterprises (BT Group plc: Annual Report & Form 20-F 2014, p. 1-18) The company provides managed networked information and technology services to large corporations, local businesses and the government. The other products and services the company offers are wholesale telecommunication services, broadband and subscribed television services. The company follows the regulations set by both the International Financial Reporting Standards (IFRS) and the UK GAAP when preparing the financial statements. The financial statements are prepared based on the principle of going concern ((BT Group plc: Annual Report & Form 20-F 2014, p. 9 -18). According to the company’s balance sheet as at 31st March 2014, the following are three non-current assets (tangible and intangible) owned by the company. The tangible assets include property, plant and equipment and derivative financial instrument. On the other hand, the company’s balance sheet including together with the notes accompanying its preparation distinguishes only one intangible asset (goodwill). No specific names have been provided for the other intangible assets. The company record the tangible assets at historical cost less the accumulated cost of depreciation, government grant and impairment losses. The company disposes the property, plant and equipments when no economic benefit is expected from their continued use. Similar to the property, plant and equipment, goodwill is recorded at historical cost less any loss through impairment. The entry value for the property, plant and equipment as at 31st March 2014 was £ 13,840 million, whereas trade and other receivables had an entry value of £ 214 million as at 31st March 2014. Aggregate intangible assets had an entry value of £ 3,087 million as at 31st March 2014 (BT Group plc: Annual Report & Form 20-F 2014, p. 126-135). The fair value measurement approach The company measures the fair value of the assets in compliance with the procedure provided under IFRS 13. The disclosure of measurement of fair value and the criteria used is a requirement by the IFRS 13. “Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” (Hitz 2007, P. 4). The IFRS 13 provides three fair value measurement approaches. They include the market approach, the cost approach and income approach. The market approach involves the use of reliable market information on any recent transaction involving a similar asset or liability. Cost approach focuses on the prevailing replacement cost of an asset or liability. Last, income approach involves the discounting of the future cash inflows generated by an asset (Hitz 2007, P. 4-6). The following are the problems the company is likely to face in the process of conducting the fair value measurement: lack of current market data on the asset or liability under consideration, incorrect determination of the class under which an asset or liability falls or lack of an active market for a particular asset or liability (IFRS- Fair Value Measurement, n.d). The mentioned instances could present problems to British Telecommunication during fair value measurement because for a measured fair value to be considered for reporting purposes, the procedure followed during the measurement must meet certain standards set under the IFRS 13. The practicability of the IASB approach to the measurement of fair value of inactively traded non-current assets The present guidance on the measurement of property, plant and equipment are provided under IAS 16. The regulations allow for the use of two models during the measurement of property, plant and equipment subsequent. That is, the cost and revaluation model. Under the cost model, the value of property, plant and equipment is determined by subtracting the accumulated depreciation and any other loss caused through impairment from the historical cost (Herrmann, Saudagaran & Thomas 2006, p.2). On the other hand, under the revaluation model, the value of plant, property and equipment is determined by subtracting the depreciation costs from the prevailing fair value. Consistency in revaluation is advised under the revaluation method in order to prevent a significant variation between the carrying amount and the fair value of the assets (Herrmann, Saudagaran & Thomas 2006, p.2). The choice on whether to either implement the fair value or the historical cost approach in asset valuation process should be made after considering the basic accounting information preparation principles provided by the FASB. FASB and IFRS have joined efforts to uphold the quality of the accounting information from various reporting institutions (Herrmann, Saudagaran & Thomas 2006, p. 2 - 3). The conceptual framework for financial reporting is built by the following qualitative characteristics: understandability, relevance, reliability, comparability and consistency (Herrmann, Saudagaran & Thomas 2006, p. 7-12). It is important to notice that fair value accounting reports both the past and the present transaction at fair values, whereas, the historical cost accounting reports past transaction at historical cost while the current transactions are reported at fair values. Fair value accounting demonstrates a heavier reliance on the mentioned accounting principles than the historical approach. Therefore, the fair value approach provides more relevant and timely asset’s value. Herrmann, Saudagaran & Thomas (2006, P. 14) assert that the fair value of an asset can be reliably estimated in an active market. The absence of an active market does not prevent a reliable estimation of an asset’s value. Even though Biondi indirectly suggests that fair value accounting is inferior to historical cost accounting, the fair value approach is practical for companies owning non-current assets that are not actively traded in the market (Biondi 2011, P. 24). Christensen & Nicolaev (2011, P. 4) Point out that the choice to use fair value accounting depends on the cost of obtaining the necessary data for the procedure. Managers prefer using the fair value accounting when the cost of acquiring the dependable estimates is low. This could justify the practicability of the fair value accounting regardless of the market situation, but the cost of data acquisition could be discouraging in an inactive market condition. Conclusion It is necessary for entities to provide high quality information to various users of the financial statements. The act would be in compliance with the regulations under the IFRS. The IFRS intends to satisfy various and dissimilar needs of different users of the financial information. Thus, it is encouraging that British Telecommunication complies with the IFRS rules. When measuring the fair value of the assets, the company’s effort is likely to be impeded by the lack of current and relevant data, incorrect asset’s class determination and lack of an active market. Despite of the problems, fair value accounting method is practicable. List of References Accounting Standards Board 1999, Viewed 7 November 2014, https://www.frc.org.uk/Our-Work/Publications/ASB/UITF-Abstract-36-Contracts-for-sales-of-capacity/Statement-of-Principles-for-Financial-Reporting.pdf. Barth, M. E 2007, Research, standard setting, and global financial reporting, Now Publishers, Hannover, MA. Biondi, Y 2011, The pure logic of accounting: A critique of the fair value revolution, Accounting, Economics, and Law, Vol. 1, No. 1, Art. 7 (available at: http://hal.archives-ouvertes.fr/docs/00/56/18/94/PDF/viewcontent.pdf). BT Group plc: Annual Report & Form 20-F 2014, Viewed 7 November 2013, http://www.btplc.com/Sharesandperformance/Annualreportandreview/pdf/2014_BT_Annual_Report.pdf Christensen, H. B & Nicolaev, V. V 2011, Does fair value accounting for non-financial assets pass the market test? Review of Accounting Studies, Vol. 18, No. 3, pp. 734-775. Conceptual and regulatory framework, n.d., Viewed 7 November 2014, http://financial.kaplan.co.uk/Documents/ICAEW/Financial_Accounting_Chapter_1.pdf. Gibson, Charles H 2012, Financial Reporting and Analysis + Thomson one Printed Access Card. South-Western Pub. Herrmann, D, Saudagaran, S. M & Thomas, W. B 2006, The quality of fair value measures for property, plant, and equipment, Accounting Forum, Vol. 30, No. 1, pp. 43-59. Hitz, J. M 2007, The decision-usefulness of fair value accounting a theoretical perspective, European Accounting Review, Vol. 16, No. 2, pp. 323-362. IFRS- Fair Value Measurement, n.d. Viewed 7 November 2014, http://www.iasplus.com/en/standards/ifrs/ifrs13 re Kwok, B. K. B 2005, Accounting irregularities in financial statements: a definitive guide for litigators, auditors, and fraud investigators, Gower, Aldershot [u.a.]. Lasher, W 2008, Practical financial management, Thomson South-Western, Mason, OH. Lee, T. A 2006, Financial reporting and corporate governance, John Wiley & Sons, Chichester [u.a.]. Saudagaran, S. M 2009, International accounting: a user perspective, CCH, Chicago, IL. Sinha, G & Sinha, G 2009, Financial statement analysis, PHI Learning Pvt Ltd, New Delhi. Read More