Disclosure of Fair Value Information in the Corporate Annual Report - Coursework Example

1. Summary of Fair Value Accounting Regulations & Standards In US: For the purpose of the paper, fair value measurements standards, which are adoptedin United States is selected because US financial market is considered as one of the biggest financial market (WorldBank, 2008, p. 283). The standards adopted by US can be generalized for companies in other countries. The US accounting body named as Financial Accounting Standard Board issued Statement of Financial Reporting No. 157 (Worth, n.d.). It is referred to as fair value measurement FAS 157. The standard was introduced in 2006. The purpose of the standard was to determine the methods that should be adopted by the companies within United States to report their fair values of their assets & liabilities (Feller, 2008, p. 65). The application of FAS 157 is suitable for all kinds of assets & liabilities whether financial or non-financial (Williams, et al., 2008, pp. 9-98). However, the fair value accounting of non financial assets and liabilities were postponed by 3 years (Duska, et al., 2011). The standards of fair value accounting of non financial assets were actually introduced in 2009. Before the introduction of FAS 157, different organizations within US used different kind of accounting standards for fair value accounting of their assets and liabilities (Menicucci, 2014, p. 21). The purpose of introducing the framework was to eliminate the inconsistencies among the companies regarding the fair value accountings of the companies in their financial reporting (Rutledge & Raynes, 2010, p. 39). Another purpose of the fair value accounting standard i.e. FAS No.157 is to reduce the inconsistencies between balance sheet and fair value figures (Slee, 2011, p. 178). The balance sheet figure can be termed as historical cost (Label, 2006, p. 29). The fair value figure can be described as income statement number (Subramani, 2011, p. 585). Fair value accounting standards i.e. FAS 157 was then become the part of financial accounting standard board ASC. ASC refers to as the accounting standard codification (Gibson, 2010, p. 10). In other words, FAS 157 was then become the part of FASB ASC topic 820. The topic describes the fair value is the price at which the asset can be sold or liability can be transferred. The transaction must be created at the measurement date (Beder & Marshal, 2011). Moreover, the transaction must be an orderly between the participants of the market. The standard defines the fair value in terms of the exit value as well (Fishman, 2013, p. 23). In addition to this, if the market deals in futures contracts then the fair value can be calculated as the equilibrium price of the contract. In other words it can be calculated as follow Futures Price= Spot Price (1+ Risk Free Interest Rate- Income Yield) or Futures Price= Spot Price (1+ Risk Free Interest Rate- Dividend Yield) Fair value of the liability, on the other hand, is calculated as the value or amount at which the liability can be realized. The FASB ASC topic 820 uses the market fundamentals to calculate the value of assets and liabilities. (Lynford, 2011, p. 437) The market fundamentals may include the price which are explicitly quoted, data from the credit sources, yield curves etc. In order to accurately measure the fair value, prices which are explicitly quoted are considered as the fair value (Mard, et al., n.d., p. 13). The quoted prices can be retrieved if the assets or liabilities are liquid in the market i.e. for the particular asset it may not be necessary that the active market exists for that asset. In the absence of the active markets, there must be alternative method that needs to be considered to determine the fair value of that asset (Carmichael & Lynford, 2010, p. 353). In addition to this, the topic 820 in Financial Accounting Standard Board Accounting Standard Codification FASB ASC regarding the fair value accounting standards i.e. FAS 157 focuses on the assumption that the fair value calculation must include unbiased estimates (Gross, et al., 2010, p. 173). Therefore, it is suggested that the fair value estimates should be assumed from the context of the parties, which are not related to the perspective of the market participants. The reason is that different market participants have different expectations regarding the price movement of the assets or liabilities (Walton, 2007, p. 110). This can be explained in a way that the person holding financial asset such as stock, expects that the price of the stock will increase. On the other hand, the party, who is planning to buy that stock with the expectation that the price will go down and he will buy at the lower price. Therefore, both the market participants have different expectations regarding the price movement of the financial assets. The expectations are based on their own preferences and biased approach. As a result of this, FAS 157 topic 820 in US suggests that the fair value must be determined from the party, who is not considered as the market participant (Walton, 2007, p. 110). The standard also covers the topic of calculation of fair value if more than one market is available. In the situation when the same asset is traded on more than one market then the best way to calculate the fair value of the asset is to determine the most advantageous market (Schmidt, 2014, p. 105). The advantageous market can be considered as the market which gives the most suitable value from the perspective of both the cost and price (Epstein, et al., 2009, p. 184). 1.1 Levels of Fair Value Accounting The accounting standard for fair value calculation in US is divided into three level (Shim, 2012). 1.1.1 Level one: These are referred to as the explicitly quoted prices of assets or liabilities in the active market. The assets or liabilities values are determined from the identifiable assets or liabilities in the market. 1.1.2 Level Two: This can be based on the observable in the market. In case of inactive market for identical assets and liabilities it is suggested by US board i.e. FASB to use the second level of the information, which is considered as observable. The observable information is ranked lower than that of quoted prices. 1.1.3 Level Three: At this level the fair value is determined using the unobservable facts. The level is used for fair value accounting if the level one and level two may not work well to calculate the fair values. In this case significant level of assumptions must be used to determine the fair value of the asset. The assumptions are made on the basis of the inputs, which are not observable in the market. 2. Critical Assessment of Fair Value Accounting Regulations & Standards A research work by Ajay kumar bose (2009) identified that the fair value accounting as described in terms of FAS 157 has increased the volatility of the market. The result of such increased volatility is that the shareholder’s wealth has been significantly destructed. The destruction of wealth caused the loss of thousands of jobs. In 2008, financial institutions had to deal with considerable unanticipated challenges in terms of economy and social factors. The issues such as mortgage and financial institution crises lead to the disastrous effects among all the sectors of the economy. The common question, which was raised at that time, was how this can happen in the most sophisticated market of the world? Most of the analysts, economists and other financial market participants blamed to Securities and Exchange Commission or the accounting standard board of US i.e Financial Accounting Standard Board (FASB). The blame was on the basis of the use of fair value accounting method which was introduced in 2006 for corporate fair value accounting in financial reporting. The reason behind such blame was that the fair value accounting lead to the increased volatility and did not reflect the actual underlying value of the assets or liabilities (Scott, 2010). Critically analyzing fair value accounting standards and regulations it can be proved that the FAS 157 generated the pro cyclical downward pressure on the prices of assets. (SECReport, n.d.). This problem of downward pressure had shown multiplier impacts when during the 2008 financial crises write down occurred considerably. In addition to this, the fair value accounting of US i.e. FAS 157 requires financial institutions to report losses which they will never incur or realize (Scott, 2010, p. 522). Realization of such losses increased the volatility. Therefore, it can be implied from the two research papers discussed that the volatility in the financial reporting occurs due to the adoption of the fair value accounting methods as defined by Financial Accounting Standard Board (FASB) of US. Moreover, it can also be implied that the volatility is less affected by the underlying fundamentals of the assets or liabilities and more affected by the defined fair value standards. However, there are proponents of fair value accounting method of US and describe that the standardization of the fair value method makes the valuation of assets and liabilities is more relevant to the readers and users of financial reports. The fair value does not reflect the underlying fundamentals of the assets and liabilities. Therefore, the risk of the instrument remains the same. (Leonard, 2010, p. 5) 3. APPLE Inc. Apple Inc is one of the leading companies of United States that has core business in consumer electronics along with the software designing and online services. The products, which have made the Apple Inc one of the leading multinational organization with the biggest quarterly profit of $18 Billion (BBC, 2015), include IPhone, IPad, IPod and Macintosh. These are the names of Smart phones, tablet computers, media player and computers/laptops, respectively. Apple Inc was founded in the year 1977 by Steve Jobs. Apple Inc is ranked as the second largest company in the IT industry in terms of revenues (Vincent, 2013). Moreover, Apple is the third largest maker of the cell phones. Apple’s stock is one of the most widely traded and valued stock in NYSE (techcrunch, n.d.). Therefore, review of the accounting standards in terms of the fair value measurements can give better idea regarding how the US based large companies report their financial accounts in terms of fair value. 3.1 Accounting Standards in terms of Fair Value Accounting of Apple Inc. The following data is retrieved from the Form 10 k of Apple Inc. (Apple, 2015). Apple Incorporation uses the fair value accounting standards as defined by Financial Accounting Standard Board FASB under the FAS 157. Apple inc. adopted the FASB Accounting Standards Codification 820 during the first quarter of 2009 for the purpose of fair value measurements and disclosures. FAS 157 as already defined above is formerly known as SFAS 157. 3.2 Disclosure Of Fair Value Information of Financial And Non Financial Assets The financial reporting of Apple Incorporation includes both the financial and non financial assets. The fair value accounting of both financial and non financial assets and liabilities is on recurring basis. The fair value definition from the perspective of Apple incorporation is the price that will be received after disposing off or selling the asset. In terms of liabilities it is referred to as the value which is paid for the purpose of transferring the liability. Therefore, the definitions of fair value from the perspective of the apple incorporation in terms of both assets and liabilities are the same as that defined under FASB. This implies that the Apple incorporation follows the accounting standards of US. In addition to this, the company discloses in its form 10 k and in the disclosure of fair value accounting in the financial reports that the company considers the most liquid market to give fair value to the underlying assets or liabilities. In addition to this, the company has also adopted the FASB ASC 825, which is the standard to measure the fair value of financial instruments. The adoption of the standard allows the companies to calculate the fair values of financial instruments which are considered as eligible financial instruments that do not have the requirements to be reported at fair value (Apple, 2015, p. 55). 3.3 Fair Value Hierarchy Adopted In the financial reports of Apple Inc. it is explicitly disclosed that the company adopts the three levels of financial reporting a) Level One : It refers to as the use of the quoted price for fair value reporting and the prices can be retrieved only if the active market of the underlying assets exists (Apple, 2015, p. 55) b) Level Two: Apple Incorporation, using the financial accounting standards as defined by FASB, uses the observable input method for the fair value reporting. This method is adopted in the absence of the active market of the underlying assets and liabilities (Apple, 2015, p. 55). c) Level Three: it considers the insputs which are considered as unobservable. The unobservable inputs are based on the assumptions which are used by the market participants for the purpose of reporting the assets and liabilities (Apple, 2015, p. 55) 4. Critical Evaluation APPLE Inc. fair value accounting information disclosure practices. The disclosure of fair value information in the corporate annual report is one of the most sensitive factors for the reporting of financials of the organization. The reason is that the proper reporting of the financial and non financial assets and liabilities can help determine the profitability of the organization. The companies like Apple Inc fulfils all the requirement of the FASB but there are some flaws in the fair value accounting standard of US i.e. FAS 157 which should be addressed to improve their procedures. Moreover, improvement in the reliability of the fair value accounting methods and procedures can help to improve the investor relations. The improvement of the investor relations will ultimately increase the stock value of the organization (Warne, 2008, p. 121). Therefore, following are some of the reporting issues which are analyzed along with their recommended procedures that should be adopted are discussed. Issues & Recommendations 1. Application of FAS 157 in apple’s corporate value accounting defines only the common definitions of fair value along with a common framework. Therefore, the standard as adopted by Apple Inc does not determine the time when fair value should be applied. 2. Apple adopts US GAAP for assessing impairments of fixed assets, property plant and equipments. The Long lived assets such as property, plant and equipment and other assets which are considered as identifiable assets are reviewed for impairment based on the events or circumstances. The model provided by US GAAP for the assessment of impairment is not uniform. Therefore it is recommended to use IFRS that can provide the uniformity to assess the impairment of assets. 3. Other comprehensive income of Apple Inc also discloses certain impairments, which are not part of the income statements. Therefore it is recommended to improve the prominence of such impairments by including them in the income statements. 4. The disclosures of Apple incorporation is in accordance of FASB ASC 820, which only requires the three level of judgements in terms of fair value accounting of assets and liabilities. Therefore, it should be recommended that the disclosures and presentation requirement should be enhanced to reflect the actual method of each level of fair value accounting. 5. The fair value accounting as adopted by Apple Incorporation discusses the determination of values by describing only the determination of the inactive market for level 2 and level 3 fair value accounting but it should also disclose the judgements when markets become inactive. 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