Fair Value Measurement - Report Example

Running header: IFRS Student’s name: Instructor’s name: Subject code: Date of submission: Abstract Subsequent to the joint convention between FASB and IASB in 2002, the two organizations issued a common statement known as the Norwalk accord in which there was an agreement to work collectively to develop high value and compatible financial accounting standards that can be utilized for both local and global financial reporting. This resulted in a memorandum between the two bodies. This paper looks at the purpose of the memorandum signed between FASB and IASB. The paper also looks at fair value measurement standards both prior and after the issuance of IFRS 13. In so doing, the paper also analyses the various efforts made by the two bodies so as to come up with standards that are compatible and acceptable worldwide. In conclusion, it is observed that the association between FASB and IASB has in no doubt renewed the way accounting is done globally. a) The reason behind the Memorandum of Understanding flanked by IASB and (FASB). The M.O.U between FASB and IASB had the aim of developing high value and compatible financial accounting standards that can be used for domestic as well as worldwide financial reporting. The organizations (FASB and IASB) in so doing would transform the existing financial reporting standards into fully compatible standards as soon as could be practically possible while ensuring a harmonized future operational programme that will ensure proper accounting reports are maintained (FASB .org, 2011). The memorandum of understanding therefore reaffirmed the two boards’ dedication to the convergence of the US GAAP as well as IFRSs.This would also enable them develop a common set of high value global accounting standards that would improve reporting of accounting information. In turn, this would lead to the removal of the reconciliation required for non US firms using IFRS although they are domiciled in the US – which would to a great extent depend on the successful implementation of IFRS in financial statements across economic entities as well as jurisdictions, in other words, the MOU was intended at: The conveyance of accounting standards which would be achieved via the evolvement of high value and common standards in the long run. Elimination of the dissimilarity between FASB and IASB standards requiring significant upgrading through the development of new universal standards geared towards the improvement of the accounting information given to investors. Converging through the replacement of weaker standards with stronger ones with an aim of serving investors’ needs (IFRS .com, 2011). B) Fair value definition prior to issuance of IFRS 13 Fair value measurements ought to be documented in the accounting statements for some accounting statements elements. This calls for adjustments to the assets carrying amounts and liabilities that give rise to the recognition of dissimilar gains and losses. The standards initially defined fair value as the receivable price when an asset is disposed/sold or compensation for transferring a liability in a normal transaction among market participants at the measurement date. On the other hand, IFRS described fair value as being the exit price and also establishes a framework for fair value measurement and requires enhanced disclosures concerning measurement of fair value. Three approaches were used for measuring fair value. a) Market approach- it used prices as well as other pertinent information generated by marketplace dealings involving similar assets or liabilities (FASB .org, 2011).The Valuation systems consistent with the matrix pricing which is a mathematical technique which is used mainly in valuing debt securities with no reliance on quoted prices for the precise securities but by depending on the securities relationship to other standard quoted securities. b) Income approach- this approach made use of valuation methods in converting future values to discounted present values. This was based on the value indicated by current marketplace prospects regarding future values. The methods include the present value techniques as well as option pricing models which are used in determining the fair value of some intangible assets. c) Cost approach The preceding standards called for fair value to be determined based on the assumption that marketplace participants would utilize in pricing the assets (FASB .org, 2011). As such, the standards differentiated between marketplace participants assumptions developed with regard to market data obtained from sources free from the reporting entity and the reporting entity’s own postulation. As such the techniques prioritize inputs in determining fair value as follows: Level 1 input These are quoted prices in marketplace for the same asset which the plan can access at the measurement date. It ought to be used in valuing that particular investment if it’s available. Level 2 input These include inputs which are observable apart from the quoted prices. They show the postulations that market participants would utilize in pricing the asset based on the market data. Level 3 input They are unobservable inputs (those that reflect the plans assumptions about the conclusions) that marketplace participants utilize in pricing of an asset. C) Reasons for issuing IFRS 13; Some of the reasons why IFRS 13 was issued include the following; The issuance of IFRS 13 was aimed at reducing difficulty as well as amplify consistency in application in determination of fair value. Most prior IFRS standards called for entities to determine the fair value of assets, equity, monetary instruments as well as liability but prior to issuance of IFRS 13, the guidance on determining of fair value was limited and at times contradictory. The rationale behind IFSR 13 was to elucidate and consolidate the guidance on determining fair value and thus eliminated the conflict as well as confusion t which existed before its issuance (IFRS .com, 2011). The new IFRS 13 was issued to improve fair value disclosures. The new fair value disclosures in IFRS 13 are geared towards helping users better their valuation methods as well as the inputs utilized in determining fair value and hence, issuance of IFRS 13 was also part of the IASB and FASB,s reaction to the G20 nations appeal in the onset of the global financial crisis. The two boards used IFRS 13 with an aim of increasing convergence between GAAP and IASB IFRS standards (Linda, 2011). The two boards worked hand in hand in ensuring that fair value has the similar meaning in both US GAAP and IFRS while making sure that their fair value determination as well as disclosure requirements are the same. Issuance of IFRS 13 was also geared towards improvement of transparency via augmentation of disclosures about fair value measurements. NB// It should be noted that the commencement of the global financial highlighted the necessity for, a) Amplification on how to determine fair value in case the market for an asset or liability is less dynamic as well as; b) Enhancement of transparency of fair value determination through disclosures regarding measurement of uncertainty. Consequently, FASB and IASB worked hand in hand in adhering to these rules as requested by the G20. D) The main differences between IFRS 13 and the exposure draft proposal that precluded the issuing of IFRS 13 are explained in the table below Exposure Ex draft proposal IFRS 13 requirements -fair value determined using price in the most beneficial market for asset or liability- the market that maximizes the amount payable in liability transfer. -high level guidance needed for measuring of fair value for liabilities. -financial assets measured on an individual’s instrument basis using the exchange valuation premise. -the draft has no guidance on determination of classes of assets or liabilities value for disclosure purposes. -the draft called for a qualitative sensitivity scrutiny for the assets and liabilities of level three of the fair value hierarchy devoid of corresponding narrative discussion. -no requirement on disclosure of information on a firm’s valuation. -fair value determined using price in the chief market for the asset or liability, or in the absence of a chief market, the most beneficial market for the asset or liability. -detailed guidance for measuring fair value for liability as well as description of the payment which market participants would expect for taking on a liability. -financial assets as well as liabilities with offsetting positions in market risk or counterparty credit risk to be measured on the basis of the entity’s net risk exposure. -classes of assets and liabilities for disclosure purposes are determined based on the nature, characteristics and risks associated with the transaction. -A narrative discussion needed on the sensitivity of a fair value determination categorized within level three of the fair value hierarchy to changes in immaterial/ unobservable inputs as well as any interrelationship between those inputs that might alleviate the effects on measurement. In addition, a qualitative sensitivity scrutiny is needed for financial instruments measured at fair value. -information on a firm’s valuation process needed for fair value determination categorized within level 3 of the fair value ladder (IFRS .com, 2011). E) How the IASB sought to ensure compatibility between IFRS 13 and US GAAP. The MOU between FASB and IASB enacted fair value measurement with a goal of improvement and alignment of the requirement. To achieve this, IFRS 13 was developed through initial publication of a discussion paper in the year 2006 that utilized the US GAAP requirements in SFAS 157 as the base for formation of beginning views. However, not all the preliminary views were in concurrence with the requirements of SFAS 157. This means that a number of the suggestions in the exposure draft vary from the requirements in US GAAP.In addition, proposals used differing words in articulating the same requirements in IFRS and US GAAP for determining fair value and for absconding information about the measurements while ensuring the same wording to the maximum possible extent. As a result, the fair value measurement project became a joint project between FASB and IASB in 2009 with FASB accepting to amend topic 82a (FAS57) as was required (FASB .org, 2011). In addition, concerned parties were comprehensively consulted all through the process which gave rise in the present IFRS 13. The consequence of the combined efforts between the two organizations (FASB and IASB) was IFRS 13 which that contains a common definition of fair value and determination as well as disclosure requirements being aligned. Some of the efforts aimed at ensuring comparability of the standard to US GAAP included the following; In a bid to ensure a thorough understanding of the views of investors and other financial statement stakeholders, the two boards (FASB and IASB) held face to face meetings as well as conference calls with stakeholders in addition to conducting user surveys. In particular, the two bodies held discussions on how to improve the fair value measurement disclosures in both the IFRSs and GAAP to better their quality. The meetings (discussions) also deliberated on the need for aligning the requirement’s wording among other things with an aim of improving consistency in application across the entire world and the usefulness of the existing disclosures (Deegan, 2009). In particular, input from various users was sought on the fair value sensitivity analysis disclosures contained in IFRS 7. This was in regard to how it could be improved as well as additional information that could be deemed useful in assessing the intrinsic subjectivity in fair value determination categorized within level 3 of the fair value hierarchy. -deliberations were also held with accountants as well as auditors of financial statements and regulators on how they prepare audit as well as apply fair value information in the IFRS and the US GAAP . -In 2010, the two boards held extensive deliberations with financial institutions on their financial risk management practices as well as how their practices affect their valuation of financial instruments held in a given portfolio. The deliberations formed the base of the guidance to be utilized in determination of the fair value of financial assets as well as financial liabilities that have offsetting positions in market risks as well as counterparty credit risk. In 2009, a request for input was published asking firms in emerging as well as transition economies to look at the applicability of the projected fair value measurement guidance in their jurisdictions. The feedback assisted the boards realize the need for publishing educational materials for accompanying the IFRS 13. -conventions were also held in Asia, Europe and US with an aim of seeking views on the suggestions in the exposure draft. The participants included accountants as well as auditors and users of financial information (Stephen, 2008) .the conventions helped participants in airing their views on the application of the suggestions in the exposure draft to entities in their jurisdiction as well as on the comparability with GAAP. -In 2008, a fair value Expert advisory panel was developed with an aim of addressing the issues brought up about the recent global financial crisis on how to determine fair value when the market activity for an asset or liability declines as well as how to boost transparency about the measurements. Concerned parties including auditors also participated in the standard by standard review of whether fair value as applied in IFRS is consistent with the exit price measurement objective and the related measurement guidance. This aided in determination of the scope of IFRS 13. In conclusion, all of the above efforts were aimed at ensuring comparability between IFRS 13 and US GAAP as well as the acceptability of the standard globally. F) How and to what extent differences can exist. Despite the great effort by both FASB and IASB to come up with IFRS 13 no fair value determination, we can still expect there to be differences between IFRS 13 and US GAAP. These international differences are bound to be there owing to differences in legal stipulation as well as accounting practices (Esther, 2010). Some of the differences expected to arise between GAAP and IFRS13 are explained below: -some different disclosure requirements on fair value determination exist. For instance, IFRS require a quantitative sensitivity analysis for financial instrument which are determined at fair value and categorized within level 3 of the fair value hierarchy previously in IFRS 7 while the US GAAP does not call for any quantitative sensitivity analysis disclosure. -Different requirements on whether and in which cases a firm with an investment in an investment corporation may use the reported net asset value as a determinant of fair value are likely to exist. This implies that differences are expected to exist between IFRS 13 and US GAAP although the differences can always be solved where necessary. Conclusion The MOU between has in no doubt played a great role in the development of modern day financial reporting standards which are not only of high quality but also compatible accounting standards that can be used for domestic as well as international financial reporting. Such standards include the fair value measurement standard IFRS 13 recently issued. Both IASB and FASB have put in a lot of efforts in developing the new standards. Such efforts include face to face meetings as well as seminars all geared towards achieving acceptability and compatibility of the standards globally. The association between FASB and IASB has in no doubt renewed the way accounting is done globally. References: FASB .org, 2011, Financial reporting standards, Viewed, 11 September 2011, http://www.fasb.org/cs/ContentServer?site=FASB&c=FASBContent_C&pagename=FASB%2FFASBContent_C%2FNewsPage&cid=1176157497474. IFRS .com, 2011, International financial reporting standards, viewed, 11 September 2011, http://www.ifrs.org/IASCFCMS/Templates/Project/Page.aspx?NRMODE=Published&NRNODEGUID=%7b5B671FAA-9B0E-4992-983B-D686F400DFCB%7d&NRORIGINALURL=%2fCurrent%2bProjects%2fIASB%2bProjects%2fConceptual%2bFramework%2fConceptual%2bFramework%2ehtm&NRCACHEHINT=Guest. Deegan, C. Financial Accounting Theory, Edition 3, McGraw Hill 2009. Linda, M.2011, IFRS 13: Fair value measurement, Australian accounting review journal Vol. 2, no. 4 pp 78- 96. Stephen, A2008. IFRS development in the USA and EU, and some implications for Australia, Australian management journal, Vol. 1, no. 3 pp 50- 56. Esther, C, 2010, the adoption of IFRS in Australia: the case of IFRS 13. Australian accounting review journal, Vol. 1, no. 10 pp 110- 116. Read More