AASB 13 Fair Value Measurements - Essay Example

Financial Reporting: AASB 13 Fair Value Measurements Student’s Name: Institution Affiliation Introduction International conceptual framework treats reliability and relevance as the main characteristics of accounting information where useful decisions are made from. The joint project by Financial Accounting Standards boards (FASB) and International Accounting Standards Board (IASB) revisited a conceptual framework that started in October 2004. The FASB’s draft of exposure, “Fair value measurements” of June 2004, has sparked debates on trade-offs between relevance and reliability with respect to fair value versus historical cost. The use of fair values has become increasingly common in the recent past, although the current accounting standards rely mainly on the use of historical costs. This has, therefore, resulted in the issue of AASB 13 Fair Value Measurement as a solution to the many questions that arise. Despite the long debate on fair value versus historical cost, there is still no convincing theoretical argument that allows one to settle on one method over the other. For that reason, this paper seeks to provide an alternative analysis of the links between relevance and reliability as it looks deeper into the new aspects of AASB standards. Discussion Theoretical principles and accounting rules of financial reporting practices A conceptual framework for financial accounting establishes the concepts underlying financial accounting. It starts with objectives that identify the accounting aims and purpose, then the qualitative characteristics that make accounting inflation useful, and finally, the constraints of financial reporting. The goals of financial reports are many. First, they present information that is of use to everyone who has a logical understanding of both businesses and economic activities, and those who are making investments and credit decisions. Secondly, it gives information to current and potential investors, creditors and other users, which assist them to evaluate the quantity, timing and vagueness of future cash influx. Finally, it provides information on economic resources, the claims and changes to the resources. In a broader perspective, the goals start on a wide concern on data that is helpful to decisions made by both investors as well as creditors. It subsequently narrows on the creditors’ and investors’ interest, on how their investments or credit to business ventures will bring them returns. Finally, the objective focuses to the financial statements that provide useful information in the assessment of future cash flows to the business enterprises (Statement of Financial Accounting Concepts 1980). Fundamental concepts Primary qualities The first characteristic of accounting information is its relevancy. Sloan (1999) states that relevance requires the perfect measurement of the underlying attribute (x) of an item (such as the current value of a fixed asset) would equate to accounting measurement (y), which is useful to investors. Users use relevant financial information to predict crucial outcome of the past, present and the future. Another aspect of relevance is making information accessible to those who make decision before its ability to affect decisions positively is deemed as void. The second characteristic is reliability, which is essential for those who have neither the time nor the know-how to examine and evaluate the factual content of the presented information (Heffes 2005). Secondary qualities There are two secondary qualities, including comparability and consistency. Comparability of information allows users to recognize comparison and contrast among two sets of economic scenarios. Comparability combined with consistency enhances the effectiveness of financial reporting information in making decisions related to investment, credit and resource allocation (Heffes 2005). Constraints of financial reporting In every situation, there must be constraints and financial reporting is not an exceptional. The limitations include materiality and benefits coupled with costs. A financial report should include all the information that is material in connection with a particular entity, but at the same time, unnecessary information should be omitted as it has a tendency to obscure more important information. The financial reporting information benefits should validate the costs of formulating and using it, and therefore, resulting in a more efficient functioning of the capital markets and lower capital costs for the whole economy (Heffes 2005). Accounting rules and its appropriateness - AASB 13 Fair value Management The Australian Accounting Standards Board makes Australian Accounting Standards, together with interpretation to be applied by government in preparation of financial statements for the entire government. Non-profit sectors as well as both private and public entities are required by the Corporations act 2001 to prepare general purpose financial statements as per AASB (Australian Accounting Standard Board 2011). The Fair Value Measurement of AASB 13 integrates the Fair Value Measurement IFRS 13 brought forward by International Accounting Standards Board, meaning entities complying with AASB 13 will concurrently comply with IFRS 13. The objective of AASB is to define fair value, set out in a particular standard of the framework for measuring fair value and the need for the fair value measurements disclosures. In regard to measurements, this Standard defines fair value as the cost that would be paid on a liability transfer or receipt on sale of an asset in an organized transaction among market participants on the date of measurement. Secondly, it recommends that the characteristics of the asset or liability to be taken into account when an entity is taking the fair value measurement. This applies if market participants would also take into consideration those features while valuing the asset or liability on the day of measurement. This portrays reliability in terms of faithful representation of the asset. Thirdly, this standard sees a fair value measurement assuming an orderly transaction exchange of assets and liabilities among market participants to sell the assets or transfer liability at the measurement date in the prevailing market atmosphere. It also presumes that the transaction of sale of an asset or liability transfer should take place either; in the liability’s or the asset’s main market, and in the absence of the main market, a neutral ground is chosen by both parties. In addition to the above recommendations on measurements, the standard recommends that every entity will measure an asset’s or a liability’s fair value making the assumption that market participant will also make when costing the asset or liability, at the same time making assumption that these participants act in their economic top interests. Lastly, the standard describes fair value as the price received on the sale of an asset or payment on liability transfer in an arranged business deal in the main market, and at the date of measurement under the current market conditions, regardless of whether that price is directly observable or estimated using another pricing method (Australian Accounting Standard Board 2011). In regard to faithful representation, AASB supports its usage instead of reliability as a qualitative characteristic claiming that it is consistent with the IASB conceptual framework. It further explains that the public sector has no definite reason for the Ipsasb’s conceptual framework to vary from the revised IASB. AASB’s application to nonfinancial assets The standard’s fair value measurement of a nonfinancial asset considers the ability of the market participant to use the asset in its best and highest use to generate economic benefits, or by giving it to another market participant that would use it in its best and highest use. This indicates the relevance of the standard. In regard to liabilities and an entity’s own equity instruments, the standard explains that a fair value measurement assumes that on the measurement date, a financial or nonfinancial liability or even an entity’s equity instrument is transferable to a market participant (Australian Accounting Standard Board 2011). Objectives and impacts of financial reporting Effects of diversity and choice in measurement methods According to Choi (2005), resistance to the process of creating a homogeneous set of accounting standards and fair value measurements methods across nations have been created by the prerequisites of different conditions in each country. This resistance is based on the merits and demerits that come along with the diversification of the methods. The following are both the positive and negative effects of diversity. Positive impact Different standards contribute to transparent, understandable and high-quality financial report to users of financial statement all over the world. Use of different methods improve comparability and transparency of financial statements to investors and stakeholders, thus improving investment decisions in terms of fewer risks of errors and less misunderstandings (Choi 2005). In addition, use of different methods can remove barriers to cross-borders trading in capital markets, thus leading to a more effective allocation of capital (Hail et al. 2009). Negative impact Employing new asset valuation methods shows that it is calculated in fair value as restated as market value and the new method seems logical from a theoretical perspective. However, it is difficult practically, especially for external partners to perceive a clear overview of the actual fundamental changes of the enterprise. Year to year, shifts of changes are likely to be augmented, which may cause withdrawal of investors. In addition, different methods may not be flexible enough to integrate different accounting practices and standards of different countries (Choi 2005). Finally, the conception of enhanced comparability of financial reports and liquidity of capital markets will only be proven true in a case where the set of accounting standards are adopted in time the political, cultural, legal and economic factors are also changing for the adoption (Hail et al. 2009). Objectives of financial reporting from user’s perspective Financial reporting is a way of communicating to users of financial reports, information that is helpful in making choices from alternative uses of scarce resources. Stakeholders of every enterprise use financial statements. The following are the importance to both internal and external stakeholders (FAS 2008). Internal stakeholders First and foremost, the employees who are engaged in providing services to the entity use financial statement to evaluate the stability, profitability and growth of the enterprise. This allows them to make long-term commitment decisions on the enterprise, and also to negotiate for higher pay and request for incentives, retirement and other benefits. Secondly, managers who are charged with the responsibility of running the enterprise’s resources base their informed decisions about the economic achievement of the enterprise by using financial statements. They therefore adjust strategies and tactics to develop identified opportunities and mitigate potential threats. Lastly, the board of directors who set objectives and strategic direction of an enterprise and thereafter engage managers to accomplish them, use financial statements to review the performance of management in connection with the attainment of the set objectives (Statement of Financial Accounting Concepts 2008). External stakeholders This group of stakeholders is usually directly affected by financial statements, unlike internal stakeholders. They include investors who generally invest their resources in an entity and are directly concerned in the quantity, timing and ambiguity of future cash influx of an entity. They also use financial statement to evaluate the management’s performance. Lenders supply funds to the enterprise on both short and long-term basis and financial statements help them decide whether to allow an enterprise to take new working capital or lengthen their debt securities to finance development and other major expenditures (Statement of Financial Accounting Concepts 2008). Other external stakeholders include suppliers who use financial statements to assess the enterprise’s creditworthiness and customers who assess the financial strength and the long-term sustainability of the company as a dependable resource for their businesses or consumption. Moreover, while current competitors use financial statements to benchmark with their own enterprises and identify differences to target for improvement or exploit as an opportunity, potential competitors use them to assess the profitability of entering the industry. Lastly, government agencies and department use the financial statements to establish the accuracy and propriety of taxes and other duties affirmed and paid by the enterprise (Statement of Financial Accounting Concepts 2008). Conclusion This paper presents a new understanding of relevance-reliability relation, and provides information on how AASB 13 portrays these qualities in their standards. It is obvious that AASB 13 provides clear guidelines to enterprises on fair value measurements making its adoption inevitable as it presents true and fair picture of an entity. Under this discussion, the friction amid relevance and reliability in the debate over historical costs versus fair value become less serious. References Australian Accounting Standard Board 2011, AASB 13 Fair Value Measurements, Government of Australia. Available from : [2 May 2012]. Choin, FDS, & Meek, GK 2005, International Accounting, Prentice Hall, New Jersey Financial Accounting Series 2008, Conceptual Framework for Financial Reporting: The objective of Financial Reporting and Qualitative characteristics and constraints reporting information, FASB. Hail, L, Leuz, C & Wysocki, P 2009, Global Accounting Convergence and the potential Adoption of IFRS by the United States; An analysis of economic and policy factors. Available from: < http://papers.ssrn.com/abstract=1357331.pdf> [2 May 2012]. Heffes, E 2005, ‘The relevance of reliability: an update on the FASB and IASB joint conceptual framework project,’ Financial Executive, vol. 21, pp. 15-18. Statement of Financial Accounting Concepts 1980, “Objectives of Financial Reporting by Non business Organizations,” Stamford, Conn, FASB Sloan, R 1999, ‘Evaluating the reliability of the current value estimates,’ Journal of Accounting and Economics, vol. 26, pp.193-200. Read More