Fair value accounting and business competitiveness

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Fair value accounting and business competitiveness
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Richard Martin Head of Financial Reporting, ACCA
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ACCA

• 320,000 members and students world-wide
• Examining in International Accounting Standards
  and International Standards on Auditing since
  1996
• Diploma in IFRS
• Own accounts using IFRS since 2002
• richard.martin_at_accaglobal.com
• www.accaglobal.com/ifrs

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Fair value accounting

• Fair values what are they and where they are
  used in IFRS
• Fair value accounting main applications in IFRS
  
• Implications for business competitiveness

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Measurement bases in IFRS

• Depreciated Cost
• Share of net assets (equity accounting)
• Value in use (VIU)
• Net realisable value (NRV)
• Fair value (FV)
• Lower of cost and NRV
• Recoverable amount (higher of VIU and NRV)
• Entity-specific or market values
• Exit or entry values

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Where are fair values used in IFRS?

• Fair value as a means of estimating cost
  initial measurement
• Revenue, swaps of non-monetary assets
• Business combinations (IFRS 3) FV of
  consideration and of net assets acquired
• Share-based payments value of options granted
• Allowed alternative for property, plant and
  equipment or intangible assets
• Pension schemes (IAS19) assets less liabilities
  plus effect of corridor and spreading over
  service lives

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Fair value accounting

• Where changes in fair values affect profit for
  the year
• Financial instruments (IAS39)
• Investment properties (IAS40)
• Agriculture (IAS41)
• Where holding the assets for trading/dealing/inves
  tment purposes
• Revaluations
• Property, plant and equipment (IAS16)
• Intangible assets (IAS38)
• Through equity, but recycled into PL
• Financial instruments available for sale and
  cash flow hedges

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Fair values in IAS39

• Four way classification of assets
• Loans and receivables at amortised cost
• Held to maturity at amortised cost
• Trading at fair value through PL
• Available for sale at fair value through equity
• Derivatives at fair value through PL
• Liabilities at amortised cost for most
• Trading or derivatives at fair value through
  PL

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Issues with fair values in IAS39

• Mixed model mixture of costs and fair values
• Hedge accounting
• Fair value hedges both hedged item and hedging
  instrument (derivative) at FV through PL
• Cash flow hedges derivative at FV through
  equity
• Fair value option

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Reliable fair values

• Hierarchy
• Active market
• Quoted price, bid price, unit price (no extra
  value for a big block)
• No active market valuation model
• Maximise inputs from market transactions
• Use all factors time value, credit risk,
  volatility, prepayment risk etc.
• No active markets equities at cost as last
  resort

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IAS40 - Investment property

• Initial measurement at cost plus transaction
  costs
• Add some subsequent expenditure
• Then at fair value through PL or at depreciated
  cost
• Market value with no deduction for selling costs
• Use of professional external valuer
• Best evidence market transactions in similar
  properties
• Next best other market transactions adjusted
  for leases, location, time etc. or discounted
  cash flow analysis

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IAS41 Agriculture

• No cost option
• Initial measurement at fair value
• Subsequently at fair value with changes through
  PL
• Fair value less point-of-sale costs
• Maximise inputs from market transactions
• Discounted cash flows as alternative
• Specific issues eg agricultural assets and the
  land they stand on

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How far will FV accounting spread?

• Measurement project
• Insurance contracts - Part 2
• Revenue recognition
• Full fair value model for financial instruments
• Comprehensive income project

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Fair value accounting business competition
issues

• Costs
• Valuations
• Models understanding and applying them
• Systems moving from transactions to value
  changes
• Reported results
• Measurements - Day 1 profits, transaction costs
• Prudence and realisation
• Reliability issues

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Fair value accounting business competition
issues

• Earlier recognition of profits
• No need for a transaction
• Recognise selling gains
• Volatility of results as market changes
• Hedge accounting and natural hedges
• Liabilities change in own credit risk
• Same as market/competitors
• Return on capital shifts from invested capital to
  market value

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Fair value accounting business competition
issues

• Understanding the fair value accounts
• Presentation issues profits from different
  sources, interest income
• Basis for taxation
• Limit to distributions

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Some conclusions

• Mixed bases in IFRS
• Various ways of accounting for changes
  revaluations, through equity recycling, fair
  value through PL
• Fair values used when costs fail derivatives,
  agriculture
• Fair values used with hesitation options in
  IAS39 and 40 but likely to increase

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Some conclusions

• Business implications
• More costs
• Reliability of fair values
• Reported results will change
• Earlier recognition of profits
• Volatility of the results as markets change
• Presentation issues to help understanding