Fair Value Accounting

Question 1

Objective of financial reporting as

Answer 1

To provide financial info about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity

Question 2

Why is there the view that financial statements produced under historical cost accounting do not provide relevant information for decision making

Answer 2

1. This is because HCA figures are often outdated and out of tough with current economic reality
2. The solution to this problem seems to lie in fair value accounting

Question 3

IFRS 13- fair value measurement (IMPORTANT)

Answer 3

-> IAS 16 = PPE required to be initially recorded at cost but entities could later choose to either value their PPE at cost or at fair value
-> IAS 38 = intangible assets requires intangible assets to be initially recorded at cost, but could later be valued at cost or at fair value
-> IFRS 9 = financial instruments: recognition and measurement requires financial assets and financial liabilities to be measured at fair value
-> IFRS 3 = business combinations requires assets and liabilities in a business acquisition to be measured at fair values at the acquisition date

Question 4

Objective of IFRS 13 (IMPORTANT)

Answer 4

1. To define fair value
2. To set out a single standard or framework for fair value accounting
3. To require disclosures about fair value measurement

-> IFRS 13 applies when another accounting standard required or permits fair value to be used and when information about fair value is to be disclosed

However IFRS 13 does not apply to some measurement situations that have similarities to fair values:
-IAS 2 inventories (net realisable value)
-IAS 36 impairment of assets (value in use)

Question 5

Definition of fair value (IMPORTANT)

Answer 5

-> 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

1. Hypothetical transaction
2. Based on selling price
3. Orderly transaction means transaction should involve marketing activities that are usual and customary
4. Assumes potential market participants
   -> general market based values
5. Market participants included buyers and sellers in principle market
   -> independent of each other
   -> knowledgable and have reasonable understanding about the asset or liability
   -> able and willing to enter into a transaction for asset or liability

Question 6

Determination of fair value price

Answer 6

1. Identification of the asset to be valued
2. Identification of the principle market for the asset
   -> market with the greatest volume and level of activity for the asset or liability
   -> when there is not a principle market, the valuer must then consider the assumptions for the most advantageous market in determining the fair value for the asset or liability
   -> advantageous market = market that maximises the amount that would be received to sell the asset or minimise the amount that would be paid to transfer the liability
   -> must consider transaction and transport costs for above
3. Estimation of the exit price of the asset using a valuation model/technique.
   -> market approach
   -> cost approach
   -> income approach
4. Determine the fair value of the asset or liability
   3.

Question 7

Transaction and transport costs

Answer 7

-lower the transaction and transport costs will indicate more advantageous markets
-transaction costs are incremental direct costs to sell an asset or transfer a liability in the principle market
-transport costs are costs incurred to transport an asset from its current location to its principle market

Question 8

Valuation techniques for fair value accounting

Answer 8

1. Market approach
   -uses recent prices and relevant info generated by market transactions involving identical or similar assets or liabilities. Prices are obtained directly from info gathered from activities in markets
2. Cost approach
   -reflects amount that would be required currently to replace the service capacity of an asset. Same qualities as asset being valued.
3. Income approach
   -converts future amounts to a single current amount. The fair value price is determined on the basis of the value indicated by current market expectations of those future amounts
   -prone to errors and subject to manipulation

Question 9

Guidelines in choice of technique (IMPORTANT)

Answer 9

1. The technique must be appropriate to the circumstances
2. There must be sufficient data available to apply the technique
3. The technique must maximise the use of observable inputs and minimise the use of unobservable inputs
4. Multiple techniques are used with the results being weighted and evaluated
5. Valuation techniques used to measure fair value must be consistently applied

Question 10

Weaknesses of IFRS Fair Value (IMPORTANT)

Answer 10

1. Only applies in specific circumstances (goodwill, fixed assets- inventory, impairment)
2. Gives three choices of valuation method but doesn’t say which to use
3. Based on exit prove even tho asset is not being sold, illogical
4. Compared to HCA it increases estimates and judgements
5. Increased complexity and confusion