Week 1 - Fair Values (IFRS 13) Flashcards
Benefits of IASB Conceptual Framework
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Helps IASB develop consistent, logical and flexible accounting standards. A basis for IFRS to help consistency e.g. helping account for cryptocurrency, legitamises and justifies accounting standard decisions
If there is a choice of treatment (multiple options) can use conceptual framework to justify the decision e.g. valuing asset at historic cost or fair value
Helps parties interpret IFRS
Helps prevent political/business interference in standard setting
Useful for auditors e.g. where no relevant accounting standard applies
Principles-based approach avoids considerable disadvantages of rule-based accounting, where parties could ‘skirt-around’ the rules, principles more robust
Fundamental characteristics of useful financial information
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Relevance: Ability to influence primary user economic decisions.
Faithful representation: The information is complete, neutral, and free from error
Enhancing characteristics of useful financial information
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Understandability: Info should be clear and concise
Verifiability: External knowledgeable interpretors can ensure that the information is correct
Comparability: Consistent accounting methods making it easy to contrast with other entities reports
Timeliness: Information should be available to users so that it is still relevant and useful for decision making
Cost of preperation should not outweigh benefits to users
Prudence
Neither understating nor overstating assets, liabilities, income, expense
Historical Cost
Assets recognised at acquisition cost, liabilities at consideration recieved
Can still be adjusted, depreciated etc., but that is in relation to that historic cost
Fair Value
Asset at market price of asset.
Contreversial as values fluctuates
Value in Use
Present value of cash flows from use of an asset
Current Cost
Cost of buying an equivalent asset + transaction costs (should be affected by age and condition)
Not used often in IFRS
Measurement Critiques
Confusing mixed meaurement models e.g. Inventories valued at lower of cost and NRV (historic cost) ‘IAS 2’ but investment properties use fair values (Barker & Texeira 2018) IAS 40. Thus this affects income and expenses
Choice of measurement within a standard decreases comparability. E.g. PPE, which can choose to calue at historic cost (gains not recognised to sold), or fair value (gains recognised in Other Comprehensive Income)
Fair Value
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
IFRS 13 three-tier model for Fair Value
valuation
Always use Level 1&2 where available, then resort to 3
Level 1:
Use prices from market transactions for identical assets
Level 2
Use prices from market transactions for similar assets.
For non-financial assets such as land/buildings the market price should be for the highest and best use
Income approach (Level 3):
Discounted future cashflows (needs estimates of cash flows and suitable discoun rate, thus less accurate)
Cost approach (Level 3):
Use current replacement cost for that asset - allowing for obsolescence. Non-observable
In FAVOUR of fair values
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Fair values introduce volatility to the statements, but this is fair that it reflects CURRENT market conditions
Market value is easily understood
Level 1&2 are not subjective, based on market info
FV uses economic principles like opportunity cost (highest and best use), thus more faithful representation
Fair values are more likely to incorporate climate-related risk factors, market prices will reflect these risks e.g. petrol stations etc.
Particularly relevant for financial services where market conditions change rapidly. marra (2020) shows that it allows firms to reglect real-time market conditions thus statements more accurate
CRITICISMS of Fair Values
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Introduces volatility to the statements: Significant criticism from managers and CEOs as skews profits based off market fluctuations rather than stewardship and management of the company. Evidence of whether investors account for this in their assesment is contrasting, studies that argue each way
Level2 & 3 estimations can be complex
Significant criticism of Level 3: hard to verify/ audit, could be manipulated
Criticism that cost of FV and getting it past auditors may make preparers opt for Historic Cost, supported by Christensen & Nikolaev (2013)
In favour of using Lower of Cost and NRV
2
Could argue cost is more reliable and is prudent (profit is not anticipated until it is certain i.e. it is sold)
Valuing at cost means investors are able to see the margin earned when sold, which is useful for them to see the firms profitability
IFRS13 Disclosure requirements
IFRS13 triggers disclosure requirements in notes to the FS
Moving towards lvl3 values are more onerous, more estimation etc.. For Level3 there is extensive disclosure of assumptions required.
Some have called for more disclosure of level 2 modelling
Some feel the notes to the FS are already too lengthy - links to materiality and whether this info is useful.
