Week 1 - Fair Values (IFRS 13) Flashcards
Benefits of IASB Conceptual Framework
6
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
Criticisms of Conceptual Framework
5
Inconsistencies with Deferred tax
IFRS inconsistent with each other e.g. discounting and measurement of assets
Framed from a Balance Sheet perspective, lack of attention to the Income Statement (Barker and Penman (2019). e.g. doesn’t offer guidance on the treatment of P&L vs Other Comperhensive Income. Obviously Profit is a hugely important metric for assessing Operating Success, so clarity is essential
Ball (2016) says it’s ‘Delusional’ to organise complex Financial Reporting practice into a small set of ideas. Reductionist
Pelger (2020) says Framework ignores importance of stewardship: reports should not only provide information for investment decisions but also offer insights into how well management has managed the company’s resources and whether they have acted in the best interests of shareholders.
Fundamental characteristics of useful financial information
2
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
5
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 (hsitoric cost) but investment properties use fair values (Barker & Texeira 2018). Thus this affects income and expenses
Choice of measurement within a standard decreases comparability
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 valuation
Always use Level 1&2 where available, then resort to 3
Level 1 & 2:
Use prices from market transactions for identical or similar assets
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
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 priinciples 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.
CRITICISMS of Fair Values
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)
