Importance of fair value accounting

Mark to Market or Fair value accounting shows the current price or the potential of the asset in the market. Assessment of fair value accounting is one to reflect economic reality in the corporate environment. The fair value shows the potential price in which the asset can be bought or sold in respect of the cash flows or the economic benefits flowing from the asset (Goh et al. 2015). The cons and pros of applying the fair value accounting in the financial reporting framework has been taken more into consideration after the financial crisis. Fair value accounting is important and should be applicable on the corporate accounting standards and the same to be applied on the financial statements of the company. A financial report of the company is a mixture which contains variety of assets and liabilities classified at different value according to their nature and characteristics. FAS 157 clearly defines the concept of fair value accounting as a price that would be paid or received from the transfer of the asset on the measurement date (Magnan, Menini and Parbonetti 2015).

The crucial debate that is linked with the application of fair value accounting is that the financial market is not static it keeps on changing. Financial Assets and economies operates through various business cycles and the value of the assets can be volatile or during the boom period and recession period making difficult for the company to present financial information. A stable and secure accounting approach providing a classified way of defining the assets and liabilities of the company should be the key aim of the financial report of the company. The key points that should be taken into account is that during economic booms financial institution and companies will be taking high amount of leverage where the value of their financial assets would be going up (Gohet al. 2015). These can be the key points which were noted during the financial crisis. However, it is crucial to note that the Historical Cost Accounting (HCA) does not allow the revaluation of the asset during the business cycle and under the economy in which the company operates. On the other hand it Fair Value Accounting (FVA) would allow the investors and the stakeholders of the company asses the financial position of the company thereby taking several steps. It would be providing an early warning signal if the financial assets of the company would be disrupting the financial position of the company and the operation of the company (Durocher and Gendron 2014). The application of the fair value accounting did result in the financial crisis as the new accounting standards showed that this companies should recognize liabilities in the financial report where the company expects that the economic benefit would be outflowing from the same. Recognition of liabilities of the company with the fair value accounting standards was the key reason for the financial crisis. Companies did not had sufficient coverage of assets and leverage and financial risk of the companies increased substantially with the application of the fair value accounting. If the Historical Cost Accounting is applied public and private sector may still take high amount of leverage if they sell their asset on a securitization basis where the performance of the asset would be guaranteed by the company. This would not only provoke banks to sell their inefficient asset but will also increase the financial risk associated with the company (Ettredge, Xu and Yi 2014).

Pros and cons of fair value accounting

A wider and a classified approach of accounting classifying and characterising the assets and liabilities based on their nature can be the best solution for the organisations. The application of IFRS 13 is for annual reporting which starts from 1^st Jan 2013 that defines the fair value and sets out the framework for the measurement of the various assets and liabilities. The financial report which is presented by the company should be such that it benefits the financial users for making important economic decision about the investment (de Jager 2014). It is also important that the fair value accounting should be applied in the context of financial assets whose values are closely linked to the performance of the financial market and the relevant movement or the adjustments should be made in the other comprehensive income statement which is done currently in the accounting standards (Lachmann, Stefani and Wöhrmann 2015). The application and the creation of such reserves solves the problem of volatile financial statements where the changes in the value of financial assets is directly adjusted with shareholders equity. Thus, the same also reflects economic reality and application of fair value accounting which can be useful by the shareholders for making important and potential decisions about the company. 

Fair Value Accounting takes an important part in the overall reporting and viability of the financial position of the company in contrast to the market values. Fair value accounting is followed by company for most of their financial assets and relevant disclosures are made in accordance so that material information could be given to the financial users and the stakeholders of the company for assessing the sustainability of the company.  The annual report for the Westfarmers and Woolworths Company for the year 2018 was taken into consideration for the analysis of the various financial information and data provided by the company in respect to the fair value accounting used by the company (Dong, Ryan and Zhang 2014).

Wesfarmers Company: Investments held by associates and financial instruments are some of the common accounts which are classified at the fair value accounting by the Wesfarmers Company.

The Goodwill reported by the Wesfarmers Company is acquired through business combination measured at the cost value. Westfarmers Company periodically reviews assets which have an indefinite lives so that any material changes in the accounts can be reflected in the financial statement of the company. The intangible assets reported by the Westfarmers Company which were having an indefinite life’s were the brand values and gaming and liquor licenses (Demerjian, Donovan and Larson 2016).

Fair value accounting in Wesfarmers and Woolworths

Classification of revenue, trade receivables of the company, financial assets, interest bearing loans and borrowings which are carried at the amortised cost and later on adjusted according to the fair value adjustments. Hedging instruments plays a crucial role in the operational and financial aspect of the company allowing the company to hedge against large volatile movement in the financial market and forex market. Wesfarmers Company has several of its derivatives instruments and forex assets which are reported by applying the fair value accounting concept.

Woolworths Company: The Woolworths Company applies the concept of historical cost accounting for the preparation of the financial report of the company except for some of the key and crucial assets of the company such as the financial assets and liabilities. The financial assets and liabilities including the derivatives instruments and interest bearing loans and borrowings have been reported at the fair value. The changes in the financial assets and liabilities of the company has been stated in the other comprehensive income statement of the company.

The financial instruments of the company has been valued at the fair value where AASB 9 has been applied by the company in the perspective of the recognition and measurement of the financial instruments of the company. For the recognition of the various lease of the company the application of AASB 16 has been done by the company. Trades and other receivables of the company is also valued at the fair value and subsequently measured at the amortised cost using the effective interest rate method and by taking the charges for impairments thereon. Financial assets of the company are also reported at the fair value and the changes in the value of the assets are reported in the other comprehensive income of the company (Bowen and Khan 2014).

Intangible Asset of the company like goodwill, brand names, liquor and gaming licenses and property development rights were some of the key assets of the asset that were having indefinite life and the same were measured at the fair value. Changes in the values of the above accounts were directly reflected in the financial statement of the company.

Fair value accounting is done by both the above companies and several disclosures and adjustments have been made by the company in respect to the above accounts. The footnotes of the company has presented crucial information’s about the assets of the company and the valuation and recognition approach used by the company in contrast to the same. 

Reference

Goh, B.W., Li, D., Ng, J. and Yong, K.O., 2015. Market pricing of banks’ fair value assets reported under SFAS 157 since the 2008 financial crisis. Journal of Accounting and Public Policy, 34(2), pp.129-145.

Magnan, M., Menini, A. and Parbonetti, A., 2015. Fair value accounting: information or confusion for financial markets?. Review of Accounting Studies, 20(1), pp.559-591.

Goh, B.W., Li, D., Ng, J. and Yong, K.O., 2015. Market pricing of banks’ fair value assets reported under SFAS 157 since the 2008 financial crisis. Journal of Accounting and Public Policy, 34(2), pp.129-145.

Durocher, S. and Gendron, Y., 2014. Epistemic commitment and cognitive disunity toward fair-value accounting. Accounting and Business Research, 44(6), pp.630-655.

Ettredge, M.L., Xu, Y. and Yi, H.S., 2014. Fair value measurements and audit fees: Evidence from the banking industry. Auditing: A Journal of Practice & Theory, 33(3), pp.33-58.

Lachmann, M., Stefani, U. and Wöhrmann, A., 2015. Fair value accounting for liabilities: Presentation format of credit risk changes and individual information processing. Accounting, Organizations and Society, 41, pp.21-38.

Palea, V., 2014. Fair value accounting and its usefulness to financial statement users. Journal of Financial Reporting and Accounting, 12(2), pp.102-116.

Dong, M., Ryan, S. and Zhang, X.J., 2014. Preserving amortized costs within a fair-value-accounting framework: Reclassification of gains and losses on available-for-sale securities upon realization. Review of Accounting Studies, 19(1), pp.242-280.

Demerjian, P.R., Donovan, J. and Larson, C.R., 2016. Fair value accounting and debt contracting: Evidence from adoption of SFAS 159. Journal of Accounting Research, 54(4), pp.1041-1076.

Bowen, R.M. and Khan, U., 2014. Market reactions to policy deliberations on fair value accounting and impairment rules during the financial crisis of 2008–2009. Journal of Accounting and Public Policy, 33(3), pp.233-259.

de Jager, P., 2014. Fair value accounting, fragile bank balance sheets and crisis: A model. Accounting, Organizations and Society, 39(2), pp.97-116.