Fair Value Measurement - Essay Example

Corporate Financial Reporting of Introduction This paper seeks to prepare an outline on the requirements of IFRS 13 Fair Value Measurement. In addition this will also discuss how fair value is used by Next PLC as a measurement attribute in IAS 19 Employee Benefits and IFRS 9 Financial Instruments (financial assets only). Finally this will critically evaluate the contribution that fair value makes to the fair presentation of the financial statements. 2.1. A brief outline of the requirements of IFRS 13 Fair Value Measurement. This outline will present what is fair value measurement and when it is required or permitted in the preparation of financial statements. To apply fair value measurement, there is need to know the meaning of fair value which is basically “exit price of” a market transaction rather than specifically applicable only to an entity. Said fair value depends basically whether or not there is an active market or not but preferably the exit price must be that of active market, if there is any. Thus if there is active market, the exit price would refer to quoted prices for identical assets or liabilities that a company or entity can access at measurement date. Thus if there is no active market, that which is observable or objective available should be the basis for said fair value as much as possible. However, IFRS categorizes the fair value into three (3) inputs which are arranged in hierarchy giving priority giving the highest priority to (adjusted) quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs as provided or in IFRS 13:72 (Deloitte 2014a). The aim of such a fair value hierarchy by the requirement of IFRS 13 is to promote consistency and comparability in fair value measurement and related disclosures (Deloitte, 2014a). When it is required to use fair value? It is required for certain assets and liabilities as implemented in each IAS or IFRS issued by the IASB. As such, the measurement and disclosure requirement under IFRS 13 do not apply to the following according to IFRS 13.6: (1) Share-based payment transaction within the scope of IFRS 2 – Share-based Payment; (2) Leasing transactions within the scoped of IAS 17 – Leases; (3) Measurements that appear similar to fair value but are not the same, such as the net realizable value in IAS 2 – Inventories, and; (4) Value n use in IAS 36- Impairment of assets (BDO, nod) When it is permitted? It is permitted as provided for certain assets and liabilities also as implemented by specific IAS or IFRS issued by IASB. In both cases however, there is a requirement of disclosure about the fair value measurement being used by the entity (Deloitte, 2014a). In so applying the categorization of inputs to measure fair value using different levels of the fair values hierarchy , the application of judgment is needed to have the fair value measurement entirely in the level of the lowest level input that is significant to the entire measurement as required by IFRS 13:73 (Deloitte, 2014a).. 2.2 Discussion on how fair value is used as a measurement attribute in IAS 19 Employee Benefits and IFRS 9 Financial Instruments (financial assets only). To determine how fair value as measurement attributes in IAS 19 Employee Benefits by NEXT Plc there is need to know the requirements of the accounting standard and whether the company applied the same in the preparation of the financial statement s accordance with the requirements. Generally, before the application of fair value on post-employment benefits under IAS 19, there is need to know whether the company adopts a defined contribution plan or a defined benefit plan (Everingham, et al (2007; Puttick, van Esch and van Esch, 2008; Mirza, Holt and Orrell, 2010). It is in the defined benefit plan that specifically requires the use of fair value since the company would have to make sure that benefits to be received in fixed amount in the future would be assured and this would mean taking risk by the entity in the value of the plan assets that would be used in making sure that fixed payments of retirement benefits would be accomplished. Under IAS 19 the entity shall use the projected unit credit method to determine the present value of its defined benefit obligation and the related current service cost and where applicable the past service cost. Under the projected credit method, the computation of present value of the defined benefit obligation includes future salary increases. This mean under IAS 19, the entity is adopting the concept of projected benefit obligation. Moreover, one of the actuarial assumptions is that the postemployment benefit obligation shall be measured on a basis that reflects estimated future salary increase. In effect the projected benefit obligation defined benefit obligation for accounting. In computing the projected benefit obligation, there is need to have the present value of the expected future payments required to settle the obligation arising from employee service in the current and prior periods. Actuarial gains and losses may result from increases or decreases in the present value of the defined benefit obligation or the fair value of the plan assets (Dolomite, 2014d). Next Plc applied the requirements of IAS 19 as per Notes to Financial Statements which states: “The cost of providing benefits under the defined benefit and unfunded arrangements are determined using the projected unit credit method, with actuarial valuations being carried out at each balance sheet date.” (NEXT Plc, 2013, p. 61) As to how fair value as measurement attribute in IFRS 9 on Financial Instruments (financial assets only) is used, there is need first to understand the requirements of said standard. . Since IFRS 9 was intended to replace IAS 39 Financial Instruments: Recognition and Measurement. Since IFRS 9 includes requirement for recognition and measurement, derecognition and accounting (Deloitte, 2014b; 2014c), compliance with IAS 39 may be considered compliance with IFRS 9. IFRS 9 Financial Instruments includes requirements for recognition and measurement, derecognition and hedge accounting. The principle behind IFRS 9 is that there is need to recognize in the profit and loss or in the statement of comprehensive income changes in fair value of financial instruments. As such IFRS 9 requires that certain matters need to be disclosed. The risks faced by the company from the financial assets need to be disclosed (Deloitte, 2014b). NEXT Plc was able to do the same in accordance with the requirement of IAS 39 As example the company applied IAS 39 in derivatives as part of its financial assets. Annual Report in 2013 provides that the company uses derivative financial instruments to manage risks arising from changes in foreign currency rates in relation to its sourcing of products overseas and the related change in interest rates on corporate debts. It never uses derivatives for speculative purposes. Said derivatives are stated at their fair value, based on the company’s estimate of how much it may receive or pay to terminate them at balance sheet date using as basis the prevailing foreign current and interest rates (NEXT Plc, 2013) 2.3. Critical evaluation of the contribution that fair value makes to the fair presentation of financial statements (1000 words). The framework to evaluate contribution for fair value presentation first to define the meaning for fair presentation of the financial statements in relation to representation made by the management who prepares the financial statement, the auditor who expresses the opinion on the preparation of the financial statements based on certain standards and the use of the financial statements as basis for business decision by decision makers. This will also include looking into research made to verify fair presentation in terms of the concept of usefulness of the financial information for decision makers. 2.3.1 Meaning of fair presentation of financial statements Fair presentation of financial statements means that the financial statements are presented in accordance with the defined accounting standard with may refer to the generally accepted accounting principles of Financial Accounting Standards Board (FASB) or the international financial reporting standards as prepared by International Accounting Standards Board (IASB) based in Europe. There is a continuing convergence of the accounting standards (Clarke and Chanlat, 2009, IFRS, 2012 and KMPG, 2013a; 2013b) as motivated or pressure by the leaders of G20 as way to promote development of capital markets and promote economic growth among nations by allowing investors to have lower cost of capital due better information for decision making. It must be noted that investors make use of accounting information as try to evaluate what will happen in the future. They needed accounting information as basis of the decision to invest as they need and want to maximize wealth (Banerjee, 1987; Banks, 2006;Brigham and Houston, 2009;Brigham, E. & M. Ehrhardt,2010), the success of which will be determined in the future. In effect accounting information guides and leads decision makers to look the future with better level of uncertainty. Accounting information as reflected in the financial statements of companies needs to follow certain guidelines or standards if they are to be reliable, relevant and useful. 2.3.2 Auditors make opinion of fair presentation of the financial statements. There is a periodic determination of fair presentation by the external auditors of companies as a result of financial regulation in the preparation of reports by company’s management. The management of companies have their accounting and finance people who prepare the financial statements as guided by accounting standards in the form of GAAP or IFRS or IAS. The fact that auditors would examine first the prepared financial statements in relation to the requirements of standard before they will express their opinions or judgements as required by regulation, they would be reasonable to be believed by the users when these auditors have done their functions under the circumstance if they express unqualified opinion as to the fair presentation of the financial statements. Initially therefore, fair presentation is validated or formally determined if auditors express unqualified opinion (Delaney, and Whittington, 2012; Gibson, 2012; Bragg, 2011) and not qualified, adverse or disclaimer type of opinion. 2.3.3 It is however the users which will finally determine whether the accounting information was useful or valuable as they are the decision makers. To establish the focal point of the above argument, there is need to answer the question: “Does the fact that a decision results in a financial to a decision maker in a transaction of the future by reliance on accounting information be a measurement of the fair presentation by of the financial statements?” The objective answer of this paper is still yes. This researcher believes fair presentation of the financial statements presumably after using fair value in the preparation of the financial statements is not measured by the loss suffered by the use of accounting information. Even if the financial statements are prepared in accordance with the requirements of accounting standards, users of information may still misuse the same as there are a number of reasons why the loss occurred. Some decision makers are simply risk takers and they may not fully believe the financial information prepared whether it uses fair value or not. Asking the auditors, they would say that they do no certify as truthfulness of the financial information since they are only to express an opinion. Said auditors when they writer their opinions are not assuring on what will happen into the future. There were not making forecast expressly as they make their opinion of whether the financial statements presents fairly the financial position or results of operation of the companies that they audit. Despite such possible explanation or excuse of auditors if they are confronted their opinion generally matters as they are exercising professional work for which they could be held responsible legally. Thus fair presentation must be ascertainable at the time the auditors has evaluated the information from past transactions. Information of the past is just used to predict the future but decision makers could still commit error since the future is not easy to predict and past information becomes less relevant as time passes by for making decision which cannot wait at certain point in time. The best way to say whether there fair presentation accomplishment on the use of fair value to look at the evidence of research from the point of view financial data prepared using fair value was able to have prediction value. Enhancing prediction value is a way to express that there is usefulness that is mathematically measured instead of making a generalization that losing in a transaction is the result of lack of usefulness of the financial data or gaining is the result of having usefulness of the same data. In a research conducted involving companies in the U.K. the researcher was trying to find if indeed the use of fair value benefited users of the accounting information. In said financial statements of top 20 UK capitalization companies from 2005 to 2009 based on financial statements from 1990 to 2009, the use of fair value was found useful (Wearing, 20110). There was good proof due to the presence of statistical significance of the expected value from the financial statements prepared using fair value as against the computed value derived without the fair value (Wearing, 2010). The research was designed determine on the effect of fair value on the top 20 capitalization companies in the United Kingdom, thus it predicted the values of 5 variables (Net income, property, plant and equipment, intangible assets, return on equity , and depreciation and amortization. Findings revealed that Depreciation and Amortization showed positive result at 5% level of significance, while the other four except intangible assets showed positive result at 10% level of significance. 3. Conclusion. This paper was able to outline the requirement of IFRS 13 Fair value Measurement by presenting its applicable to all financial and non-financial assets and liabilities in the preparation of financial statements except for certain items. This also discussed how fair value is used by NEXT PLC as a measurement attribute in IAS Employee Benefits and IFRS 9 Financial Instruments (financial assets only). This has critically evaluated the contribution that fair value makes to the fair presentation of the financial statements by discussing the meaning and significance or fair presentation and by providing evidence as to the usefulness of fair value in the preparation of financial statements based on research. References: Banerjee, B (1987). Financial Policy and Management Accounting. PHI Learning Pvt. Ltd. Banks, E. (2006). Finance: The Basics. Routledge BDO (n.d.). NEED TO KNOW: IFRS 13 Fair Value Measurement. Retrieved 20 February 2014 from Bragg, S. (2011). 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Retrieved 20 February 2014 from < http://www.iasplus.com/en/meeting-notes/ifrs-ic/2013/ifrs-ic-september-2013/ias-19-employee-contributions > Everingham, G.K. et al (2007). Principles of Generally Accepted Accounting Practice. Juta and Company Ltd. Gibson, C. (2012). Financial Reporting and Analysis. Cengage Learning IFRS (2012). Joint Update Note from the IASB and FASB on Accounting Convergence. Retrieved 20 February 2014 from < http://www.ifrs.org/Use-around-the-world/Global-convergence/Convergence-with-US-GAAP/Documents/r_120420d.pdf> KMPG (2013a). Fair Value Measurement: Question and Answer . . Retrieved 20 February 2014 from https://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/IFRS-Practice-Issues/Documents/fair-value-qa.pdf KMPG (2013b). IFRS compared to US GAAP: An Overview, Retrieved 20 February 2014 from < http://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Documents/IFRS-compared-to-US-GAAP-An-overview-O-201311.pdf > Mirza, A, Holt, G and Orrell, M. (2010) International Financial Reporting Standards (IFRS) Workbook. John Wiley & Sons Puttick, G., van Esch and van Esch (2008) The Principles and Practice of Auditing.Juta and Company Ltd Wearing, R. (2010). The effect of Applying Fair Value on the Financial Statements on UK Leading Companies . Retrieved 20 February 2014 from Read More