The Effect of Fair Value Accounting on Banks' Financial Reports - Research Paper Example

The Effect of Fair Value Accounting on Banks Financial Reports: A Comparison Study Table of Contents The Effect of Fair Value Accounting on Banks Financial Reports: A Comparison Study 1 Table of Contents 2 Chapter 1: Introduction 3 Chapter 2: Literature Review 3 2.1. The Concept of Fair Value Accounting 3 2.2. Valuation Techniques 5 Chapter 3: Problem Statement 6 Chapter 4: Research Question 7 4.1. Research Objectives 9 Chapter 5: Research Methodology 9 5.1. Research Approach 9 5.2. Data Collection & Analysis 10 Chapter 6: Research Structure 10 Chapter 7: Conclusion 12 Chapter 8: References 13 Chapter 1: Introduction The historical costs have been characteristically professed as being increasingly intentional as well as dependable in comparison to the fair value. The notion of the fair value has been found to signify and depict additional pertinent and accurate information with regard to the investors as well as creditors (Harris & Ohlson, 1987; Magnolio, 1986; Carroll & et. al., 2003; Kanagaretnam & et. al., 2009; Wier, 2009). The fair values have been considered to be increasingly value-pertinent in comparison to the historical costs from the point of depicting a stronger relationship with regard to the indicators related to the stock market. The accounting specification related to Property Plant and Equipment International Accounting Standards (IAS) 16 has been identified to be the initial specification to disseminate this particular notion. The notion related to fair value accounting (FVA) was found to become an essential part with regard to the accounting specifications since the mid of the 1980s (White, 2008). Chapter 2: Literature Review 2.1. The Concept of Fair Value Accounting The idea or notion of Fair Value Accounting (FVA) is stated to exist since quite few years now. The accounting specifications disseminated by the International Accounting Standards Board (IASB) along with Financial Accounting Standards Board (FASB) both are believed to entail the notion related to FVA (Prasad & et. al., 2011). According to Ryan (2008), FVA was referred as a particular approach related to financial reporting where it is considered necessary for companies to gauge and report on a constant basis regarding specific assets as well as liabilities. The financial reporting was required to be done at guesstimates related to the prices that the companies were supposed to receive had they been able to sell those considered assets or were supposed to pay for the reason of alleviating their respective liabilities (Sinnett, 2007). To put it differently, a particular financial asset with regard to which a dynamic market is identified to exist needs to be placed in the respective balance sheet in terms of the prevalent market price. It was also stated in this context that any kind of alteration in the prevailing market price needs to be recognised and recorded right away in the account of profit and loss. The Statement of Financial Accounting Standards No. 157 along with the Fair Value Measurements was found to provide an explanation with regard to fair value along with setting up a structure for the reason of gauging fair value in terms of Generally Accepted Accounting Principles (GAAP) (Sinnett, 2007). It has been mentioned earlier that fair value has been stated to be that particular price which is expected or rather approximated to be received for the reason of selling a particular asset or even the price that is intended to be paid for the reason of shifting a particular liability in a methodical business deal made amongst the members or the parties at the expected dates. This particular explanation was found and is believed to desert quite an old application of making use of the price in relation to the business deal for a particular asset or even in case of any liability to be its preliminary fair value. Therefore, it could be well deduced from the provided explanation that the fair value would no more be reliant on the amount that needs to be paid for something but it would rather be reliant on the amount of financial consideration that can be obtained from selling it which can also be referred as the related ‘exit price’. It can also be stated in reference to the provided explanation that the notion of fair value is considered to be reliant on the market which calls for the necessity of taking into concern the amount of financial consideration that is likely to be paid by the other existing market contestants for a particular thing. Thus, it can be comprehended from the given elucidation that fair value can no more be considered as entity-specific (Ebling, 2001). The valuation presently would be expected to be ascertained by a buyer who would be rather cynical than being optimistic. The extent of accessible information in order to gauge the fair value is believed to ascertain the way of valuation in relation to an asset or in case of a liability (Wallison, 2009). Observable contributions in this context would be reliant on the information regarding the market which is supposed to be gathered from autonomous sources, for instance exchange prices in relation to stocks. However, for the time being, in the nonexistence of a dynamic market with regard to a particular asset or in case of a liability, the unobservable contributions are thought to mirror replicate the suppositions of the respective reporting entity. The standard or the specifications are believed to make available a pecking order in relation to the fair value which provides highest precedence to the cited or estimated prices prevailing in the dynamic markets. The lowest precedence was found to be offered to the unobservable contributions (Chea, 2011; Chambers, 2008). 2.2. Valuation Techniques An appropriate structure for the reason of gauging the fair value as well as for proper disclosure was laid down by FAS 157. The vital characteristic identified with regard to the FAS 157 was the necessity to define the intended financial statements according to few specific levels for the reason of portraying the dependability with regard to the contributions that are made use of with the purpose of ascertaining the fair value. It has been stated that there exists three different levels in accordance to which the intended financial statements are defined. The initial level is believed to be quite clear-cut and uncomplicated as the quoted prices are found to be equal in terms of the contributions (Landsman, 2005). The structure of defining the intended financial statements was found to get increasingly complex in the following level with regard to the assets as well as the liabilities. The witnessed complications were observed to persist as the considered prices were at times drawn from particular index or even from other similar securities which shared the identical characteristics with regard to the one that was intended to be gauged. The ascertainment of the fair value in the final level with regard to the assets were considered to be solely model-driven, which consisted of the unobservable contributions and were also found to be reasonably inflated owing to the disorderly as well as illiquid development of the relevant markets (Chambers, 2008). Chapter 3: Problem Statement This research study is planned to focus on the effects of Fair Value Accounting on the financial reports of the banks. Accounting has been considered to be the backbone of any kind of business transactions. It was found from numerous studies and analyses that the forethought principles along with the historical-cost have been directing and channelizing the accounting related to the financial investments followed by substantial or rather fixed assets that are considered to be tangible in numerous jurisdictions across the world. This situation has however been predicted to likely undergo an alteration as an outcome of the growing amount of countries taking on or encompassing the concept of International Financial Reporting Standards (IFRS). This particular notion related to IFRS has been observed to initiate as well as implement the practice of accounting based on fair value to a certain degree. The fair value has been increasingly gaining popularity owing to its practicability related to accounting. Fair value has been found to ascertain the price of the assets as well as liabilities on the prevailing market price that is expected to be derived from them. However, the system of accounting related to historical-cost has been found to value the assets as well liabilities on the basis of past business dealings which was not considered to be feasible. Therefore, on the whole, the effects of the system with regard to Fair Value Accounting on the financial reports of the banks would remain the main focus of this research study. Chapter 4: Research Question Considering the general and specific problem being identified in the present research, the main aim of this research was set. The questions have been designed taking into concern the intention of the research. The research questions have been designed in order to gain an in-depth understanding regarding the aim of the study. The research question to be addressed in this research study is to analyse and find out the way the financial reports of the banks are influenced. The effects of this aspect of accounting still need to be comprehended in the present day context. To put it specifically, the contribution of fair value accounting (FVA) towards systematic risk in the banking industry needs to be still ascertained by comparing banks in Australia and Saudi Arabia. The banks selected for this research study are Common Wealth Bank of Australia, Australia and New Zealand Banking Group, National Australia Bank & Westpac Bank from Australia and Al-Rajhi Bank, Riyadh Bank, Banque Saudi Fransi and Saudi American Bank from Saudi Arabia. This would also help to comprehend the constructive consequences posed by fair value accounting on the financial reports of the banks. 4.1. Research Objectives The subject of this research study is quite broad however the main purpose of the study has already been identified. The research objective would facilitate to develop an understanding regarding the broad subject of this research study as well as give a direction to the research study. With regard to the identification of the aim of this research, the following objectives have been set which would lead towards the achievement of the aim: To comprehend the application of the standards related to FVA To ascertain the usefulness of fair values for the banks To comprehend the errors related to the measurement of the fair values Chapter 5: Research Methodology 5.1. Research Approach Research approach refers to the means or ways of research taken on by the researcher in the study. There are fundamentally two sorts of research approaches and they are the qualitative along with the quantitative approach. This study will be structured on a qualitative approach as the overall aim and the subject of the study would involve quite a few broad aspects which are quite challenging to be quantified. For instance, the study will entail the ascertainment of the acceptance and usefulness of the contribution of FVA towards systematic risk in terms of the banking industry by making a comparison of banks in Australia and Saudi Arabia. Therefore, it is evident that these aspects are descriptive in character and would involve extensive detailing which is possible through the qualitative research approach. Thus, it is apparent that qualitative approach will be best suited for this study owing to the descriptive nature of it which would make it difficult to be quantified (Kothari, 2008). 5.2. Data Collection & Analysis The information or data will be collected from secondary sources such as library materials. The sources will include journals, books, reports, articles and magazines. This will be observed to be quite suitable for the research study owing to the easy accessibility and the broad mixture of sources which will assist in making the research more precise and correct. Data collection will augment the degree of superior quality of the study and thus, it is important that the information is gathered from the right sources. The legitimacy of the sources considered in this study will also be considered as a reason behind selecting this process. The way of evaluating the information in this research study will be with the help of qualitative method. Qualitative method will be selected for the study as the data collected will consist of a wide range of information which will be to certain extent impossible to be quantified. Therefore, this approach of evaluating the data will justify the research study to be reliable. Chapter 6: Research Structure The first chapter will be concerned with ascertaining the basis of the research that initiated its foundation. For determining the importance of this research, the background study will be presented along with identification of the problem statement. The intention and the objectives of the entire research will be ascertained along with identification of the research questions which will be resolved throughout the research process. The second chapter will present the analytical findings of the various researches being conducted in the past. The findings will provide the formation of the path to be followed for the present research. In the third chapter of the research study, the methods which will be followed throughout the research process will be evaluated and justified. The methods will be inclusive of selecting the data source, data collection and data analysis. The fourth chapter will be designed with the presentation of the findings from the research process along with their analysis. The analytical findings will be explicitly utilised for drawing up the conclusion of this study. The conclusion will be derived and recommendations for additional research will be offered in the last chapter of the research. Chapter 7: Conclusion The specification setters in relation to accounting in numerous jurisdictions worldwide, even taking in the United Kingdom, European Union, the United States and Australia have been believed to structure specifications necessitating the detection or acknowledgement of the amounts related to their respective balance sheets at a fair value along with entailing the alterations in their respective fair values related to income. For instance, in case of the United States, a prerequisite was laid down by the Financial Accounting Standards Board in terms of identifying few of the derivatives as well as investment securities at a considered or estimated fair value. The mentioned conditions would also entail the factor of impairment such as loans as well as goodwill and also on the factor that any kind of derivative is being made use of to circumvent alterations with regard to the fair value such as loans, inventories and payments related to fixed lease. Constant endeavours are being learnt to be made by Financial Accounting Standards Board along with the International Accounting Standards Board in order to inspect the viability and practicability of granting permission for the identification of fundamentally the complete set of assets as well as liabilities at a particular fair value in relation to the intended financial statements. Therefore, the research will help to comprehend and ascertain the effects of FVA on the financial statement of the banks in the different countries. Chapter 8: References Chambers, A., 2008. How Do You Mark to Market? Euromoney, pp. 1-3. Carroll, T. J. & et. al., 2003. The Reliability of Fair Value Versus Historical Cost Information: Evidence from Closed-End Mutual Funds. Journal of Accounting, Auditing and Finance, Vol. 18, Iss. 1. Chea, A. C., 2011. Fair Value Accounting: Its Impacts on Financial Reporting and How It Can Be Enhanced to Provide More Clarity and Reliability of Information for Users of Financial Statements. International Journal of Business and Social Science, Vol. 2, Iss. 20, pp. 12-19. Ebling, P., 2001. Fair Value Accounting: Breaking A Butterfly Upon A Wheel? Balance Sheet, Vol. 9, pp. 22-27. Harris, T. & Ohlson, J., 1987. Accounting Disclosures and the Markets Valuation of Oil and Gas Properties’. The Accounting Review, Vol. 62. Kanagaretnam, K. R. & et. al., 2009. Usefulness of Comprehensive Income Reporting in Canada. Journal of Accounting and Public Policy, Vol. 28. Kothari, C. R., 2008. Research Methodology: Methods and Techniques. New Age International. Landsman, W. R., 2005. Fair Value Accounting for Financial Instruments: Some Implications for Bank Regulation. University of North Carolina, pp. 1-27. Magnolio, J., 1986. Capital Market Analysis of Reserve Recognition Accounting. Journal of Accounting Research, Vol. 24. Prasad, P. & et. al., 2011. Fair Value Accounting in the Finance Sector: A Fiji Perspective. International Review of Business Research Papers, Vol. 7, Iss. 1, pp. 282-300. Ryan, S. G., 2008. Fair Value Accounting: Understanding the Issues Raised by the Credit Crunch. New York University. Sinnett, W. M., 2007. New Fair Value Standards Stress How Not Just What. Financial Executive, Vol. 23, pp. 33-36. Wallison, P. J., 2009. Fixing Fair Value Accounting. OECD Journal on Budgeting, Vol. 9, pp. 99-105. White, M., 2008. Fair Value Accounting. The Fiji Accountant. Wier, H. A., 2009. Fair Value on Conservatism: The Case of the Gold Industry. Contemporary Accounting Research, Vol. 26, Iss. 4. Read More