Accounting Assignment Help writing analysis: Accounting Theory For Xin Lian

Accounting Assignment Help writing analysis Review:

Accounting Fair Value Accounting System

Southward journey of  the share prices of Qantas, Harvey Norman, Billabong and BlueScope Steel in recent months have put a big question mark on the authenticity on the their asset value which they report in their books of accounts versus their market valuation. Several listed companies have been culled out by corporate regulator ASIC where there have been massive fall in the share prices. In order to ensure that the value on which these companies carry their assets represent the fair value, these companies have been asked to drive the full-blown impairment test on their assets. The need to meet the accounting standards, considerably the standard which deals with asset impairment is a big concern for the companies and it has stimulated the ASIC’s hardline approach of impairing assets. Fall in market cap of a company below its book value is a major indicator that company needs to go for impairment standards. There has been immense volatility in the stock markets globally, as a result there have been major increase in the number of companies which are trading at a discount to their book value. It is an anfractuous situation for the companies as in case there is a massive fall in their share prices then they have to run the gauntlet of a full impairment test in order to assure ASIC that  proper accounting standards are being abide by them and fair value is being reflected for an asset. For this purpose they will have to do a lot of cash flow and assumption modelling. After the completion of this exercise, if company fails to prove that the asset is reverberating the fair value, then the board will be forced to make an impairment charges. This will again lead to the fall in the share price of the company, the fall which initially led to this whole process.

Let’s take the case of Computershare where a warning was made by the management that they may have to make an impairment charges in the range of $ 55 million to $ 65 million for second half of Financial year 2012. Marketing was already expecting  these impairment charges, but when company announced that the actual charges were less than what were expected there was a rise in its share prices. If we will talk about Qantas, there has been a fall of more than 30 percent in a week and its share price was about to touch the low of $1.11 after the warning of impairment charges and the kind of shock it would have given to the profit. In case we look at the property trusts, most of them are trading far below the backing of their assets of tangible nature. As a result there have been  question marks on the reliability of market players on market value of the companies as they are not sure whether the value that is being placed to property asset justify the existing market value of the company or not. Asset write down or impairment charges can abysmally affect the company. They may result in debt covenants of a company and bring down its return on equity.

The key agenda of ASIC is that the companies should make accurate disclosures about the assumptions which they follow or take into account while conducting impairment test on an asset. Increasing the level of scrutiny with respect to standards that are followed in accounting  is part of this activity. Another example for write-down is of Metcash, who has warned that the company will be writing an amount of around $ 133 million as impairment charges in the current financial year.

An in depth analysis of books of accounts of companies like Fairfax Media, BlueScope Steel, Qantas, Myer, Billabong and QBE has bring out the fact that out of total equity of $ 10.4 billion reported by these companies in FY2011, intangibles contribute almost $ 6.1 billion, more than fifty percent. This fact has led to the fall in share price of QBE, which now trades at $ 12.40 as compared to $ 17.28 a year ago. This fall in price of share of QBE has brought down its market cap to $14.6 billion.

As per the accounting standards, carrying assets at the price greater than its recoverable amount is an unacceptable practise. In case one is carrying the assets at price which is greater than its recoverable amount then they should follow a proper assessment procedure on the reporting date. For this assessment purpose external as well as internal sources should be involved to gather information. Interest rates prevailing in the market, prominent technological changes, primary as well as secondary financial markets, both economic as well as legislative environment , relation between market capital and net assets are some examples of external sources. Then internal sources include restructurings, evidence of obsolescence or damage to the asset.

The reason why market capitalisation is getting so much of focus is that it is an indicator which reflects how stock market is assessing the future value of assets of a company. Therefore it has become a focal point and management is expected to devote time to make it crystal clear why there are differences between the value at which net assets are carried and value at which these assets can be recovered.

Fair Value Accounting is a method through which calculation of assets and liabilities which are reported on the balance sheet of a company are done. Australian Accounting Standards 13 defines fair value as  the price that can be received in case an asset is sold or the price that one has to pay in case a liability is being transferred to a participant of a market at the measurable day.

Accounting standard AASB13 of The Australian Accounting Standards Board deals with the Fair Value Measurement under section 334 of the Corporations Act 2001.

The objective of this standard includes:

• Definition of fair value
• Framework for measuring ‘fair Value’ under single standard
• Disclosures required about fair value measurement

Fair value falls in the category of market based measurement and is not specific to an entity. There are some assets and liabilities for which getting information related to transactions which take place in market is easily available but in many cases getting authentic data and information related to market transaction is not an easy task.

However, the objective of a fair value measurement in both cases is the same –Fair value falls in the category of market-based measurement instead of entity-specific measurement. Observable market transactions or information related to market might be available for some assets and liabilities but not in case of all assets and liabilities. Irrespective of the availability of observable market transactions or information, technique of measurement of fair value remains the same in both the cases – Considering the conditions currently prevailing in the market, estimation of price, which can take place in case an orderly transaction is executed  between the market participants to sell the asset or to transfer the liability, has to be done (ie an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability).

In case the prices for an identical asset or liability is not available for observation, then  a different technique is adopted by an entity. Under this technique, observable inputs are given maximum priority and unobservable inputs are given minimum priority. Fair value measurement is a market based measurement. Thus while measuring fair values those assumptions which market participants would consider while calculating the same. These assumptions also take account assumptions with respect to risks associated with financial instruments. As a result, an entity’s intention to hold an asset or to settle or otherwise fulfil a liability is not relevant when measuring fair value. Assets and liabilities are the primary subject of accounting measurement and thus while defining fair value, significant focus is given on them. In addition, this Standard shall be applied to an entity’s own equity instruments measured at fair value.

Accounting professionals will be facing severe tests under this fair accounting system. There is no doubt that the level of transparency and validation is very low in case of cost accounting system. The financial crisis leads to continuous evolution and improvement of accounting standards

We are living in an unprecedented time. The volatility in the market is extremely high. Thus fair value accounting is the need of the time. There is no doubt that companies are surely not going to like the system of fair value accounting as it will put a big question mark on the values which reflect worth of their entity.

Refinement in the practice of fair-value can prove to be of great advantage. Under this system, the area under which asset is being valued is always open for review. Auditors generally prefer two types of indicators. First one are present value of an asset and discounted cash flow. Other category is ratios and prices of comparables assets.

Key Points

• Measurement and reporting of financial instruments are done at “Fair Value”
• Specific forms of financial modeling is used in order to estimate the fair value of a category of financial instruments.
• Most of the firms are equipped with world class internal control processes which ensures that the models used in these valuations are reasonable and reflect underlying market conditions
• Disclosures related to information and method used in calculation of fair value are available in the financial reports.

When a company is in the process of preparation of financial statements, it has to decide whether the recording of financial instruments should be done at their fair value or not. The decision depends broadly on two aspects. The first one is the category or type of institution who are owners of these financial instruments and second is the intention with which the instrument is being used. Let’s take the example of a brokers and dealers; in their case majority of their assets are tradable and therefore they must be recorded in accordance with the fair value accounting system. Another example is of Australian Treasury bond, suppose an institution takes a decision to hold the bond till its maturity, thus the original cost of the bond can be used for recording purpose. But if the same bond is purchased by an institution with an intention to sell it off in short term then for accounting purpose of this bong Fair Value Accounting System will be applicable.

Apart from purpose of complying with the requirements of reporting, for the purpose of internal processes also Fair value measurement system is used by companies. Some examples of these internal processes are decisions regarding investment and trading, risks measurement and management, determination of quantum of capital that should be devoted to various business lines and for the compensation calculation.

Effortless availability of market price of a financial instrument is quite essential for initiating the process of valuing a company on the basis of its fair value. Fair value can be defined as the price at which there is an agreement between buyer and seller to trade the financial instrument. Thus the main key for the purpose of valuation is the determination of right price.

There are levels of inputs which can be used to measure the fair value of  an asset or a liability. They are mentioned below:

Level 1 inputs: In case the prices of similar assets or liabilities are available in active markets then for the measurement of fair value these prices are to be used.

Level 2 inputs:  These level of inputs are applicable similar assets or liabilities are available in active markets as well as in  inactive markets. In addition other market data which is relevant to an asset or a liability is also available in case of level 2 inputs.

Level 3 inputs: In this level inputs are difficult to observe. They should be used to derive a fair value if observable inputs are not available, which is commonly referred to as a mark-to-model approach.

Scope

All transactions and balances, be it financial or non financial, comes under IFRS 13 and for them fair value measurement is essential. But there are certain exceptions as well. For example, transactions where payment is on the basis of shares and they are covered under IFRS 2. Another one is transactions related to lease which are covered under IAS 17 under the scope of “Lease”. Moreover there is also clarification regarding  the measurements which seems to be fair value but in actual they are not fair value. For example under IAS 2 “Inventories” and under IAS 36 “Impairment of Assets” are not within its scope as they are recorded on the basis of their net realizable value.

Following items have also been relieved by IFRS 13 as far as their disclosure requirements are concerned:

• plan assets where measurement is done  in accordance with IAS 19 “Employee Benefits”;
• Measurement of retirement benefit plan investments in accordance with IAS 26 “Accounting and Reporting by Retirement Benefit Plans”; and
• assets for which the recoverable amount is fair value less costs of disposal in accordance with IAS 36 “Impairment of Assets”.

An in depth dissection of ‘fair value measurement system’ by the International Accounting Standards Board (IASB) and the Australian Accounting Standards Board (AASB) brings out various doubts with respect to utilization of these measurements under the framework of current accounting standard. Some of them are listed below:

• Through fair value measurement system only the exit value of an asset and liability can be determined. However this system keeps silent on the significance of cash flows that can be generated by the firm in future. Thus the goal of providing information on the forecasted cash flows and their appurtenant risks is not accomplished through this system. In addition to this, under this system even the contribution made by the management to the value of shareholders.
• Second apprehension is about the lack of reliability as this system is exposed to biasness. The existing corporate governance regime is full of culpable practices. There are no crystal clear rules and regulations which can discourage them from cooking the books of accounts as under the current environment they do not have to face any aftermaths even if they are doing any manipulations in their financials. Even the auditors are least bothered for the interest of investors and work in favor of their clients as they get their fees from them only. In order to make carrying value and recoverable value in addition to other measures of accounting generated in compliance with principle-based rather than rule-based standards, it is necessary to blend the interest of directors, officers and auditors with those of investors.

In order to evaluate the performance of an economic entity analysts consider income as the key indicator. Instead of cash flows, investors are much bothered about the income or earning per share of a company. Net income which companies report in their income statement is a preferable tool than comprehensive income which companies report in their statement related to change in equity. In fact in case of  comprehensive income, companies extended financial fields are incorporated by companies and therefore this income is more transparent tool to measure income. According to Hodder et al. (2006), in terms of volatility, net income is the least volatile indicator of all financial indicators. The level of volatility is maximum in case of Full fair value income (FFVI), as it includes all financial instruments at fair value. However, comprehensive income is the middle route between net income and FFVI.

Another preferred financial indicator which analyst use frequently is equity of shareholder or shareholder’s equity (SE). This indicator is used for the calculation of level of gearing and level of solvency of an entity. Financial stability of an entity has different levels of gearing (Brierley and Bunn, 2005). Commercial banks will be exposed to extended volatility once Fair Value Accounting System will be enforced. Thus the entities involved in the preparation of financial statements and regulators who are responsible to bring financial stability are the one who are majorly worried for this volatility. As fair value accounting system will be implemented on more and more number of financial instruments, financial statements will become more and more volatile (Boyer, 2007; Novoa et al., 2009; Plantin et al., 2008a, Plantin et al., 2008b).

Conclusion

It is very rare to hear that some accounting standard has become a hot bed of passion and debate in financial markets. However, there have been heated speculations in the backwash of the financial crisis in the financial markets globally that whether fair value accounting practices have worsened the situation and has let to the increase in volatility in the market. Politicians, economists, business leaders and professional associations have traded opinions in a discourse that seems set to have long-term implications for auditors, financial controllers and company directors as they go about their respective corporate duties. As the dust settles, it’s timely to consider the nature of fair-value accounting versus historical-cost practices.

The debate on application of Fair Value Accounting system is a decade old. People who support it claims that it will bring transparency in the working of a company and people who oppose it argues that it will only result in undesirable actions from banks and firms. There is another school of thought relation to fair value accounting system which says that the assets which a company is holding from a long period of time, particularly with the view of their maturity benefit. Factors like inefficiencies prevailing in the market, irrational behavior of investors or liquidity crunch can disfigure their true value. Thus people with this believe that Fair value derived by these models are not reliable.

MC98

If you need Assignment Help guidance to help you write professional Accounting Assignment help essay’s?

Receive assured help from our talented and expert writers! Did you buy assignment and assignment writing services from our experts in a very affordable price.

To get more information, please contact us or visit www.myassignmenthelp.Com