TOPIC 4

ISSUES ON THE
APPLICATION OF
ACCOUNTING STANDARDS
Fair
Presented
for: Value Accounting
Dr. Syahrul Ahmar Ahmad
Presented by:
Azlina binti Ahamat
Nazurah binti Bistamam
Nurul Syazwani binti Rosli

Question 4
Critically discuss the use of
FV measurements on the
assets and liability in the
financial statements

Answer
Landsman (2007)
According to Barth (1994), finds that
investment securities fair values are
incrementally associated with bank share
prices after controlling for investment
securities book values.
Barth et al. (1996) also find evidence that
loans fair values are also incrementally
informative relative to their book values in
explaining bank share prices.
Fair values of loans reflect information
regarding the default and interest rate risk of
those loans.

 They consider requiring disclosure or

recognition of tangible fixed assets at fair
value.
Regarding managerial discretion in
determination of revaluation amounts, the
study also finds little evidence indicating
independent appraiser based revaluations are
more relevant than director based estimates.
In contrast to the findings in Barth and Clinch
(1998), Muller and Riedl (2002) find evidence
that the market finds asset revaluations
estimates made by external appraisers are
more informative than those made by internal
appraisers.
Aboody et al. (2004), although both studies
provide evidence that employee option
expense is value relevant to investors.

Answer : Georgiou & Jack(2011)

Use of FV measurement on the
asset
In IAS 16 Accounting for Property, Plant and
Equipment, assets acquired in exchange for other
assets might be recorded at the fair value of the
assets given up, and a similar requirement applied to
assets acquired in exchange for shares.

Use of FV on the asset

IAS 18 Revenue Recognition, observed that the amount of
revenue in an exchange of non-monetary assets is normally
determined using the fair value of the assets exchanged, whilst
IAS 22 Accounting for Business Combinations also included
reference to fair values.
FRS 15 Tangible Fixed Assets, which permits a choice as to
whether tangible fixed assets are stated at cost or at a revalued
amount. These standards contained the concept of fair value
which during the 1990s played an increasingly prominent role in
the standards of the IASC and several national standard setters.
Through IAS 40 Investment Property that applies FVA to nonfinancial assets and IAS 41 Agriculture (both issued in 2000)
requiring the FVA model to be implemented by all enterprises
that undertake agricultural activity.

Use of FV measurement on the

liability
first included the concept of fair
value in the 1977 drafts of IAS 17
Accounting for Leases. In IAS 17, fair
value played a role in determining
the classification of a lease as either
a finance lease or an operating lease,
as well as in the determination of
profit or loss in sale and leaseback
transactions.

Issues of implementing FV
measurement

use of fair values will be emphasised

wherever necessary to obtain faithful
representation.
harmonisation of the reporting standards
of over 100 countries to those of the IASB,
implies a level of regulative legitimacy for
FVA. However, this legitimacy is limited by
the weak enforcement mechanisms in
place.
The IASB does not have the power to
enforce the standards it promulgates in
practice and FVA is resisted at the national
level (especially by code law jurisdictions).

Question 5
The use of fair value
measurements provides
more relevant information.
Discuss.

Answer
Ball (2006)
According to Ball (2006) has stated that the
FV accounting rules aim to incorporate moretimely information about economic gains and
losses on securities, derivatives and other
transactions into the financial statements,
and to incorporate more timely information.
Fair value incorporates more information into
the financial statements.
Incorporating more information in the
financial statements by definition makes them
more informative, with potential advantages
to investors, and other things equal it makes
them more useful for purposes of contracting
with lenders, managers and other parties.

Answer
Landsman (2007)
According to Landsman (2007) the fair values
would mitigate the use of accounting motivatedtransaction structures designed to exploit
opportunities for earnings management.
Fair value accounting for all financial instruments
would reduce the complexity of financial
reporting arising from the mixed attributed
model.
The research findings suggest that disclosed and
recognized fair values are informative to
investors, but that the level of in formativeness is
affected by the amount of measurement error
and source of the estimates management or
external appraisers.

Answer
Oncioiu et al. (2012)
Each of the current values measures a current rather
than an historical attribute of the asset and looks to the
market rather than the specific transaction for evidence,
but this leads, in each case, to a degree of estimation,
because the current measures are not based on actual
transactions but upon transactions that might take place
in markets that are far from perfect and, in the extreme,
may not even exist.
These decisions are assumed to be primarily those made
by an investor, and they therefore relate primarily to the
prediction of future cash flows. However, prediction does
not imply merely forecasting, and the concerns of
stewardship are also assumed to be included in the
objective.

Answer
Oncioiu et al. (2012)
Continued
However, when the cost measure used is the
historical cost, it could be argued that such
measures cannot be compared in an
economically meaningful way because the
measure is dependent on the time of acquisition,
which will differ across different assets.

It may still be helpful to users to have a

common valuation objective, imposing
consistency of purpose, even if the
techniques used to achieve it may vary
according to asset type.

Answer
Deans (2007)
The fair value information to vary in relevance
depending
on
sector
which
price-to-book
measures are widely used for valuation purposes,
and therefore fair value information for balance
sheet items to be more value relevant in these
sectors.
The extent of usefulness of fair value information
to depend on the types of assets and liabilities.
The FV frequently involve adjusting for the value
of investments, associates, minority interest
share of the business, options outstanding,
pension fund deficits.

 There are some fair value measurements

that investors routinely incorporate into
their company valuations, though not
necessarily relying on information in the
accounts and this fair value is relevant.
The fair value information would only have
to be a little bit relevant and a little bit
reliable to be more useful than the
alternatives.

Answer
Qudah (2012)
The fair value measurement and disclosure
supposedly provide appropriate information to
rationalize the decision making process
The greater quality of accounting information
and best informative content of the financial
reporting for managers on various organizational
levels or other stakeholders associated with the
organization.
Poon (2004) reported that fair-value accounting
provides more suitable and meaningful
information to decision-maker than the historical
cost accounting.
The fair value depends more on many estimates such
as future monetary flows and discount rates in cases of
illiquid markets.

 Penman (2007) stressed on the advantages of the

fair value from perspective e of proponents arguing
that investors are much concerned with value
rather than cost, so fair value should be reported.
The fair value has been issued considering its
perceived features and the meaningful information
they provide to help market partners make
different decisions.
The fair value also considered as more relevant
compared with historical costing provides better
indication to current risk, and as a result enable
investors take corrective actions with respect to
corporate decisions.
The fair value is an ideal model reflecting present
market conditions; provide timely information
which increases transparency, and encourages
instant corrective action.

Answer:
Penman(2007)
Benefits of FVA
Investors are concerned with value,
not costs, so report fair values.
With the passage of time, historical
prices become irrelevant in assessing
an entitys current financial position.
Prices provide up-to-date information
about the value of assets.

Benefits of using FVA(cont)

Fair value accounting reports assets
and liabilities in the way that an
economist would look at them; fair
values reflect true economic
substance.
Fair value accounting reports
economic income
Fair value is a market-based measure
that is not affected by factors specific
to a particular entity;

Answer
Penman(2007)
FVA
the balance sheet becomes
the primary vehicle
f or conveying information to
shareholders;
the income (profit and loss)
statement reports economic
income because it is simply
the change in value over a
period;
income reports the
stewardship of management in
adding value for shareholders.

HCA
the income statement is the
primary vehicle for
conveying information about
value to shareholders
current income forecasts
future income on which a
valuation can be made;

earnings measure the

stewardship of management in
arbitraging input and output
markets, that is, in adding
value in markets.

Penman(2007) ..cont

FVA
(unexpected) earnings, being a
shock to value, reports on the risk of
the equity investment.
Volatility in earnings is informative
for value at risk;
the P/E ratio is Price/Shock-to-value,
that is, a realisation of value at risk
(with a very different interpretation
to that under historical cost);

income reports the stewardship of

management in adding value for
shareholders.

HCA
earnings do not report shocks
to value, but shocks to trading
in input and output markets;

the P/B ratio is typically not

equal to 1.0 and the P/E ratio
takes current earnings as a
base and multiplies it
according to the forecast of
future earnings;
earnings measure the
stewardship of management
in arbitraging input and output
markets,that is, in adding
value in markets.

Answer: Song & Hang Yi(2010)

Source of information used in fair value measurement:

Level 1- Valuation based upon quoted prices for identical
instruments traded in active market.
Level 2 Valuation based upon quoted prices for similar
instruments in active markets, quoted prices for identical or
similar instruments in markets that are not active, and modelbased valuation techniques for which all significant assumption
are observable in market.
Level 3 Valuation generated from model-based techniques
that use significant assumption not observable in the market.
These unobservable assumption reflect our own estimates of
assumption that the market participants would use in pricing
the assets or liability.
Valuation techniques include use of option models, discounted

1) Value relevance of level 1 and level 2 fair

value is greater than the value relevance of
level 3 fair values.
- Level 3 fair values are less observable. The more
subjective nature of level 3 fair value lead to
greater estimation error by management.
- Less reliable accounting information reduces the
ability of investors to monitor managerial
behaviour, potentially reducing the firms
operating performance and future cash flow.
- As the quality of information is reduce, investor
lose their ability to link the activities of the
manager to firm performance. This means,
manager will act less accountable for their actions
and operate the firm less efficient.
- Therefore, investor are likely to decrease the
weight they place on less reliable Level 3 fair
values measurement in their equity-pricing
decision. Investor will choose Level 1 fair value

2) Value relevance of fair value

(especially Level 3 fair values) is
greater for firms with strong
corporate governance.
-This is because, firm with independent
boards, highly financial literate audit
committees, active audit committees, the
presence of institutional investors, audit by
auditors from large office, and no material
control weaknesses are less likely to engage
in financial reporting biases.
-Managers may manipulate inputs for fair
value for their own interest. However, with a
good corporate governance, this can be
reduce and the information provided will be
more relevance.

3) Fair value hierarchy disclosure

disaggregating type information with
level information will increase value of
relevance to the information
-Matrix format for reporting fair values
based on assets/liability type and level of
input will provide more relevance
information.
-This will depends on how investors
differentially value inputs across the three
levels and whether the firms report
sufficient fair value assets and liability
types.

Conclusion
Fair value is the best available methodology
for determining and reporting the value of
financial instruments compared to historical
accounting
However, if it had been implemented poorly,
both FVA and HCA can produce misleading
information and lead to risk accumulation
problems and the potential for market
distortion(Greenberg et.al,2013)
Thus, improving the quality of both FVA and
HCA information in financial statements
should be a priority consideration for
policymakers.