Corporate Fair Value Reporting: Relevance In The Contemporary World Essay.

The topic that relates to the assignment is on Corporate Fair Value Reporting. The group will be required to investigate any 2 ASX listed companies on the above topic

Statement:

Laux and Leuz (2009) argue that “the fair value debate is far from over and much remains to be done” (p.833). As well, Whittington (2008) argues that “in a realistic market setting, the search for a universal measurement method may be fruitless and more appropriate approach to the measurement problem might be how to define a clear measurement objective and to select the measurement method that best meets that objective in the particular circumstances that exist in relation to each item in the accounts”. (p.139)

Required:

Based on the above arguments, write an essay on the relevance of fair value accounting in the contemporary world. In your demonstration you should highlight of whether fair value accounting is applicable for a wide range of private and public sector organisations in corporate reporting. Also, explain whether fair value accounting has had any influence on the subprime and/or other crises in the contemporary world. The expectation is that a reasonable amount of research articles (academic and professional) are used in the body of the essay.

The topic that relates to the case study assignment is on Corporate Fair Value Reporting. You will be required to investigate 2 ASX listed companies corporate reporting on Fair Value.

You are required to down load the financial reports of any two selected companies and identify the required information from the notes on fair value disclosures. You need to compare and contrast as to how two companies’ fair value disclosures are made. In your presentation, you need to identify and report on comparative fair value hierarchies, tiers, and methods used for differing classes of assets by the selected two companies.

Relevance of Fair Value Accounting

It is observed that for the past two decades the practice of fair value accounting to measure the asset and liabilities at estimated current value is rising rapidly and the measuring process is very different from the traditional historical cost book-keeping method. The changing pattern of asset and liability measurement has a huge impact on the business world effecting the business activities, investment choices, management decisions, and the same pattern also is responsible for major economic consequences (Laux and Leuz, 2009). The supportive theory of fair value accounting states that it is more relevant for the accounting information but the historical cost accounting is more reliable. In this context, the 1929 Wall Street crash and the blame of dubious practices for Fair value accounting is significant as the process was banned by the US SEC for 40 years (1930-70).

In the 2008 financial crisis, some scholars blamed the accounting based performance metrics as the major reason behind the banking and financial management issues. The securitized assets were recognized as net income during the rise of asset price (2008) and after the price fall, the Fair value accounting was directly accused of the issue. However, the issue has not stopped the usage of Fair value accounting in many countries as the generally accepted principles and the key included terms are derivatives, hedges, stock options, financial assets, and goodwill testing.

In terms of financial theory this accounting process is popular because the theme considers the financial market as efficient with prevalent prices and proper value-based measurement activities. The key objectives of accounting information are to reflect two things and they are relevance and reliability (Whittington, 2008). To increase the usefulness of the financial reports FVA provides a variety of functions more relevant than the traditional method. In this context, the information receivers are important and they are usually the creditors, investors, and stakeholders. However, the reliability concerns include the non-traded instruments and different managerial decisions. The closing term for the company ledgers was long been dominated by the accounting periodicity in terms of balance sheets and income statements.

Again, the traditional system uses double entry bookkeeping and transaction reporting where the gain and losses are real indicators. In the historical cost method, the matching principle is the robust theme which has dominated the financial environment for a decade. But the emergence of FVA has made it clear that the investors, creditors, employees, and communities are preferring the FVA in terms of value relevance (Chen et al, 2017). With the dynamic economic structure, the usefulness of financial statements have become more important and GAAP determines that Fair value refers to the price of an asset in the current transaction environment excluding the liquidation factor. Moreover, the balanced sheet confirms the Fair value of a liability covers the transfer scenario of market participants excluding liquidation. So, the active market and its reference market price must be a key theme of Fair value measurement. That means FVA is applicable for wide range of public and private sector financial reporting.

Comparison of Fair Value Disclosures of Two ASX Listed Companies

However, in practice, it is observed that reference market prices are not easily available. That means the estimated fair value is facing the best information availability issue in the marketplace. So, the measurement guidelines are creating an inconsistency with its evolving nature for the GAAP. In case of large and established companies, there are many examples of derivative trading and high losses which is a threat for the key investors. In this context, the interest swapping case (1994) of Procter & Gamble and the loss of 157 million dollars is significant where the company disclosed the case after the closing of the transactions (Amel-Zadeh et al, 2017). Again, many whistleblowing reports including the Enron case have confirmed that financial environment needs better guidelines for value and auditing in present time. Therefore, the FVA can help accurately in case of high-tech and service-oriented economy, regulatory issues, standard settings, and accounting projects.

In the recent dynamic and volatile market, people are more interested in the current worthiness of the assets. That means the FVA is a better choice in terms of transparency than the conventional measurement process. The FVA measures the assets and liabilities using three types of inputs. The level one input covers the availability of quoted price of the similar assets in the market while the level two includes the observable data of both inactive and active markets as well as other relevant data. Finally, the level three input covers the inputs like model assumptions which are unobservable inputs. So, the FVA approach increases the scope of relevance considering different input situations including the market-to-model approach. Another important thing is that the IFRS definition of Fair value is similar to the FVA definition which means asset exchanged, liability settings and transactions have similar themes like the FSA 157. As an example, the IAS 39 uses maximized valuation techniques for the observable inputs. The supportive statements confirm that the FVA can reflect current marketing conditions by timely information in case of asset and liabilities but the contradictory statements state that the corrective actions in terms of transparency sometimes add undesirable actions misleading the assets in case of long-term planning and maturity (Magnan et al, 2015). So, the distortion in pricing can lead to market inefficiencies as well as investor irrationality and liquidity. That means the dependence of Fair value on the models may lead the procyclicality of the financial environment in case of FVA.

Impact of Fair Value Accounting on Subprime and Other Crises

So, the potential concerns of the FVA make the scholars and investors look again in the traditional alternative or the historical cost accounting. In terms of liquid assets the HCA may not be suitable but for the long-term loans, it may be helpful. During financial crises, the FVA was often suspended but the HCA is not always a relevant information providing approach. Again for the investors the current market value and for the banks, capital requirements aim for the future changes which mean market value and liquidity are important for margin determination (Chircop and Novotny-Farkas, 2016). In this context, the explicit HCA limitations indicate FVA as a great choice. Moreover, the observed prices in case of fundamental values sometimes are limited for the market-to-market approach. So, the transaction costs, arbitrage and market prices face behavioral bias limiting the additional information. However, FVA never limits the additional information disclosure covering estimated values and market reactions.

It seems that FVA has a consistent theme with coherence and simplicity. So, the intuitive and simplistic view supports this approach while imperfect and realistic market conditions limit the opportunities of FVA. In terms of standard setting operations, the relevance issue may pass but the logical coherence introduces some major concerns for the FVA. For industrial specificity in case of the fundamentals like income, saving and depreciation the current cost measures of the HCA seem more relevant and the pure theory confirms income as an ill-defined idea in the incomplete market scenario (Xie, 2016). For perfect market conditions, the sustainable earning options are more important and the market is fully informed determining the focus on the option pricing theory. That means the subprime market can be influenced by FVA in terms of risk-based pricing disclosure and securitization of rates.

Conclusion:

So, it is impossible to deduce a theoretically correct accounting measure for general accounting issues as the economic consequences are diverse too. Moreover, the different economic theories like game or agency theory are relevant for different issues confirming more developed tool than FVA. In this context, the deprival value with its result specific algorithm is important and FVA introduces volatility, contagion issues where the prudential regulation needs counter-cyclical capitals for the financial stability (Livne and Markarian, 2018). Ignoring market price and capital information cannot provide a robust financial system. So, the FVA approach is effective but it needs more improvement for scenarios like financial crises, implementation especially for the litigation risks. Finally, it is confirmed that considering the securitization issues and additional information limits of HCA a more progressive FVA model is required for the current financial environment.

Fair Value Accounting and Financial Theory

References:

Amel-Zadeh, A., Barth, M. E., and Landsman, W. R. (2017). The contribution of bank regulation and fair value accounting to procyclical leverage. Review of Accounting Studies, 22(3), 1423-1454.

Chen, W., Shroff, P. K., and Zhang, I. (2017). Fair value accounting: Consequences of booking market-driven goodwill impairment.

Chircop, J., and Novotny-Farkas, Z. (2016). The economic consequences of extending the use of fair value accounting in regulatory capital calculations. Journal of Accounting and Economics, 62(2-3), 183-203.

Laux, C., and Leuz, C. (2009). The crisis of fair-value accounting: Making sense of the recent debate. Accounting, organizations and society, 34(6-7), 826-834.

Livne, G., and Markarian, G. (Eds.). (2018). The Routledge Companion to Fair Value in Accounting. Routledge.

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

Whittington, G. (2008). Fair value and the IASB/FASB conceptual framework project: an alternative view. Abacus, 44(2), 139-168.

Xie, B. (2016). Does fair value accounting exacerbate the procyclicality of bank lending?. Journal of Accounting Research, 54(1), 235-274.

URLs:

https://hbr.org/2013/03/why-fair-value-is-the-rule

https://www.alanyoonassociates.com/news/fairValueAccounting.pdf

https://www.audytax.mx/wp-content/uploads/2015/07/Laux-y-Leuz-2009.pdf

https://www.um.edu.mt/__data/assets/pdf_file/0011/135668/Fair_Value_and_the_IASB_FASB_CF_Project.pdf

https://files.stlouisfed.org/files/htdocs/publications/review/06/01/ChomPennCross.pdf

The aim of this report is to investigate and compare two ASX listed company reports of fair value. Therefore, from the current ASX list, two Australian company is chosen and they are ANZ and NAB. These two financial institutes are two of the Big Four banking structures of Australia. From the official sites of the financial entities, the recent financial reports are downloaded and considering them the comparison is made on different classes of assets in terms of hierarchy, tier, and methods.

The financial reports of both ANZ and NAB highlight the fair value disclosure in the accounting sections. In the case of ANZ, the information is provided in the condensed consolidated financial statement while the NAB introduces the same in the principal accounting policies. The disclosures are compared below:

Hierarchy & Tier::

In the case of ANZ financial assets and liabilities considered at the fair value is based on the AASB 13 for the observed inputs and there are three levels of inputs. The first level of input includes active market valuation on the quoted price and the same is compatible for identical assets and liabilities. The second input level covers the valuation inputs other than the level 1 based quoted prices and consider both the direct and indirect components ("CONSOLIDATED FINANCIAL STATEMENTS", 2017). In case of the third level of input significant unobservable components are considered for fair value measurement.

Concerns and Limitations of Fair Value Accounting

For NAB the fair value for financial instruments is basically carried at the amortized costs and the three level of inputs are visible here too. The level one input means the value of reference for unadjusted quoted prices and covers the Commonwealth of Australia and New Zealand government exchange-traded derivatives, bonds and spots. In case of the second level of input the major points are price or price derivative based financial assets and liabilities excluding level one and may include over-the-counter trades, hedges,semi, and corporate bonds, mortgage securities, issued bonds, subordinated debts etc. The third level of input covers unobservable market information based components which increase the market complexity due to liquidity issue. So, the third level of input includes bespoke derivatives, trading derivatives with credit adjustment issues etc.

Methods:

The bank ANZ has described the fair value approaches in the "approach and valuation technique" section where recognition, measurement, and purposes receive equal importance. As an example, the financial instruments are classified in the following classes:

• Short sold securities and trading securities
• Derivatives of financial assets and liabilities
• Ready to sell assets and other available assets

Moreover, the other asset or liability components are net loans, deposits, insurance and advances as well as the held asset and liabilities for sale. Therefore, the fair value methods cover the valuation techniques and discounted cash techniques. Apart from this, there are agreed sales prices before the transaction. The valuation techniques are for the observable inputs while the discount cash flow technique is useful for the future cash flow and discount rates in the case of wholesale markets and terms of maturity. The overall measurement disclosure is highlighted efficiently in the form of measurement table where the audience can see the types of assets, liabilities and total value. The unobservable market data is discussed in detail considering structured credit products, reversed mortgages, equities in terms of the material transfer and investment backing policy. The disclosure of ANZ also covers the available for sale investment issues in the Tianjin branch and sensitivity issues. Finally, the deferred financial gain and losses, as well as classes excluded from FVM, are also given in the disclosure.

For NAB the fair value is defined as the receivables from the asset sales or liability transfer among market participants at the specific measurement date. Therefore, the loans and advances cover the variable rating without the repricing tenor and they are calculated by the discounted cash flow model considering maturity, interest rate and performance. Again, the deposits and other borrowings are considered as the non-interest-bearing which means DCF model is applicable here too with the focus on the repricing fixed rates ("NAB: Annual Financial Report", 2017). In case of bond, notes, subordinated debts and other debts again the same mode is used covering the instrument maturity. The balanced sheet confirms that if the quoted market price is not available then credit value adjustment balances the credit risks in terms of interest rate and liquidity. Moreover, the counter derivative issues are covered by the fund value adjustment process. In case of the equity instruments, the actual and forecasted financial positions are considered while the trading and hedging derivatives are covered by the quoted closing market prices. This bank also highlights the instruments and financial components in the tabular format.

Conclusion:

From the financial reports of the two banks, it seems ANZ uses more flexible methods while NAB has a robust reporting structure. The example and definition based reporting structure is an advantage of NAB report in comparison to the ANZ report.

References:

CONSOLIDATED FINANCIAL STATEMENTS. (2017). Retrieved from https://shareholder.anz.com/sites/default/files/pk_1h18_anz_consolidated_results_announcement.pdf

NAB: Annual Financial Report. (2017). Retrieved from https://capital.nab.com.au/docs/NAB-2017-annual-financial-report.pdf

https://shareholder.anz.com/sites/default/files/pk_1h18_anz_consolidated_results_announcement.pdf

https://capital.nab.com.au/docs/NAB-2017-annual-financial-report.pdf