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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)

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. 

What is Fair Value Reporting?

The figures represented in the financial statements are based on calculations and estimations. Therefore, in such scenario fair value reposting helps the users in deriving an understanding from the organization’s financial statements so as to make appropriate decisions. Users of financial statements get great support from fair value reposting which further allows them to take substantial investment related decisions. The figures projected in the financial statements entirely depend on certain expectations that are further based on a few calculations and estimations (Merchant, 2012). Due to such expectations considering various risks it is highly required. Fair value determination is a three-tier process for there is a strict preference given to measures that are related to the market.

Currently, in the era of rapid globalization and innovation, complexity arises which can be overcome with the means of using fair value as it adds more utility to the financial information provided in the financial statements which further helps the users in taking appropriate decisions. There is a lot of debate going on over the utility of fair value. Some also label fair value in the controversial box owing to the need for various other estimates by utilizing various inputs such as management’s expectations and other projections.

Taking fair value into due consideration, a new model is being developed which carries measurable inference on the items of the B/S. Fair value allows ascertaining the current price of an older transaction so as to dispose of certain assets and liabilities between the parties of industry considering the current standards. Fair value, in other words, is the price at which a liability could be settled between the parties of the market or an asset that could be exchanged or changed in the present market scenario (McDonough & Shakespeare, 2015).

FVA has become a subject of debate ever since the financial crisis that took place in 2008. The value of the underlying asset majorly determines the accounting and reporting of derivatives type of non-financial assets. It is why there are consequences faced in the market while reporting assets and liabilities at their determined fair value owing to the distorted financial statements. The efficiency of the market solely determines the fair value of an older transaction (Needles & Powers, 2013). Efficient the market, passing the tests shall be easier and vice versa. The criticism revolving around fair value measurement is minimized owing to the introduction of new AS. FV measurement helps in evaluating the price of even such assets and liabilities that are harder to be traded on the liquid market.

With the revolution in IT in the recent 20 years, the significance of fair value is also seemingly increased. Companies that earlier opted to prepare their statements on a basis other than FV measurement are now considering it which can be seen as notes to their financial statements.  The need for fair value has also gone up due to the increasing innovations and rapid globalization. The financial transaction over cross borders is also simple and hassle-free as it saves a lot of time. Fair value makes a valuation of non – financial items a lot easier and provides profound details that are required for acquiring or disposing of a financial asset. It is very much recommended nowadays for it helps in computing the value of certain intangible assets like goodwill. Fair value accounting has become popular and is in very much in demand owing to its significance in AS in the rapid globalization and various innovations. The significance of FVA in financial statements is huge owing to the globalization in the economy (Peirson et. al, 2015). Amidst all this, it must always be remembered that FVA is a set off between reliability and relevance related to the AS.

Importance of Fair Value Reporting for Users of Financial Statements

As per IASB/ FASB, FVA is inconsiderate of the price inefficient market conditions for the evaluations of the transaction is amidst parties that are rational, skilled, knowledgeable, and independent for they communicate with the motive of interrogating, providing and delivering thorough information of the related transaction. This is because of the private details offered by the market prices are more reliable than the details offered by the internal participants and the items those are regularly traded on a liquid market most likely offers the best-desired information owing to their market prices (Petersen & Plenborg, 2012). In the absence of such information, one can take market prices of such items into consideration. It is necessary to estimate the fair value on the basis of internal estimates and calculations when the above-mentioned methods cannot be taken into use.

The economic view is the basis of valuation and is the key driver behind the techniques so as to derive the fair value of a transaction.  It is not always necessary that fair value measurement encompasses the market tests in cases of all the assets and liabilities and this becomes a matter of subjectivity. For instance, when a class of assets is purchased, it is required for the Purchase Price Allocation to look for the difference lying amidst FVA and its purchase price. This difference between the purchase price of an asset and its fair value needs to be accounted as goodwill. It is absolutely true that the fair value of assets does not necessarily pass the market test completely (YooChoi & Pae, 2017). Purchase Price Allocation’s judgment is based on few assumptions which are rightly said in its own way and therefore, the debate on the fair value of assets can be agreed upon to a certain extent for it is not always that the fair value of assets qualifies the market test to a decent extent. Also, it should be noted that the fair value of assets is not the only and ultimate way to evaluate non-financial assets. FVA not only recognizes non-financial assets but at the same time is an ongoing measurement that includes judgment and estimation each and every time of reporting (Leo, 2013).

The annual reports of BHP Billiton and Rio Tinto have been selected for an enhanced understanding related to reporting of fair value by these companies. In relation to the hierarchies of fair value based on both the companies, it can be seen they have adopted valuation method as the key strategy. Besides, when it comes to Level 1 fair value hierarchy, both the companies have based their fair value valuation on unadjusted quoted prices in the active markets for all the financial instruments or assets and liabilities that are identical in nature. In relation to Level 2 hierarchy, both companies have valued the same based on inputs that can be seen or observed for the financial assets or liabilities either indirectly or directly. In other words, both have chosen observable market information for valuing their level 2 hierarchies. Finally, in relation to level 3, both companies have chosen valuation based on inputs that are not observable in the market. Therefore, both have not relied upon observable market data in relation to level 3 fair value hierarchies. Furthermore, in relation to tier assets, it can be seen from the annual report of both companies that they have primarily focused upon tier one assets. Moreover, primary focus on tier one assets has allowed both the companies to diversify their affairs throughout various countries. In addition, this assists them in facilitating low-cost options for creation of value and future growth. Besides, this also plays a key role in implementation of culture and value together with emphasis on productivity and safety through the deployment of technology and effective capital disciple to attain the most value from their assets. In addition to these discussions, it can also be observed that both the companies have chosen FVLCD method to ascertain the recoverable amount of assets. This method stands for fair value less cost of disposal wherein the recoverable amount of a CGU (cash generating unit) is measured based on the same and the amount is thereafter classified based on the hierarchy of fair value for observable data of market that is efficient with the unit of account for such CGU being examined. Overall, both the companies believe that the best evidence of such method (FVLCD) is the value attained from an active market.

Controversies Surrounding Fair Value Reporting

Furthermore, in relation to classes of assets, both the companies have believed in having a world class base of assets so that they can address the requirements of customers throughout the world and tier one countries on a whole. Further, both the companies have depreciated their assets like property, plant, and equipment (PPE) on a straight-line or production unit basis. Furthermore, in relation to trades and receivables, both the companies have identified the same at their respective fair values and thereafter, at amortized costs through the usage of effective interest method minus an impairment allowance. Besides, in relation to royalty receivables in the case of Rio Tinto, the company has measured the same on an estimate of forward sales but on the condition of royalty agreement. BHP does not have any asset like royalty receivables when it comes to measurement of assets based on fair value.

In relation to BHP Billiton, it can be seen that the company has tier one assets all around the world. These assets primarily comprise of underground mines, open-cut mines, offshore gas and oil production, onshore production, and other processing facilities. Besides, the company has grouped these assets into different segments to offer efficient governance and enhance performance increment (Laux, 2014). For instance, the gas and oil assets are grouped collectively into global petroleum group of assets, etc. In contrast to this, when it comes to Rio Tinto, even though it has focused on tier one assets as well, yet the assets are distinct from BHP. In other words, they have assets like aluminum, diamonds, and copper. Furthermore, Rio has not grouped its assets like that of BHP. Instead, it has framed distinct strategies and targets for these three lines of business (Rio Tinto, 2017). For instance, for aluminum, the company intends on offering security of supply to the smelter of product group. The prime focus is to drive costs down to enhance the position of refineries on the industry curve of costs (BHP Billiton, 2017). Similarly, other assets like diamonds and copper also has their own strategies and targets and are not grouped under a head like that of BHP. When it comes to fair value hierarchy, while Rio Tinto has primarily valued its financial instruments like assets and derivatives, BHP on the other hand have valued its financial assets and liabilities apart from financial instruments. For instance, based on the valuation hierarchy of Rio Tinto, it is observable that assets like trade and other receivables, equity shares, quoted funds, investments, come under assets whereas forward contracts, derivatives, etc come under the purview of derivatives. In contrast to this, BHP has not only valued its financial instruments like derivatives but has also valued financial liabilities like non-financial liabilities and total liabilities (BHP Billiton, 2017). Therefore, this is a major contrasting difference in the valuation hierarchy of both companies as one has not considered current assets like cash and total liabilities while one has considered the same as well.

Lastly, when it comes to fair value measurement of assets, when it comes to non-current assets, Rio Tinto has primarily valued the same based on fair value less cost of disposal basis (FVLCD) to compute the recoverable amount of the same. In contrast to this, BHP Billiton has not only utilized the method of FVLCD to compute the recoverable amount of its non-current assets, instead it has also utilized value in use method wherein the same is ascertained at the current value of the expected future flows of cash anticipated to arise from the regular utilization of the asset in their present form and its disposal. Lastly, the assets class of Rio are world-class assets that are intended to put the company in a position of being capable of investing in high-value growth. BHP’s assets class is focused towards diversification so that improvement in productivity can be attained in the upcoming tenures.

References

BHP Billiton. (2017). BHP 2017 Annual report and accounts. https://www.bhp.com/media-and-insights/reports-and-presentations  [Accessed 12 September 2018]

Leo, K. J. (2011). Company Accounting. Boston:McGraw Hill

Merchant, K. A. (2012) Making Management Accounting Research More Useful. Pacific Accounting  Review. [online]. 24(3), 1-34. Available from: https://pdfs.semanticscholar.org/6ccf/f78a452763f17ed5e4f4ddc6b96703801403.pdf Needles, B.E. &  Powers, M. (2013) Principles of Financial Accounting. Financial Accounting Series: Cengage Learning.

Peirson, G, Brown, R., Easton, S,   Howard, P. and Pinder, S. (2015) Business Finance, 12th ed. North Ryde: McGraw-Hill Australia.

Petersen, C. and Plenborg, T. (2012) Financial statement analysis. Harlow, England: Financial Times/Prentice Hall.

Yoo, C.Y,  Choi, T.H & Pae, J. (2017) Demand for fair value accounting: The case of the asset revaluation boom in Korea during the global financial crisis.  Journal of Business Finance & Accounting. 45(2), 92-114. Retrieved from: https://onlinelibrary.wiley.com/doi/abs/10.1111/jbfa.12266

McDonough,R.P & Shakespeare, C.M .(2015) Fair value measurement capabilities, disclosure, and the perceived reliability of fair value estimates: A discussion of Bhat and Ryan. Accounting, Organizations and Society. [online] vol. 46, 96–99. DOI: 10.1016/j.aos.2015.05.003

Rio Tinto. (2017)  Rio Tinto Annual Report and accounts 2017 [online]. Available from: https://www.riotinto.com/documents/RT_2017_Annual_Report.pdf [Accessed 12 September 2018]

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