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BAO3309 Advanced Financial Accounting Assignment

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  • Course Code: BAO3309
  • University: Victoria University
  • Country: Australia

Question:

The choice between fair value and historical cost accounting has been a widely debated issue in the accounting literature (Christensen & Nikolaev, 2013). However, the conceptual framework for international financial reporting (hereafter the IASB Framework) and the equivalent AASB Framework does not prescribe a specific measurement base to account for the key elements in financial reports (the IASB Framework 2010). Specific measurement methods for different accounting elements are provided in the specific international financial reporting standards (IFRS). Unlike most other accounting standards, IFRS provides a free choice between fair value and historical cost accounting for the non-financial asset groups: property, plant and equipment (PPE) (see IAS 16) and intangibles (see IAS 38). This has resulted in variations in valuation practices for PPE and intangible assets.
 
Required

1.Refer to the current IASB Framework and IFRS 13 Fair Value measurements, briefly explain the measurement concepts in relation to historical cost and fair value accounting.
2.Evaluate the benefits and challenges of using historical cost and fair value accounting for PPE and intangibles, by reviewing accounting literature.
3.Identify valuation practices (in relation to the use of historical cost and fair value accounting) for the following non-financial asset groups: PPE and intangibles, by reading the ‘accounting policy’ sections of three listed companies’ 2016 annual reports.
Note: You are required to select one company listed London stock exchange, one company listed on the New York Stock Exchange, USA, and the third one is selected from the Australian Securities Exchange.
4.Analyse if the valuation practices for PPE and intangibles are consistent across the three companies.
5.What is your opinion on the free choice between historical cost and fair value accounting for PPE and intangibles:  should such free choice be continued in practice? Or should it be abandoned? Justify your answer.
 
 

Answer:

Introduction:

The report is prepared to evaluate the valuation practice of non financial assets of companies regarding their non-financial assets such as intangible assets and plant, equipment and property. Valuation practices are analyzed in terms of fair value and historical cost accounting. It has been depicted from the analysis of literature review that these two methods of accounting often come under debate regarding its applicability. Provision of free choice as suggested by IFRS for the non financial assets group have been debated as any particular method cannot be made universal as one is suitable in any particular scenario while other is suitable in another scenario (Palea 2014). Report presented here also demonstrates the benefits and challenges under both the accounting method. For the purpose of evaluation, three companies from three different stock exchanges have been selected. Rio Tinto limited listed on Australian stock exchange, Yamana Gold Inc listed New York exchange and Acacia mining plc listed on London stock exchange.

Rio Tinto is a leading mining group that is involved in mining and processing of natural resources of earth and was established in year 1873. Acacia mining is one of the largest gold mining producers and is a public company of UK. It is involved in extracting gold from underground mines and open pits and conducts several exploration projects. Yamana Gold plc is company a sustainable producer of gold offering increased leverage and significant exposure through growth of mineral resources. All thee selected three companies have been evaluated for the valuation techniques of their respective non financial assets.

Explanation of the measurement concepts in relation to fair value accounting and historical cost:

Fair value as per IASB is defined as the price received in an orderly transaction between market participants by transferring liability or selling assets. Certain concepts of valuation have been set out as per IFRS 13 that assist in fair value determination. Fair values for non financial assets are determined based on highest and best use of assets that is determined by the market participants. It is indicated by the standard that determination of highest and best use of non financial assets, organization should consider all the uses that are physically possible, financially feasible and legally permissible (Ellul et al. 2015). On other hand, historical cost is a basis of measurement that is used by organization for pricing the assets based on their historical or original price. Initial costs that are incurred on assets acquisition is used for measurement under historical accounting.

The objective of fair value measurement is to estimate the price of underlying assets under the current market conditions and as determined by market participation. When the economic benefits of such assets cannot be accessed, then they are measured at existing or current use. On other hand, historical accounting reflects investment’s opportunity costs. As per IFRS, if an organization chose to value the non financial assets at fair value, any changes in value of investment property will become a component of operating income and such assets will be subjected to depreciation (Mayo 2017). On other hand, company choosing historical cost method, acquisition cost must be systematically depreciated and the fair value should be disclosed in notes to financial statements. Any positive changes in assets fair value is credit to revaluation reserve (Taplin et al. 2014). Accounting treatment of intangible assets is similar to that of PPE under fair value and if there exist an active market for the assets, company has the choice of applying only fair value.

Evaluating the benefits and challenges of using historical cost and fair value accounting for PPE and intangibles:

Benefits of fair value and historical accounting:

Valuation of PPE and intangible assets using fair value would provide users with timely and reliable information. It provides accurate information of assets on ongoing basis as the current market price reflect actual price that will be received by selling such assets. Understanding the market scenario would provide users with inputs into their process of decision making. Historical cost accounting method is verifiable on independent basis and is generally free from bias. True income is reflected on the balance sheets as the fair value method limits the ability of company for potentiality manipulating the net income. Historical accounting also comes with least affecting the accounts with any personal judgement of management (Smith and Smith 2014). Investors finds easy to make comparison between companies using fair value and thereby receive assistance in their decision making process.

Challenges of fair value and historical accounting:

Under fair value, it is certainly possible that there will be wide fluctuations in assets value on an ongoing basis. Such volatility can provide or mislead investors with wrong information. Historical costs do not incorporate time value of money in the measurement of the non financial group of assets and does not reflect ongoing change in inflation. Constant value cannot be regarded as realistic and the cost of operations is not matched with the revenue generated. Therefore, it fails to reflect actual scenario of business (Lubbe et al. 2014).

 

Valuation practices of non financial assets groups of three listed companies: 

From the analysis of annual report of Rio Tinto, it is ascertained that Plant, property and equipment valuation is done at cost by deducting the accumulated depreciation and impairment charges (Riotinto.com 2018).

Acquired intangible assets are recorded at costs and they are tested annually for the impairment purpose (Riotinto.com 2018).

Now, evaluating the annual report of Acacia mining plc for their valuation techniques in relation to property, equipment and plant along with intangible assets depicts that they are stated at cost. Acquisition cost is the estimated value of probable and proven reserves as indicated by inferred sources resulting from acquisition of assets and business combination (Acaciamining.com 2018).

On other hand, acquisition of intangible assets by way of business combination and asset acquisition are recognized if the assets are separable from contractual or legal rights (Acaciamining.com 2018). On the initial recognition, measurements of such assets are done at fair value.

From the analysis of annual report of Yamana Gold Plc, it has been ascertained that valuation of non financial assets are done at costs by deducting impairment loses and amount of accumulated depreciation. The cost at which land building, property and plant is recorded comprise of purchase price of assets and any other costs attributable to bring assets in the required location (Yamana.com 2018).

Recognition of interest in liabilities and assets are done in accordance with IFRS 3 that provides for free choice between fair value and historical accounting (Yamana.com 2018).

Recognition of the intangible assets by way of business combination and asset acquisition are done if they arise from any legal contracts and are separable. Such intangible assets are measured at fair value (Yamana.com 2018). On other hand, intangible assets having finite useful lives acquired by company are measured at costs by deducting impairment loss and accumulated amortization.

Analysis of consistency of valuation practices across three companies:

From the analysis of the valuation method for non-financial assets of all three companies, it can be inferred that there was not much consistencies between them. It is so because the valuation method all three companies are different in respect to the plant, equipment and property along with intangible assets. Rio Tinto measured their PPE and intangible at their historical cost while for Acacia mining, PPE are valued at cost and some intangible assets are valued at fair value and other are valued at costs. When looking at Yamana Gold, it can be seen that they have adopted IFRS 3 in relation to valuation method and opt for free choice in their valuation. PPE are value at cost and intangible assets at both cost and fair value (Hussan and Sulaiman 2016). Therefore, it can be concluded that valuation methods are consistent to some degree and nit completely

Framing an opinion on the free choice between historical cost and fair value accounting for PPE and intangibles:

Opinion regarding free choice between fair value and historical accounting takes into consideration the view point of both management and investors. While it will be suitable for investors to have a particular method of valuation technique as it will facilitate making comparisons at ease. On other hand, management would be opting for free choice as it will enable them to employ the valuation technique or accounting method according to their business conditions and suitability. Accounting practices are chosen by managers opportunistically and most of them chose historical method of accounting for opportunistic reasons. On other hand, choosing fair value is attributable to the fact when benefits outweigh cost. The free choice as provided by IFRS should be mandated from investors view as they will not face difficulty in making comparisons and making rough estimates about the same. On other hand, mandating free choice will be beneficial to organizations as they are provided to act opportunistically. Therefore, framing an opinion on free choice comes with ambiguity as one method is suitable in certain circumstances for asset valuation and other method in other circumstance.

Conclusion: 

It can be inferred from the evaluation of valuation method of all selected companies, that there is little degree of consistencies. While Rio Tinto performs the measurement of assets at historical costs and other two companies that is Acacia mining and Yamana Gold habve incorporated both fair value and historical cost accounting method. Consistencies have been identified in the valuation of assets at cost basis by deducting impairment loss, accumulated amortization and depreciation. The free choice of valuation method is an ongoing debate and there is ambiguity associated with it. However, both the valuation approach comes with some drawbacks in reflecting true value of assets, appropriate measures should be taken by organizations for improving information quality. Additional requirement should be made for disclosures and all the factors should be addressed that influences fair value of accounting.

 

References list:

Acaciamining.com. (2018). Home. [online] Available at: https://www.acaciamining.com/ [Accessed 26 Jan. 2018].

Demerjian, P.R., Donovan, J. and Larson, C.R., 2016. Fair value accounting and debt contracting: Evidence from adoption of SFAS 159. Journal of Accounting Research, 54(4), pp.1041-1076.

Ellul, A., Jotikasthira, C., Lundblad, C.T. and Wang, Y., 2015. Is historical cost accounting a panacea? Market stress, incentive distortions, and gains trading. The Journal of Finance, 70(6), pp.2489-2538.

Henderson, S., Peirson, G., Herbohn, K. and Howieson, B., 2015. Issues in financial accounting. Pearson Higher Education AU.

Hussan, S.M. and Sulaiman, M., 2016. BETWEEN INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSS) AND FINANCIAL ACCOUNTING STANDARDS (FASS): THE DEBATE CONTINUES. International Journal of Economics, Management and Accounting, 24(1), p.107

Lubbe, I., Modack, G. and Watson, A., 2014. Financial Accounting GAAP Principles. OUP Catalogue.

Mayo, W., 2017. GAAP: An Analytical Study of Financial Accounting Standards (Doctoral dissertation, University of Mississippi).

Palea, V., 2014. Fair value accounting and its usefulness to financial statement users. Journal of Financial Reporting and Accounting, 12(2), pp.102-116.

Pratt, J., 2016. Financial accounting in an economic context. John Wiley & Sons.

Riotinto.com. (2018). Australia. [online] Available at: https://www.riotinto.com/australia-9559.aspx [Accessed 26 Jan. 2018].

Singh, J.P., 2015. Fair value accounting: A practitioner's perspective. IUP Journal of Accounting Research & Audit Practices, 14(2), p.53.

Smith, S.R. and Smith, K.R., 2014. The journey from historical cost accounting to fair value accounting: The case of acquisition costs. Journal of Business and Accounting, 7(1), p.3.

Taplin, R., Yuan, W. and Brown, A., 2014. The use of fair value and historical cost accounting for investment properties in China. Australasian Accounting Business & Finance Journal, 8(1), p.101.

Yamana.com. (2018). Yamana Gold Inc. - Home. [online] Available at: https://www.yamana.com/English/Home/default.aspx [Accessed 26 Jan. 2018].

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