This research report focuses on the evaluation and discussion of fair value method of accounting. The discussion also includes the case study of QUL Nickel Group, which has made tremendous improvements in financial position in the year 2015. The report is divided in to three parts and at the end of the report a conclusion is derived by summing up the overall findings.
Part A: Reviewing and discussing the existing accounting literature of fair value accounting
In the present business world, the companies are opting for the fair value method to measure the value of their assets. The governing authorities like, IASB and FASB have also suggested to use fair value method while identifying the valuation of the firm’s assets and liabilities (Demerjian, Donovan & Larson, 2016). There are several positive sides, for which companies the choosing the fair value method. The measurement of the value of assets and liability of the firm is more reliable if the fair value method is followed because this method considers the current market value of the assets and liabilities (Goh et al. 2015). If the market value increases, the companies enhance the value and vice-versa.
At the same time, the fair value method is verifiable because the valuation is done based on the current market price, which can be verified. The relevance of the method is also high because valuing an asset or liability at their current market price is more relevant than the valuation done by considering the historical or past cost of the assets or liability. However, Xie (2016) noted that fair value method can cause high swings of the assets’ or liabilities’ value with the changes in the market’s conditions. In this context, Demerjian, Donovan and Larson (2016) argued that the comparability of fair value method is higher than that of historical cost method because fair value method helps the company to survive in the market at the time of economic downturn.
However, Rolland et al. (2015) mentioned that the measurement in fair value method may de-motivate the investors. This creates a big problem for the companies. Ballas, Panagiotou and Tzovas (2015) added that most of the times, the investors do not check in which value the assets and liabilities of a firm are measured. Hence, if the investors indentify that the value of the assets is low and then they become dissatisfied with the financial results of the company. On the contrary, Yao, Percy and Hu (2015) commented that the timeliness of fair value accounting method is high.
Part B: Discussing possible motivational factors of QLD Nickel Group
In the financial year 2013, the financial reports of the company QLD Nickel Group showed net loss and declined assets’ value. This affected the financial position of the company and due to that the higher management of the company started to improve the situation. The management of the company identified that due to the adoption of cost model, the current value of the assets has decreased (Qni.com.au, 2016).
At the same time, the company also identified that, if it adopts the revaluation model, then it can improve the value of its assets because in revaluation model, the valuation of the assets is done based on the current market value of the assets. Apart from that, by using the revaluation model, the company could improve its debt to equity position and along with that the net income of the company can also be increased (Strouhal, 2015). The company understood that if it applies the revaluation model, then it can maintain the balance between the interests of managers and shareholders.
As per the agency theory, a company should always try to maintain the balanced relationship between the agents or managers and principal or shareholders. In case of QLD Nickel Group, by adopting the revaluation model the company could increase the net income, which could help the company in satisfying the managers by increasing their remuneration and the shareholders by increasing the return percentage. On the other side, the revaluation model could also help the company to survive in the high competitive market, which is suggested by the efficient contract theory (Ballas, Panagiotou & Tzovas, 2015).
Therefore, from the above discussion, it can be said that there were several reasons for which the management of the company decided to apply the revaluation model in the place of cost model. The revaluation model not only helped the organization to improve its financial position in the market, but it also helped the company to satisfy the managers and shareholders and enhance the sustainability.
Part C: Analysing whether fair value accounting plays an important role in recent financial crisis and the implementation problems in fair value accounting
Assets valuation using the fair value method helps the companies to ascertain the assets’ value based on their current market price. Now, before the financial crisis, when there was economic boom in the global economy, the companies valued their assets by using the fair value method. Due to the use of the fair value method, the values of the assets of different companies increased to high level and the financial positions of the companies’ improved (Demerjian, Donovan & Larson, 2016). However, when the downturn of the global economy started, the market values of the assets decreased tremendously. Due to this, the balance sheets of the companies showed the lower value of the assets and the financial positions declined at high speed.
According to many economists and financial experts, the accounting rule that is valuation in fair value method has influenced recent financial crisis in the global economy. However, according to Xie (2016), the fair value accounting is not at all the reason behind the global financial crisis. The financial crisis was caused by bad decision taken by the management of the companies. However, it can be said that though the fair value accounting method was not solely responsible for the recent financial crisis in the global market; the financial crisis was influenced by the fair value method to some extent.
There are implementation problems with the fair value of accounting. The main problem is that the companies gain no ultimate benefit at the time of sale because the assets are already valued at their current market price and so no extra benefit is gained (Rolland et al. 2015). At the same time, if the loss occurs in assets valuation, then it affects the profit and loss statement or profit amount of the company. Therefore, it can be said though the accounting standards suggest to adopt the fair value of accounting method, it cannot be said that the method is flawless.
In this study, it has been identified that fair value of accounting provides reliable valuation of the assets of the companies. At the same time, the fair value of accounting also helps the companies to complete the valuation in less time. However, the method is not flawless. However, the company QLD Nickel Group had changed its valuation method from cost model to revaluation or fair value method in order to gain some advantages like, satisfying the management as well as shareholders and achieving the sustainability in the highly competitive market. On the other side, the study has also identified that the fair value method of accounting was responsible for the global financial crisis to some extent.
Ballas, A., Panagiotou, V., & Tzovas, C. (2015). Accounting Choices for Tangible Assets: A Study of Greek Firms. SPOUDAI-Journal of Economics and Business, 64(4), 18-38.
Demerjian, P. R., Donovan, J., & Larson, C. R. (2016). Fair value accounting and debt contracting: Evidence from adoption of SFAS 159. Journal of Accounting Research.
Goh, B. W., Li, D., Ng, J., & Yong, K. O. (2015). Market pricing of banks’ fair value assets reported under SFAS 157 since the 2008 financial crisis.Journal of Accounting and Public Policy, 34(2), 129-145.
Qni.com.au. (2016). Qni.com.au. Retrieved 7 August 2016, from https://www.qni.com.au
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Strouhal, J. (2015). Historical Cost or Fair Value in Accounting: Impact on Selected Financial Ratios. Jurnal of Economic, Bussines and Management,3(5).
Xie, B. (2016). Does Fair Value Accounting Exacerbate the Procyclicality of Bank Lending?. Journal of Accounting Research, 54(1), 235-274.
Yao, D. F. T., Percy, M., & Hu, F. (2015). Fair value accounting for non-current assets and audit fees: evidence from Australian companies. Journal of Contemporary Accounting & Economics, 11(1), 31-45.