Transcript No Slide Title
Fair value accounting and business competitiveness
Richard Martin Head of Financial Reporting, ACCA
ACCA
320,000 members and students world-wide Examining in International Accounting Standards and International Standards on Auditing since 1996 Diploma in IFRS Own accounts using IFRS since 2002 [email protected]
www.accaglobal.com/ifrs
Fair value accounting
Fair values – what are they and where they are used in IFRS Fair value accounting – main applications in IFRS Implications for business competitiveness
What are fair values and where are they used in IFRS
Measurement bases in IFRS
Depreciated Cost Share of net assets (equity accounting) Value in use (VIU) Net realisable value (NRV) Fair value (FV) Lower of cost and NRV Recoverable amount (higher of VIU and NRV) Entity-specific or market values Exit or entry values
Where are fair values used in IFRS?
Fair value as a means of estimating cost – initial measurement Revenue, swaps of non-monetary assets Business combinations (IFRS 3) – FV of consideration and of net assets acquired Share-based payments – value of options granted Allowed alternative for property, plant and equipment or intangible assets Pension schemes (IAS19) – assets less liabilities plus effect of corridor and spreading over service lives
Fair value accounting
Where changes in fair values affect profit for the year Financial instruments (IAS39) Investment properties (IAS40) Agriculture (IAS41) Where holding the assets for trading/dealing/investment purposes Revaluations Property, plant and equipment (IAS16) Intangible assets (IAS38) Through equity, but recycled into P&L Financial instruments – available for sale and cash flow hedges
Fair value accounting – main applications
Fair values in IAS39
Four way classification of assets • Loans and receivables – at amortised cost • Held to maturity – at amortised cost • Trading – at fair value through P&L • Available for sale – at fair value through equity Derivatives – at fair value through P&L Liabilities – at amortised cost for most Trading or derivatives – at fair value through P&L
Issues with fair values in IAS39
Mixed model – mixture of costs and fair values Hedge accounting Fair value hedges – both hedged item and hedging instrument (derivative) at FV through P&L Cash flow hedges – derivative at FV through equity Fair value option
Reliable fair values
Hierarchy Active market Quoted price, bid price, unit price (no extra value for a big block) No active market – valuation model Maximise inputs from market transactions Use all factors – time value, credit risk, volatility, prepayment risk etc.
No active markets – equities at cost as last resort
IAS40 - Investment property
Initial measurement at cost plus transaction costs Add some subsequent expenditure Then at fair value through P&L or at depreciated cost Market value with no deduction for selling costs Use of professional external valuer Best evidence – market transactions in similar properties Next best – other market transactions adjusted for leases, location, time etc. or discounted cash flow analysis
IAS41 Agriculture
No cost option Initial measurement at fair value Subsequently at fair value with changes through P&L Fair value less point-of-sale costs Maximise inputs from market transactions Discounted cash flows as alternative Specific issues – eg agricultural assets and the land they stand on
How far will FV accounting spread?
Measurement project Insurance contracts - Part 2 Revenue recognition Full fair value model for financial instruments Comprehensive income project
Implications for business
Fair value accounting: business competition issues
Costs Valuations Models – understanding and applying them Systems – moving from transactions to value changes Reported results Measurements - Day 1 profits, transaction costs Prudence and realisation Reliability issues
Fair value accounting: business competition issues
Earlier recognition of profits No need for a transaction Recognise selling gains Volatility of results as market changes Hedge accounting and natural hedges Liabilities – change in own credit risk Same as market/competitors Return on capital shifts from invested capital to market value
Fair value accounting: business competition issues
Understanding the fair value accounts Presentation issues – profits from different sources, interest income Basis for taxation Limit to distributions
Some conclusions
Some conclusions
Mixed bases in IFRS Various ways of accounting for changes – revaluations, through equity + recycling, fair value through P&L Fair values used when costs fail – derivatives, agriculture Fair values used with hesitation – options in IAS39 and 40 – but likely to increase
Some conclusions
Business implications More costs Reliability of fair values Reported results will change Earlier recognition of profits Volatility of the results as markets change Presentation issues to help understanding