Fair Value Accounting in IFRS
To what extent fair value accounting holds good for valuation in IFRS
Significant percentage of the balance sheet would be at Fair Value compared to current practice of carrying at historical cost under IFRS.
Use of Fair value:
At present Fair Value is limited to impairment of assets, measurement of retirement benefits and mark to market accounting of derivatives where as under IFRS it extend to Held for Trading portfolio, Available for Sale, assets/liabilities designated as fair value through profit and loss and for initial recognition of all financial assets/liabilities will be at fair value.
Current definition:
Currently the definition of fair value stands as “Amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction”
– If quoted in an active market then objective would be the price at which transaction would occur at the balance sheet date in most advantageous market and methods applied would be published price quotations when available, use market quoted rate in valuation techniques or bid price for asset held
– If not quoted in an active market then objective would be transaction price in arm’s length transaction motivated by normal business considerations and method applied would be valuation techniques (recent market transactions, similar instruments, DCF analysis etc.), use commonly used and reliable valuation technique or use market based information
There is lot of doors open for judgement in terms of what will constitute “arm’s length transaction”.
Impact of Fair value:
Fair value accounting brings significant volatility in the income statement.
For instance: All derivative financial instruments have to be recorded at fair value on measurement date, and any change in fair value has to be recorded in income statement thereby bringing volatility in Profit an Loss Account.
Since markets are not liquid for all assets, corporate will have to obtain expert opinion to determine fair value. For e.g. unquoted equity shares have to be recorded at fair value which are now recorded at cost
Different valuation models will be used by various companies which reduce consistency and comparability of financial information to a certain extent.
All these will involve substantial cost for hiring of expertise.
Proposed Definition:
Therefore for bringing all of them under one roof International Accounting Standard Board (IASB) has come out with Exposure draft on “Fair Value Measurement” where fair value has been defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (current exit price)”.
So does exit price reflect real fair value? Will exit price will be available for all assets and liabilities to be fair valued on measurement date.
Exit price can be used only when it is supposed that the asset or liability will be sold in a near future; if it is supposed that the asset or liability will remain for long in the company, exit value can’t reflect the right perspective.
In fact, if we want to obtain the value in use of the elements we can’t consider the benefits obtained by selling it, because it won’t be sold.
IASB is expected to come out IFRS on Fair value measurement by third quarter of year 2010.
Author: CA Shalini Tibe, IFRS Consultant
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