Currently, none of management solution is do without a careful analysis of financial information that is presented in the form of various financial reports. Potential investors analyzing financial statements, pay special attention to the choice of evaluation method of assets and liabilities. External users interested and want to see the actual financial position and the results of its economic activity. These interests may keep presenting assets and liabilities in the financial statements using the method of fair value measurements. Application of assets and liabilities valuation method at fair value is one of the key requirements of International Financial Reporting Standards.
Thus, taking into account the principle of fair value is increasingly in demand. The concept of fair value in the evaluation for the purposes of accounting, individual objects, assets or liabilities of the enterprise, can be found in IFRS 2, 16, 17, 18 and 38. The term is closely related to the concept of «Market Value». For example, IAS 16 clarifies that the fair value of land, buildings and equipment is their market price. It usually defines a professional appraiser.
The definition of fair value as well as the procedure for fair value estimation is set out in IFRS (IFRS) 13, «Fair Value». Fair value is the price that would be received to sell an asset or paid to transfer a liability in conducting operations on a voluntary basis between market participants at the measurement date. And it should be noted that market participants are well informed and are independent, willing parties such operation. Operation between independent parties is a transaction between the parties, which do not have among themselves any particular relationships that would make the price of transactions not typical of market conditions.
Also, the standard provides the basic principles applied in the assessment of fair value. According to this principle, the entity shall use the methods of evaluation that best account for the observed raw data and take into account the minimum unobservable inputs. The fair value hierarchy is set in order to regulate this principle, as well as to ensure comparability of fair value measurements standard, where quoted prices in active markets for identical goods and liabilities in the highest priority and unobservable input data in the lowest. However, in the current economic conditions, many markets are poorly functioning, oversupply and overproduction are observed, and companies have problems with sales. As a result, the number of forced sales increased. This often eliminates the possibility of the company to use the original data of the Level 1 and complicates the assessment of the fair value of the account as the forced operation is not carried out under favorable conditions (and often on an involuntary basis).
When the market becomes inactive, it does not mean that all market activity represents forced operations to liquidate or sell the property described as well as any transaction price is the decisive factor in determining fair value. In this situation, IFRS requires to minimize their own assumptions and make maximum use of independent data. For that, recent transactions with unrelated parties must be taken into account.
When the relevant observed market data is absent or when the observed data require substantial revisions based on estimates, fair value is determined by using valuation techniques based, first of all, on internal management assumptions of future cash flows and discount rates, taking into account the risks involved. Thus, if the market valuation is not possible, the fair value shall be equal to present value of that asset during its durability. Finally, if the revenue estimate is not possible, the fair value estimation can be replaced by reinstatement value.
Those evaluation methods are regulated in IFRS 13. It is proposed 3 widely used valuation techniques are:
1. market approach — uses prices and other relevant information generated by market transactions involving identical or comparable (similar) assets, liabilities, or a group of assets and liabilities;
2. cost approach — reflects the amount that would be required currently to replace the service capacity of an asset (current replacement cost);
3. income approach — converts future amounts (cash flows or income and expenses) to a single current (discounted) amount, reflecting current market expectations about those future amounts.
In national accounting practices the fair value of assets and liabilities, as a rule, almost not calculated and not recorded in the accounting. Features of Russian business culture, capital market, and law do not contribute to the adaptation of the fair value concept. Russian accountants often do not apply the principle of equitable representation of information for the following reasons. Firstly, they are afraid to go beyond their competence, and to break the law. Second, the definition of «fair» value of a function is perceived as an appraiser, not as an accountant. Finally, the fair value is quite new for the Russian legal system.
Specialists and experts, politicians around the world are conducted continuous debate regarding fair value accounting model, which is particularly exacerbated by the 2008 economic crisis. Some experts expressed the view that taking into account the fair value was one of the causes of the crisis. However, it is obvious that this judgment is groundless and is only true to the extent that this has exacerbated the accounting position of the companies. After all, with the assessment of the fair value (in particular, financial assets and liabilities) observed the highest degree of dependence in market conditions on foreign enterprises. Also, a significant deterioration in the situation of companies in this period contributed to their predominantly speculative orientation.
Also important the fact that, according to critics, the fair value accounting model is too susceptible to manipulation whose purpose — to show the desired result for management of a company. The appearance of these schemes happens since the Financial Statements had appeared.
However, the fair value calculations made a number of previously unknown elements to manipulate financial statements, because fair value evaluation mechanisms are often formed on an indirect data. These data are used for the value of assets and liabilities fixing based on certain assumptions, which are called judgments.
Thus, the judgment is based on indirect costs and not on observed data. As the result, information relates to Level 3, i.e. a lower level of reliability of the information, as distinct from Level 1 and Level 2 (according to FASB № 157). If the data of such a market, which ceases to be active, are using then the process of determining the fair value should be amended, e.g. should switch to using an entirely different data source it is likely to move from Level 1 and Level 2 to Level 2 and Level 3. This change has created new opportunities for fraud and statements manipulation. Initial data of Level 3 are «unobservable»; this means that they are created within the organization by its management. It is also important to note that many factors require professional judgment. In this case, the potential fraud is increasing.
Now consider the advantages and disadvantages of the model evaluation facilities accounting at fair value. The accounting at fair value, on the one hand, causes a significant increase in labor costs and other costs due to changes in their prices on the market, entailing a change in their fair value, and changes associated with the reconciliation of the carrying value of the objects of accounting, including profit (loss) from changes in fair value and other indicators. In addition, if the company chooses a model of fair value accounting, then it will be necessary to conduct double accounting. More precisely, the company will have to keep a parallel accounting cost (taking into account the impairment recognized on the remeasurement to groups of assets), the book value of the revalued (where additional evaluation and impairment losses are accounted for each asset) and ledger revaluation previous revaluation (if held) which is necessary to reflect the results of new revaluations. The only thing that can help in such a situation — a well-designed software (or database) that allows for a parallel accounting in three books.
On the other hand, it allows to evaluate the results of operations for the current period and prospects for the future, because fair value reflects the current market conditions, where buyers and sellers would conclude a transaction. Fair value accounting has several other advantages: it provides additional information reliable real value of assets estimation; it is useful for decision-making, as reflects economic reality; financial statements is one of the sources of information to evaluate the business.
But there is also an opinion that fair value accounting may lead to losses, increase risks, and ultimately reduce cost of the companies, which may lead to their bankruptcy. In this type of accounting there is a very high dependence of the company from market fluctuations, both nationally and on the world market (depending on the scope of the organization). As for enterprises engaged in agricultural activities, a risk of adverse climate, disease outbreaks and other natural risks that may further worsen the situation of the company may occur.
Economic crisis leads to financial market drop, assets impairment that is why enterprises begin to write off losses in substantial amounts. If the company is heavily dependent on external financing, substantial losses complicate the receiving loan finance from the banks and trust of the banks to financial reporting of a company decreases.
Regarding accounting liabilities at fair value, in the financial crisis conditions, their evaluation affects the amounts reported. British scientists S. Fearnley and S. Sunder indicate the disadvantages of the fair value model during the crisis. For example, when market value of the company's borrowing at fair value in the financial crisis is falling, it will report to sudden increase the profit for the period, as the decline in value of the liabilities is carried through the profit and loss account. As a result — investors will be misled, especially fairness of such statements in situations in markets with high inflation.
The complexity is the transition from the fair value accounting to cost accounting. For example, in accordance with IAS 16, the option of taking into account long-term assets after initial recognition is prescribed in the accounting policies of the company. A change in accounting policy can be made only in two cases. First, when it is provided by a standard or interpretation. Second, if it leads to the fact that «the financial statements give a more reliable and relevant information about the effects of transactions, other events and conditions on the entity's financial position, results of its operations and cash flows» (IAS 8). In other words, company will be able to move from one model of fixed assets to another if subsequently prove to auditors and users of reporting that after the changes reporting information will become more reliable.
Accounting for operating at a revalued amount may also complicate the work of the internal auditors. We are talking about a comparative analysis of prices. If a company in determining the fair value of the asset using the market prices, the internal auditor should review the prices on the market to ensure the correct choice of a particular market price as fair value. In the case where the company uses the services of an appraiser in the auditor's responsibilities also include the implementation of analytical work over the fair value of the property as determined by the appraiser, the level of prices for the same date on similar properties on the market. If the analysis revealed significant differences in prices, the internal auditor is obliged to report this fact to the board of directors (or management), since such a discrepancy may be due to reporting data manipulation.
So, based on all the above, we can conclude that the evaluation model objects accounting at fair value, has many drawbacks. Meanwhile, the existing benefits are not so significant to cover the costs associated with the use of this model. Therefore, the problem of choosing a method for evaluating the assets and liabilities of the company today has not lost its relevance, despite the adoption of International Financial Reporting Standards, which sets out the accounting for certain objects. It is obvious that one of the primary steps to improve the effectiveness of accounting of assets and liabilities is to remove barriers in the transition from accounting for overvalued cost to historical cost. But it should be noted that through a balanced and comprehensive analysis of the advantages and disadvantages of each model taking into account the need to establish a universal type of evaluation for each accounting object. This will improve the comparability of financial statements of different companies within a country, and to avoid manipulation and reporting of fraud, which are possible through the right choice of leaders and managers of organizations evaluation method. In our view, it is appropriate to use as a model accounting objects (assets and liabilities) historical cost convention, as it will provide a significant reduction in labor companies, the comparability of results of the evaluation and reporting of data, reducing the possibilities of manipulation through the use of managers of the companies of their own judgment. This model also simplify the work of auditors and inspection bodies, including tax authorities. A different pricing model may be used in order to attract investors and creditors. In this case, it is the most efficient use of the fair value, as it provides the reliability of information on the current situation in the market.
References:
1. Fair Value Accounting Fraud: New Global Risks and Detection Techniques. Gerard M. Zack, Wiley; 1 edition (August 31, 2009).
2. Comments to the RAS «Accounting for biological assets and agricultural products» // www.dsh23.org.ru.
3. «Accounting for financial instruments in accordance with IFRS», Alpina Publisher, 2013
4. IFRS Basics. Preparation of International Financial Reporting., Mikheev Elena, ANO IRSOT, 2014.
5. International Financial Reporting Standards: the publication in Russian, Askeri-ACCA, 2010.
6. www.msh.ru.
7. http://gaap.ru/
