Fair Value Reporting Advantages and Disadvantages

sporting Value Reporting Advantages and DisadvantagesDiscuss the pros and cons of attractive comfort reporting for investors? Why has this trend emerged, and how does addition jimmy volatility seen during and since the Global monetary Crisis effect your views on this?There cod been many debates in old decades amongst the investors, users of the monetary statements, on whether beauteous take to be news report is worth being used. According to IFRS 13, fair prize is the terms that would be received to sell an asset or paid to transfer a liability in an orderly transaction between merchandise participants at the measurement date (ACCA, 2016). Usage of fair repute has advantages, however, it has disadvantages as well. This essay will discuss how fair shelter is more advantageous than disadvantageous and how it is carried out. It will also examine how fair prise led Lehman Brothers, an American investment bank, into bankruptcy during the global fiscal crisis and why t he trend of fair value has emerged in the recent decades.As historical appeal loses relevancy with the passing of time, it is more appropriate to use fair value reporting as it considers current market prices and conditions. This provides investors with the most relevant estimates of the value of c whollying (Gjorgieva-Trajkovska et al., 2016), and timely culture which is important for making investing decisions (McEnally, 2007). Penman (2007) states that fair value accounting reports assets and liabilities through an economists view and thence reports economic income the change in fair value of net assets on the balance sheet. This is of interest to investors as they can make predictions of future earnings based on current information (Marra, 2016). On the other hand, Sundgren (2013) claims that in that location will also be fluctuations in fair determine, leading to uncertainty of future inflows. Although this poses a disadvantage towards certain stakeholders, it is useful to investors as high fluctuations could indicate high risk, which may reward them with high returns.Another advantage of fair value reporting is the reliability and transp bency of the method. much transparency means that the investors are able to get an insight into the real value of the company. This allows investors to make more informed decisions that will benefit the business (Bigelow, n.d.). Fair value reporting is reliable as it can be checked in hindsight from available information about current and past market prices (Betakova et al., 2014). This is adept for the investors as it means that they can be confident that their decisions are correct and that the finances of the business will not suddenly change.Bubble prices can be an issue for investors as it may mislead them into making poor investing decisions. There is plenty of empirical evidence to envision that bubble prices exist (Ryan, 2008). These price bubbles, according to Penman (2007), are introduced into financ ial statements through the usage of fair value accounting. He goes on to say that this causes bubble gains to reflect on the income statement, and these may, falsely, show the company as being healthy which could lull investors into a false sense of security. These bubbles also result in the investor receiving ineffective financial statements which will violate their decision making. An example of this would be where investors pay prices that far exceed their own valuation (Scheinkman and Xiong, 2003). This would make it tough for investors to earn a reasonable return on their investments. However, the research fails to consider the difficulties locating price bubbles or how investors can prevent themselves from being misled. It also fails to consider that bubble prices show the current trading price, albeit inflated, and therefore show the true value of the investment according to current prices.When there is illiquidity in a market, fair value is called mark to model accounting. Ball (2006) explains that when this occurs, market prices are not accurate as firms try to find an approximate value for the assets. He continues by stating that this can let managers easily manipulate values according to their own preferences affecting the reliability of financial statements. Betakova et al. (2014), argues that measurement procedures of fair value create loopholes and this means that prices can be written as vastly different from what they really are, which again allows manipulation.The fair value of assets and liabilities is derived from the 3 aim hierarchy of inputs. According to IFRS 13, the highest priority is given to direct 1 inputs the quoted price of assets and liabilities that are traded in the active market. Laux et al. (2010) state that assets or liabilities should be marked to market, which means that the quoted price has to be used to determine its fair value as it is the dress hat approximation of how much an asset would be sold for (Magnan, 200 9). IFRS also emphasises that the price to be used has to be those of an orderly transaction to ensure that it is not a forced transaction in order to maintain its representability. An example of level 1 valuation would be listed stocks or stays. In cases where an asset does not have an active market, level 2 fair value measurement should be used. This is when the valuation inputs are directly or indirectly observable but do not fall under Level 1 (Magnan, 2009). Level 2 inputs, the net replacement comprise, include quoted prices for similar assets or liabilities in active or non-active markets, and other relevant market data like the yield curves (Sundgren, 2013). For example, Petrobras issued a bond which is not traded. However, if there is an active market for a Valero Energy bond that is similar, the price of the Valero Energy bond can be used as level 2 input to value the Petrobras bond. Finally, the least priority is given to level 3 inputs, which are unobservable inputs. It is the least accurate as it is based on model assumptions. An example of level 3 measurement is when there is no observable input to value the Petrobras bond, then the value of the bond can be estimated by discounting its future cash flows. As a result, the reliability is trim back due to the subjectivity of the discount rate. Fair value is argued to be more appropriate, compared to historical cost, when level 1 valuation is used as it only allows nominal manipulation. However, during 2008, many companies overvalued their assets by utilize the level 3 measurement, contributing to the global financial crisis. Furthermore, there is an advantage in valuing certain assets using historical cost over fair value, like property, plant and equipment. This is because historical cost results in a more consistent calculation of depreciation. Moreover, under fair value, assets would need to be revalued frequently due to changing market conditions and this would impose additional costs to the organisation (Christensen and Nikolaev, 2013).Fair value was a dominant force in the financial crisis and exacerbated its severity (Cai-xia and Chi, 2010). Huizinga and Laeven (2009) note that fair value is procyclical and therefore intensifies the phases in the economic cycle. They expressed that banks were materially impacted due to the contrast between market and loudness values. Lehman Brothers was an American investment bank, founded in 1850, and was the fourth-largest investment bank in the United States. Its bankruptcy in 2008 was a prominent event in magnifying the repercussion of the financial crisis (Acharya and Richardson, 2009). One of the pivotal reasons for this collapse was due to the high leveraging (Lehner, 2016). Lehman disguised this from stakeholders by utilising fair value accounting and creative accountancy. The incentive behind such(prenominal) manipulations would be the benefit pressurised managers derive by camouflaging vulnerabilities in the organisation. This is proved by the movement of the leveraging ratio from 23.71 in 2003 to 30.71 in 2007 (SEC Info, 2007) which signifies a high level of risk to investors. In addition, Azadinamin (2012) mentions that accounting standards, due to their defects, enable management to misrepresent financial information for momentary monetary rewards. He states only that Lehman window dressed the financial statements, using fair value, to present healthy looking balance sheets which assisted in concealing a major fork negative cash flows. Magnan (2009) states that As of November 30, 2007, 75.1% of assets measured at fair value were measured according to level 2 or level 3 inputs. This indicates that Lehman primarily did not use the more reliable level 1 values. In addition, the proportion of assets valued using level 2 or 3 increase to 81.7% the following year. This shows the speed at which reliability in the accounting method was reduced. It is backed up by the empirical evidence provided by Ma gnan which shows that the movement from level 1 to levels 2 and 3 was done intentionally so that they were able to report assets too highly and hide losses. He goes on to explain that fair value provides beneficial information to investors when assets trade in deep and efficient markets but are less useful when the markets are less liquid. One of the get word reasons for the fall was the lack of liquidity caused by banks securing themselves, due to the financial crisis, by asking Lehman to pay off their debts. In addition, even though Lehman had a Brobdingnagian asset base, they lacked assets which could quickly be sold for cash (Brunnermeier, 2009). Apart from the ongoing financial crisis, another aspect that increased the speed of the collapse was the unrealised gains and losses brought about by the usage of fair value accounting (Magnan, 2009). For example, Hughes (2008) mentions that Lehman Brothers showed a $400m gain from fair-valuing its own liabilities. As no other firm w ished to buy Lehman, in its state at the time, they declared bankruptcy on the 15th of September 2008 and this was quoted as the largest bankruptcy in the history of the United States (Mamudi, 2008). Therefore, fair value accounting without adequate additional disclosure is neither fair nor a good reflection of the value that is at risk (Magnan, 2009).To summarise, whilst relevance and reliability are the primary feather qualities of the usefulness of a financial report, there is a constant debate on the trade-off between these qualities when fair value measurement is adopted. Fair value is known to be relevant as it uses the current market price, however, it sacrifices its reliability as level 2 and level 3 inputs are used. The value of relevance and reliability is equally important because relevant information that has no reliability would mean nothing to the investors (Sing and Meng, 2005). In contrast, Hitz (2007) notes that fair value would be reliable if there was an actively traded market but the problem arises when there is not. He also remarks that usage of historical cost is falling whereas fair value accounting is on the rise. The reason for this is because fair value provides more timely and comparable information than amounts that would be reported under other alternative accounting approaches (Laux and Leuz, 2009). Furthermore, they add to this by saying that fair value accounting recognises losses earlier than other methods of accounting and this makes it much more difficult to hide problems in the corporation which, if odd to grow, would make crises more severe. However, we have seen that even through the use of fair value accounting, as in the case of Lehman Brothers, fair value accounting was a significant player behind the crisis of 2008. Wallison (2008) argues that fair value causes instability among financial institutions, although the title of the journal suggests that he would be taking a biased military strength towards the topic. Mo reover, the usage of fair value accounting causes volatility due to constantly changing prices. This concerned banks during the financial crisis due to the enormous write-downs caused by falling asset prices. However, Enria et al. (2004) argue that volatility provides information to investors regarding the risks of their investment. We believe that solely utilising fair value has pitfalls and therefore companies should adopt an integration between historical cost and fair value to eliminate the weaknesses of each. Nonetheless, we conclude that investors still prefer fair value accounting despite the disadvantages and the trade-off because it represents the true economic condition of assets and liabilities.ReferencesACCA, 2016. A framework for ascertain fair value? Online. ready(prenominal) from http//www.accaglobal.com/gb/en/student/exam-support-resources/professional-exams-study-resources/p2/technical-articles/ifrs13.html Accessed 08/03/17Acharya, V.V. and Richardson, M., 2009. C auses of the financial crisis. Critical Review, 21(2-3), pp.195-210.Azadinamin, A., 2012. The bankruptcy of Lehman Brothers Causes of Failure recommendations going forward. Swiss Management Center.Ball, R., 2006. International Financial Reporting Standards (IFRS) pros and cons for investors. invoice and business research, 36(sup1), pp.5-27.Betakova, J., Hrazdilova-Bockova, K. and Skoda, M., 2014. Fair value usefulness in financial statements. DAAAM International Scientific Book, pp.433-448.Bigelow, L. The Advantages Of Fair Value Vs. The Equity Method. The Finance Base. Available from http//thefinancebase.com/advantages-fair-value-vs-equity-method-3255.html Accesses 02/03/2017Brunnermeier, M.K., 2009. Deciphering the liquidity and credit crunch 2007-2008. The Journal of economic perspectives, 23(1), pp.77-100.Cai-xia, H.E. and Chi, Z.H.A.N.G., 2010. Fair value accounting under financial crisis. Journal of Modern story and Auditing, 6(6), p.59.Christensen, H.B. and Nikolaev, V.V., 2013. Does fair value accounting for non-financial assets pass the market test?. Review of Accounting Studies, 18(3), pp.734-775.Enria, A., Cappiello, L., Dierick, F., Grittini, S., Haralambous, A., Maddaloni, A., Molitor, P.A., Pires, F. and Poloni, P., 2004. Fair value accounting and financial stability.Hitz, J.M., 2007. The decision usefulness of fair value accounting-a conjectural perspective. European Accounting Review, 16(2), pp.323-362.Hughes, J., 2008. Fair value can flatter to deceive on your own debt. Financial Times, 24(07), p.2008.Huizinga, H. and Laeven, L., 2009. Accounting discretion of banks during a financial crisis.Laux, C. and Leuz, C., 2010. Did fair-value accounting contribute to the financial crisis?. The Journal of Economic Perspectives, 24(1), pp.93-118.Lehner, O.M. ed., 2016. Routledge Handbook of Social and Sustainable Finance. Routledge.Magnan, M.L., 2009. Fair value accounting and the financial crisis messenger or contributor?. Accounting Perspectives, 8(3), pp.189-213..Mamudi, S. 2008. Lehman folds with record $613 billion debt Online. New York Market Watch. Available from http//www.marketwatch.com/story/lehman-folds-with-record-613-billion-debt Accessed 08/03/2017.Marra, A., 2016. The Pros and Cons of Fair Value Accounting in a Globalized Economy A Never outcome Debate. Journal of Accounting, Auditing Finance, 31(4), pp.582-591.McEnally, R., 2007. Fair Value Financial Reporting. CFA Magazine, 18(1), pp.25-26.Penman, S.H., 2007. Financial reporting quality is fair value a plus or a minus?. Accounting and business research, 37(sup1), pp.33-44.Ryan, S.G., 2008. Fair value accounting Understanding the issues raised by the credit crunch. Council of Institutional Investors, (July, 2008), pp.1-24.Scheinkman, J.A. and Xiong, W., 2003. Overconfidence and speculative bubbles. Journal of political Economy, 111(6), pp.1183-1220.Sing, T.Y. and Meng, S.C., 2005. Fair value accounting-relevance, reliability and progress in Malaysia. Universi ty College Sedeya International.Sundgren, S., 2013. Is fair value accounting really fair? A discussion of pros and cons with fair value measurement. The Finnish Journal of bank line Economics, 62(3-4), pp.242-250.Trajkovska, O.G., Temjanovski, R. and Koleva, B., 2016. FAIR VALUE ACCOUNTING-PROS AND CONS. Journal of Economics, 1(2).Wallison, P.J., 2008. Fair value accounting A critique. Financial Services Outlook.LEARNING LOG SUMMARY(maximum 1 page using Aerial 12-point with at least 1cm margins)Suggested contentWhat did you learn from the assignment both technically and in terms of working together as a base?We learnt about what caused the global financial crisis to occur and the impact it had on various financial institutionsWe gained a deeper understanding on the faults in fair value accounting which also shows why historical cost was so prevalentWe learnt how to al position work between the members of the group as well as set practical deadlinesWhat strategy as a group did you follow in tackling the assignment task?Making sure everyone was involved in writing each divide so that we received various different viewpointsHaving frequent meetings and discussions in order to compare our research and decide on which points we should include within our paragraphsWhat problems did you face and how did you overcome them?Understanding what was required of the question. We overcame this ask question to the lecturer and finding out, through research, about other topics that could be included in each paragraphWhat went well?Coordination was good since we kept in touch with each other frequentlyEveryone kept to their deadlines and provided what was required of them when neededWhat, in retrospect, would you have done differently, why and how?In the beginning we took time to assign research topics and research took a while as we were all new to it. However, later on we were able to increase the charge per unit as we became more proficient. If, however, we had been ab le to start off at this pace, the work would have been more evenly distributed over the weeks rather than being skewed towards the deadlineWhere did you locate most of your sources?GoogleUniversity of Bath libraryGoogle ScholarLOG OF GROUP MEETINGS(complete a maximum of 1 page for each meeting) clashing 1 pick up of Meeting23 Feb 2017 (Thursday)AttendeesBen MaitlandKylie SiowGavriella KafkaliaSidharth RanjithName of AbsenteesAgenda and tasks finishDecide on days of meeting every week (Tentatively Tuesday 1-2pm Friday 12.30-2pm)Talked about the structure of the essay concord itemsStructure of EssayIntroductionPros and Cons of FV 3rd of environHow its carried out 10th MarchExample of FV during Financial Crisis 10th MarchConclusionTasks to be completed by following(a) meetingFind points for pros and cons of fair valueDate of succeeding(a) meeting28 Feb 2017 (Tuesday)Meeting 2Date of Meeting28 Feb 2017 (Tuesday)AttendeesBen MaitlandKylie SiowGavriella KafkaliaSidharth RanjithNam e of AbsenteesAgenda, items agreed on and tasks completedAllocation of points for the first paragraph pros and cons of fair value accounting to investorsTasks to be completed by next meetingFull paragraph of pros and cons of fair valueDate of next meeting3 March 2017 (Friday)Meeting 3Date of Meeting3 March 2017 (Friday)AttendeesBen MaitlandKylie SiowGavriella KafkaliaSidharth RanjithName of AbsenteesAgenda and tasks completedCompiled the first paragraphTalk about the next 2 pointsGlobal financial crisisHow fair value is carried outAllocate points to each personTasks to be completed by next meetingFind points for the financial crisis and how fair value is carried outDate of next meeting7 March 2017 (Tuesday)Meeting 4Date of Meeting7 March 2017 (Tuesday)AttendeesBen MaitlandKylie SiowGavriella KafkaliaSidharth RanjithName of AbsenteesAgenda and tasks completed make which points to write about and discuss how to evaluate it.Tasks to be completed by next meetingFinish the paragraphs how FV is carried out and the example during financial crisisDate of next meeting10 March 2017 (Friday)Meeting 5Date of Meeting9 March 2017 (Thursday)AttendeesBen MaitlandKylie SiowGavriella KafkaliaSidharth RanjithName of AbsenteesAgenda and tasks completedCompleted all body paragraphsTasks to be completed by next meetingIntroduction and ConclusionDate of next meeting14 March 2017 (Tuesday)Meeting 6Date of Meeting15 March 2017 (Wednesday)AttendeesKylie SiowGavriella KafkaliaSidharth RanjithName of AbsenteesBen Maitland (However did send his share of the work by e-mail)Agenda and tasks completedCompleted introduction and rough drawing for conclusionTasks to be completed by next meetingComplete full paragraph for conclusion and make some changes for body paragraphsDate of next meeting16 March 2017 (Thursday)Meeting 7Date of Meeting16 March 2017 (Thursday)AttendeesKylie SiowGavriella KafkaliaSidharth RanjithName of AbsenteesBen Maitland (However did send his share of the work by e-ma il)Agenda and tasks completedWorked on conclusionDate of next meeting18 March 2017 (Saturday)Meeting 8Date of Meeting18 March 2017 (Saturday)AttendeesBen MaitlandKylie SiowGavriella KafkaliaSidharth RanjithName of AbsenteesAgenda and tasks completedMade some changes to body paragraphsFinalised the whole essay