Use Of Fair Value Research Articles

Bank Commercial Loan Fair Value Practices

Recent accounting changes, for the first time, permit the use of fair value in the primary financial statements for held-to-maturity (HTM) bank loans. While the use of fair value has historically attracted significant discussion and debate, there is little information in the public domain on how banks would measure fair value or use it in loan management. This study presents and analyzes results from in-depth discussions with seven large internationally-active banks on their fair value use and measurement for HTM commercial loans and commitments. The objectives of the discussions and those of the study are to: identify the extent to which fair value is used for HTM commercial loan facilities and how it is used; describe valuation methodologies used and consider the roles of market price sources and modeling and their relative importance in fair value estimation; consider model validation and price verification; draw conclusions as permitted and suggest areas for future research.

Market Consistent Embedded Values as 'Fair Value' Measurements for Life Insurance Accounting: A Step Too Far With Finance Theory?

Embedded value has been widely adopted by European and Canadian life insurance companies for supplementary performance reporting and increasingly by US insurers for management purposes. It has important implications for the international debate over the appropriate use of fair values in financial reporting. But EV has still not been accepted by standard setters (e.g. IASB) for inclusion in the main financial statements. The concept of Market Consistent Embedded Value has been developed primarily by actuaries utilizing modern financial economics. This paper analyzes how both top-down and bottom-up methodologies for estimating MCEV may lead to unrealistic allowance for risk and explores the dangers of double counting of elements in the MCEV 'economic balance sheet', of a misunderstanding of the synergistic nature of overall firm value, and of a naive belief in market efficiency. It outlines potential empirical research with wider implications for 'fair value' accounting and reporting.

Forest valuation and the AASB 141 accounting standard

Summary This paper examines issues relating to forest valuation using the Australian Accounting Standards Board accounting standard AASB 141 for large and medium-sized forestry entities. Current practices generally follow AASB 141:25 that states that an independent valuation of land may (emphasis added) be deducted from the present value of the combined asset to yield a value for the living trees (i.e. value of the biological asset), from which gains or losses relative to the previous year may be brought to account in the income statement. Such an approach distorts the income statement by gains and losses that are arbitrarily one-sided because the value of the living trees becomes a residual whose value is influenced by any movements in land value, sometimes masking the inherent productivity and value of the living trees. The paper reviews key terminology and principles of AASB 141 and other standards, including the definitions of biological assets, non-current assets, fair value, active markets, combined assets, and highest and best use. In the absence of an active market for medium and large forestry assets, which is generally the case in Australia and New Zealand, the estimation of fair value using the present value of expected cash flows is central to valuation. Whatever the respective form of ownership, land and living trees constitute a combined asset in which the roles are inseparable biologically. To be consistent with the use of fair value of the combined asset based on the present value of expected cash flows, the planning horizon needs to be extended to a uniform future year for the entire asset. This is to enable the optimum schedule of wood and cash flows and hence the maximum present value to be estimated. We describe an operational method to derive the present value of the living trees (the biological asset value as rigidly defined in AASB 141) by discounting the cash flows relating solely to those living trees, in essence the current crop. Segmenting those cash flows from those used in evaluating the present value of the combined asset can do this. Assuming the going concern is viable, such that forestry is the highest and best use, the remaining issue is how to ensure that the fair value of the combined asset is properly reflected in the balance sheet. This can be done by deducting the present value of the living trees (i.e. the value of the biological asset) from that of the combined asset (after due adjustment for land improvements). The resulting present value of ‘future rotations’ should then be shown as a non-current asset under ‘property, plant and equipment’. Finally, the discount rates used in forest valuations generally allow for taxation (and risk) in using a weighted average of the discount rates for equity and debt. Post-tax evaluation of cash flows is therefore recommended, rather than pre-tax, subject to avoiding double counting of any tax liabilities or debts elsewhere in the accounts.

A research note

The paper contributes to the research agenda of studies on accounting measurement by suggesting that incremental change is taking place in IFRS which has the effect of moving recognition of assets and liabilities to an earlier point in the transaction cycle. This is manifested in recognition of executory contracts and changes in economic state in some standards. The professional debate about fair value obscures the underlying boundary shift. Fair value is used to simulate completion of the transaction cycle. The use of fair value in this way is accompanied by a change in emphasis as to how reliability should be construed, with representational faithfulness being advanced over verifiability. The recognition of income and expense earlier in the cycle is corrected on final realization, so the overall profits or losses of the entity are not changed, although recognition may take place in different periods than under historical cost.

The Use of Fair Value in IFRS

ABSTRACT The implementation of International Financial Reporting Standards (IFRS), particularly in the European Union, has led to frequent comments that IFRS are “fair value based standards” and that the IASB is moving inexorably towards full fair value accounting. This article examines the extent to which IFRS do, in fact, require the use of fair values for the measurement of assets and liabilities. It explains the definition of fair value in IFRS, the evolution of that definition and the need for further clarifications and guidance with respect to the application of the definition. It then identifies the four main uses of fair value in IFRS. Three of these uses reflect what should have happened under many national standards. The fourth use is, in practice, restricted to very few assets and liabilities. The article concluded with suggestions about the possible areas in which the IASB might extend the use of fair values.

A Fair Question

This article addresses the following key points: Global accounting standard setters are increasingly embracing the use of fair values rather than historical costs. Convergence of global financial reporting standards is taking place. With exceptions, most fair value standards are currently voluntary.

Fair Value as a Relevant Metric: A Theoretical Investigation

Supporters of fair value accounting claim that this metric has two central advantages, including that it is a relevant measure and that it accurately reflects the underlying economic condition of a firm. In this paper I investigate the robustness of these presumed advantages by undertaking three related analyses. First, I develop a theoretical framework to identify the necessary and sufficient conditions for market price (as a fair value metric) to be relevant. Second, I develop an economic model to examine the two claims. I show that, when markets are in disequilibrium, the market price of an asset alone does not reliably allow a user to infer a firm's long-term value. If the user also has information regarding a firm's economic profits, market price could be relevant. Third, I construct computer simulations of the economic model and find that reported accounting profits do not have the same predictive power as economic profits. I also find that there exists a non-trivial relationship between accounting profits and fair value that could help a user to identify a firm's long-term value. Thus the usefulness of fair value depends on users' understanding of this relationship.

Does fair value accounting provide a better representation of a company?

This article looks at the usefulness of measuring a company's wealth and net income using the fair value method. In this regard, the key question - is fair value relevant ? - can be analysed as follows : do fair value « accounting numbers » provide a better estimate of the value of a company and the risk relating to its activity ? How informative are they for users ? How useful is fair value information for decision-making ? In order to answer these questions, the author examines first the basis and limitations of the traditional accounting model. He analyses then the determining factors in the emergence of the fair value method, with particular regard to the role attributed to financial statements and the needs of their users. Lastly, he presents a summary of the empirical studies carried out to assess the usefulness of fair value accounting information. JEL classifications : G14, M41