The real value of financial statements is in their ability to provide relevant and accurate information that enables investors and others to make informed decisions. For many assets and liabilities, the fundamental test of relevance is met when they are measured and presented at their fair value in financial statements.
Back in 2011, the International Accounting Standards Board (IASB) took it upon itself to unify fair value measurement requirements through the development of IFRS 13 Fair Value Measurement. With a couple of exceptions, we now have a standard that provides a single set of requirements on how to measure and present assets and liabilities at fair value in financial statements.
As convenient as it sounds, it hasn’t been plain sailing for IFRS 13, nor for those who try to comply with these requirements. The IASB’s past chairman Sir David Tweedie articulated some of the frustrations – "I assumed with IFRS 13 there was a fair value and people were just going to use it. And then we discover there is one fair value here and another one there, for exactly the same thing".
Not unlike a unified field theory in physics, while the theory is sound, the practical application of one unified set of requirements for fair value measurement has proved problematic, especially in different global jurisdictions.
Developed economies have certainly encountered challenges in applying the new requirements, but it is when we turn the spotlight on emerging economies seeking to join the IFRS fraternity that we find more pronounced problems.
For recognition of assets and liabilities at fair value, IFRS 13 gives the highest priority to quoted prices in active markets for identical assets or liabilities. One of the problems for emerging economies arises when their capital markets are still developing. Whilst economic growth itself might be fast-paced, all the characteristics one might expect from a truly "active" market may not be present.
The determination of other inputs to fair value measurement which are prescribed by the standard also present problems in emerging economies. Establishing a fair value based on the present value of future income requires estimating future expected cash-flows and an appropriate discount rate. In many cases these variables require valuation expertise, a resource that can be both scarce and expensive in many countries.
The IASB recognises that not all assets and liabilities can, or should be measured at fair value. Consequently, for the foreseeable future, financial reporting is likely to continue with the "mixed measurement" model of valuing some assets and liabilities at cost and others at fair value.
Despite the practical impediments, there is broad consensus that the recognition of certain assets and liabilities at fair value is the right approach. A 2008 consultation by the United States Securities and Exchange Commission concluded overall that fair value provides the investor with "additional insight into the risks to which the company may be exposed and the potential liquidity issues the company could face if it needed to sell securities rather than hold them for the long-term".
Those invested in seeing IFRS become the global financial reporting solution have a role to play in developing the skills needed for emerging economies to transition to IFRS based financial reporting, including fair value measurement. Fine-tuning some of the requirements within the fair value model, along with the development of additional guidance and resources for the practical implementation of fair value will go a long way to ensuring a consistent and global application of the requirements.
Alex Malley is the chief executive of CPA Australia