Fair Value

Introduction
In todays business world, an widespread of arguments and debate has taken place recently over the use of fair value in financial position. Fair Value can be definite as the amount for which an affect could be exchange between knowledge, willing parties in an arms length transaction ( Ball, 2006). An arms length transaction is a fair value measurement assuming that the asset or liability is exchanged in an orderly transaction between market participants to sell the asset or transfer the liability at the measurement date, where an orderly transaction is a transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (e.g. a forced liquidation or distress) (Ryan & et, al., 2002). It has been argued that international accounting standards board (IASB) are moving away from the concepts of stewardship historical cost and historical cost towards the concepts of providing useful information for making decisions based on fair value and cash flow (Ball, 2006). Fair value is the most controversial issue of broadly adopted International Financial Reporting Standards (IFRSs) Belkaoui (2004) argued that accounting system should be set to produce relevant information for rational decisions making. While the users needs are different, accounting system cannot provide information which is desirable for all users decisions. So financial statements preparers should decide on the kind of information which should be included in and which should not, aiming to achieve high level of providing effective information towards making rational decisions. Fair value financial statements can reflect the firms economic reality which enhances not only the efficiency of the invested capital, but also the management efficiency, financial statements harmonization and the justness of income distribution. Most of the countries economies are developing; new accounting standards are needed to fulfil the gap of needs which are produced by the new industries and transactions. IFRS was set to fill this gap and enhance the financial statements quality and harmonization. The main objective in IFRS 13 to estimate the price of transaction either too sell or transfer the assets, it would take place under current market measurement.

PUNETHA PEREMALO

The University of Greenwich

Fair Value

2.0 Measurement and Effects of fair value in financial statements

Financial statement are one of the main sources of accounting data where very useful to world of accounting. The two main important criteria are fair value have to be relevance and reliability. Considering this two main criteria as starting point, the following point will explore in the details on how effective fair value accounting have measured. However, the pros and cons would be determined not only from the view of the firm or company but also from externally effect view from the viewpoint of investor or a financial institution.

2.1 Timely/relevant information

Based on this relevance measurement, fair value can be estimate by the price of an entity would be relevance if the asset been sold or paid if it been relieved based on the reporting date in an arms length exchange. By this relevance measurement, there will more information in Financial Statement where the investor or user can predict about the outcome of past, present and future events to confirm or correct expectation ( Poon, 2004). Therefore, it has a great informative value for a firm itself and encourages prompt corrective actions. Since fair value is inferred from the market price of a given asset, this value can be checked in hindsight from available information about current and past market prices. Since it is necessary to include the methodology and disclose the information about possible deviations from a quoted price in the financial statement, this information can also be verified. Fair value does not include specific information related only to the owner of a given asset. An owner of a firm is likely to seek complementary properties or assets so that a value of a single asset/property is that much higher for the firm as it not only represents its own individual value but also an additional value, as a part of a distinct and functional whole. A neutral value does not consider this asset-specific information and only makes an estimate of its value based on general publicly-known information and thus makes this estimate reliable. For example, an unpredicted gain on a financial asset due to a decrease in interest rates in the current period reduces expected fair value interest revenue on the asset throughout its remaining life. This third component of the periodic returns to financial instruments is the unexpected change in their fair values during the period which cause unexpected changes in the fair values of financial instruments are both unsustainable and uncertain (Ryan & et, al., 2002).

PUNETHA PEREMALO

The University of Greenwich

Fair Value

Addition of more information is possible whenever there are - observable market prices that managers cannot materially influence due to less than perfect market liquidity; or independently observable, accurate estimates of liquid market prices. Eventually this increases the transparency of a firm where the values or amount which stated are useful for the investors, contractors and borrowers to calculate the stability of the firm either sustain with good cash flow. Fair value accounting limits a companys ability to potentially manipulate its reported net income. For example to use gains or losses from the sales to increase or decrease net income as reported at its desired time normally management would arrange asset sales. Using fair value accounting, gains or losses from any price change for an asset or liability are reported in the period in which they occur. A decrease in asset value or an increase in liability value reduces net income based on the valuation of asset and liability. Besides that, Fair value also has the advantage to investors and the markets in that it shows the true position of the company, be it good or bad. However, there is an contracts in this point of view into fair value accounting in financial statement. There is also a big possibility in misleading information for example like observed value of an asset in the market is not indicative of the assets fundamental value. This can lead to the wrong deviated in market by investor irrationality, behavioural bias or problems with arbitrage among others. Ball (2004) stated also points out that market liquidity is a potentially important issue because spreads can be large enough to cause substantial uncertainty about fair value and hence introduce large overall value deviations (noise) in the financial statements.

PUNETHA PEREMALO

The University of Greenwich

Fair Value

2.2 Reliable Information

Reliability measurement indicate the fair value in financial statement has quality information or statement that assures is free from error and faithfully represented with reasonably. For example, fair value can be estimate if there is no liquid market where will inevitably involve prediction of future cash flows and selection of appropriate discount rates. However, this estimation are depends on the measurement error and management assumptions where it should be stated as use of estimate while in preparing of financial statement. (Poon,2004). If there is an liquid market, then the fair value accounting would be more reliable in financial statement for the managers to make decision. Nevertheless, because many assets and liabilities do not have an active market, the inputs and methods for estimating their fair value are more subjective and, therefore, the valuations less reliable stated by Bies, 2005 For an fair value to be reliable in financial statement there must be more verifiable and neutral financial data. Since fair value is inferred from the market price of a given asset, this value can be checked in hindsight from available information about current and past market prices. This information also can be verified by including the methodology and disclose all possible information from the quoted price in the financial statement. Neutrality is meant to represent a value that is best explained as an objective value and therefore devoid of any factors that would cause a rise or fall in such a value, atypical of general market conditions. For instance this is a value that does not include specific data or amount which related only to the owner of a given asset. An owner of a firm is likely to seek complementary properties or assets so that a value of a single asset/property is that much higher for the firm as it not only represents its own individual value but also an additional value, as a part of a distinct and functional whole (Ryan & et, al., 2002). Therefore, a neutral value does not consider this asset-specific information and only makes an estimate of its value based on general publicly-known information and thus makes this estimate reliable.

PUNETHA PEREMALO

The University of Greenwich

Fair Value

However the reliability point of view are still argue able where there the data provided in financial statement are relevant and reliable only for a limited period. There information in the statement are more towards time-specific based on the market disorder. If there is an change in the market, it will cause major differences in the financial situation in a company or firm. For an inexperienced professional in the accounting realm, a changing market situation would thus cause confusion as to what is the actual wealth of a firm where to get reliable information this individual would have to request a new financial statement ( Poon, 2004). This can cause high business cost if there is request made often. Besides that, the fair value measurement in financial accounting also may not be reliable because there is procyclicality effects. Procyclicality effects means exaggerate financial or economic fluctuations based on the market condition that could cause the market slump by a deterioration of a firms financial situation that in turn causes the market to panic, bringing it closer to an outbreak of a crisis. This will indicate , losses will also be reflected on the banks capital. This type of weakening balance sheet ( bank) has been disconcerting event for a future development of some markets, and the state of the whole financial system. In more reliable term, this fair value accounting also can be contribute to increases in bank profits if there would be inflated during upturns in the market and would encourage an overextension of credit, that would then create the conditions for a deeper and more longlasting downturn. This will affect the asset valuation on bank and capital, where lead to further restrain in their borrowing. Furthermore, to counterparties whose credit is more volatile ( either small and medium-sized enterprises) will have better potential result which might be to limit credit availability.

PUNETHA PEREMALO

The University of Greenwich

Fair Value

2.3 Manipulation
Manipulation of the price by the firms themselves also presents a risk in obtaining a fair value estimates because in illiquid markets, trading by firms can have an effect on both traded and quoted prices. Absence of a market price If a market price for a given asset is not available in the active market, fair value estimate that is supposed to provide the most reliable information is more difficult to obtain. In this case, the usual procedure is to use mark to model accounting. This requires creation of a more extended estimate which runs the risk of creating a deviation of price for a given asset from its price if it was to be found in the market. Furthermore if this mark to model method is used to simulate a market price for a given asset, it provides an opportunity for the firm to manipulate this estimate, as it is the managers of the firm that can decide on what kind of a model or a parameter would be used. One of the most often quoted disadvantages of fair value accounting is the vagueness of the measurement procedure of assets for financial statements which creates loopholes for pricing deviations. There are several ways that this measurement could produce differing prices and thus result in a deviation from a desired fair value. Some also argue that the outcome of fair value accounting on entitys financial liabilities is counterintuitive if its credit risks changes. Due to the interest rate on the initial date would now be lower than what it would be if the liability was issued today which will cause the fair value in the financial statement will decrease when the issuing entitys credit risk deteriorates . Conversely, if an entitys credit rating improves, an increase in the fair value of its financial liability will result. However, as explained in Barth and Landsman (1995), changes in the credit rating represent wealth transfers between creditors and stockholders where it is not counterintuitive to see a decrease (an increase) in the value of a financial liability when there is a wealth transfer from creditor (stockholders) to stockholders (creditors) corresponding to the deterioration (improvement) of the credit rating of the issuing entity.

PUNETHA PEREMALO

The University of Greenwich

Fair Value

Therefore, the outcome of fair value accounting is not readily counterintuitive. But as illustrated in Lipe (2002), financial statement users must be better educated about the impact of fair value accounting on financial liabilities. In particular, a decrease (an increase) in the fair value of financial liabilities should not be interpreted as positive (negative) if it is due to deteriorating (improving) credit quality. In addition, loan covenants have to be revised and financial ratios involving financial liabilities have to be analysed accordingly (Lipe, 2002).

2.4 Volatility
The problem of volatility is closely related to the previous issue of limited reliability. If the fair value of an asset follows the development of a market environment, this means that the value of an asset changes with the market. If the market with regards to the nature of a given asset booms, the price of a given asset goes up; if it busts, the price goes down too. A volatility of the market, which is an existing possibility, therefore creates a superfluous risk and could adversely affect the investment capacity of a firm. According to the research conducted by the European Central Banks experts for assets and liabilities held to maturity, the volatility reflected in the financial statements is artificial and can be ultimately misleading, as any deviations from cost will be gradually compensated for during the life of the financial instrument, pulling the value to par at maturity. This volatility of income may not relevant to managements performance and that this will cause more complex for the user to predict future act. First, this is not a reliability issue since fair values can be reliably measured but still vary a great deal from one period to another. Second, the requirement of fair value reporting does not have to go hand in hand with the requirement of recognizing changes in fair values in reporting earnings (Poon, 2004) . For this reason changes in fair value should be separately reported based on causes such as the passage of time, changes in market conditions, changes in the entitys financial health, changes in estimate, and changes in valuation techniques. Requiring fair value information as supplemental disclosures instead of financial statement recognition also addresses some of the concerns (e.g., volatility of reported assets, liabilities, and earnings) of the opponents of fair value accounting.

PUNETHA PEREMALO

The University of Greenwich

Fair Value

CONCLUSION
The concept of measuring fair value in financial statement have clearly explained in this paper and clearly this discussion prove that the fair value measurement are reliable and relevant. The fair value explores more issues to give better outcome in measuring fair value and to make the user, creditor or user to understand better and fix the limitations within the measurement to make it more effective and better when allocating the amount in financial statement. Most of the user or investor is looking for transparent, reliable and relevant reporting in financial statement which can reflect the economic reality as close as possible to make a good decision making. The discussion in this paper evaluating the capable of fair value in measuring certain instrument which reflects the changes in the financial statement, for example like the earning process which not tied into market transaction. Fair value measurement can be more relevant, reliable, and transparency than historical cost. However, the absence of active market and combined with the natural upward bias of management, that neutrality or objectivity can be called into question. A measurement approach applied across all business strategies and most financial instruments may result in a distortion of economic reality and financial performance. The critical analysis in the fair value measurement argues of both impact and benefit in financial statement. Fair value measurement is accompanying robust disclosures where the accounting standards measurement has effected and gives more relevant impact in financial statement. Besides that, the fair value information as become more relevant, reliable, transparency, volatility and manipulated in financial statement.

PUNETHA PEREMALO

The University of Greenwich

Fair Value

Recommendation
Fair value accounting are more relevant measurement accounting compare to historic value where it more information and more transparent in the financial statement. All fair value adjustment and information should be reported in financial statement clearly to get better measurement and to avoid any fraud or misstatement. The fair value measurement in financial statement must have full fair value disclosures before it considering as a shift to fair value recognition in the statement. This method can make the investors, auditors, users and regulators to get more information from the valuation of fair value. To improve more better fair value measurement in financial statement, IFRS should review on the existing fair value requirements, readdress the accounting for financial asset impairment s, establish formal measures to address the operation of existing accounting standards in practice, implement further guidance to foster the use of sound judgment of practitioners and address the need to simplify the accounting for investments in financial asset. Besides that, the user and preparer of financial statement should work together to avoid fraud by considering the practice in the proposal and demonstrate or refute the relative merits of fair value and historic cost based reporting of financial statements for users to analysis the information into more relevant. By implementing this method, there will more reliable, relevant, transparent and more useful info about the company.

PUNETHA PEREMALO

The University of Greenwich