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Financial Reporting and Fair Value: Where Do We Stand?

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IFRS in a Global World

Abstract

Over the past two decades, the accounting standards under which large companies determine and report their performance measures have led to much debate. Indeed, a wide-reaching movement, originally initiated by the U.S. Financial Accounting Standards Board (FASB), and spread at an international level by the International Accounting Standards Board (IASB), aimed to replace historical cost with the market-based concept of fair value. Fair value can potentially be used for measuring a large number of non-financial assets and liabilities (e.g. goodwill, post-retirement scheme values, share-based payments) and can therefore serve as the basis for a new corporate accounting model aiming to provide a more accurate view of the future cash flow estimates’ and investment opportunities’ uncertainties within financial reports. Based on the extent literature, this article discusses the usefulness of financial information disclosed under the fair value approach. In this respect, the key question—is fair value relevant?—will be analysed in a threefold way: (1) Do fair value-based “accounting numbers” help better estimate the value of a company and the intrinsic risk relating to its activity? (2) How informative are they for financial statements’ users? (3) How useful is fair value information for decision-making?

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Notes

  1. 1.

    IFRS 13 (2011), Fair Value Measurement, Appendix A. The US SFAS Standard N°107, issued in 1991 and entitled ‘Disclosures about Fair Value of Financial Instruments’, provides the following definition that used to prevail under IAS 39 (2005) prior to the introduction of IFRS 13 in 2011: “the fair value is the amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale”.

  2. 2.

    The market value is the “price that the seller can get (or that the purchaser will accept to pay) … on an active market”.

  3. 3.

    For a study of the different notions of value underlying the different accounting models, see Simon (2000).

  4. 4.

    It is noteworthy that the prudence principle can stand in contradiction with the fair value measurement (see the speech of Hans Hoogervorst, chairman of the IASB, ‘The Concept of Prudence: Dead or alive?’, 18 September 2012, Brussels, Belgium).

  5. 5.

    With regard to company valuations, for example, Ohlson (1990) stresses the quasi-systematic bias introduced by the use of accounting numbers based on historical cost.

  6. 6.

    For example, Littleton (1952), Kohler (1963), Ijiri (1971) and, in the context of the current debate surrounding fair value, Ramanna (2013).

  7. 7.

    Allen and Ramanna (2013) show that FASB members with backgrounds in financial services strongly advocate for the use of fair value reporting during the FASB standard-setting due process.

  8. 8.

    The IASC was the predecessor of the IASB till 2001.

  9. 9.

    Difficulties relating to its implementation meant that the authors often considered this method impractical.

  10. 10.

    In 1989, the IASC conceptual framework recognized the following valuation bases: historical cost, current cost (or replacement value), realizable value and present value.

  11. 11.

    The conceptual framework of the FASB identifies the essential qualities of accounting information. Relevance is an attribute that enables users of financial statements to make decisions, to confirm or correct previous forecasts and to evaluate the results of past, present or future events. Accuracy is a characteristic that means the accounting information can be used with confidence as it is neither partial nor incorrect.

  12. 12.

    This is particularly the case with the American Accounting Association (AAA), see (Cornett et al. 1996).

  13. 13.

    In view of this, it is necessary to ask, for example: are financial analysts requesting a wide-spread use of fair value? Do they advocate financial reporting that favours the balance sheet over the income statement? The study conducted among financial analysts by Garmilis (2001) highlights only mild demand for fair value information.

  14. 14.

    For the origins of the notion of fair value, see Simon (2000).

  15. 15.

    For the emergence of the notion of Fair Value in US accounting standards, see Cornett et al. (1996).

  16. 16.

    SFAS standard 107 (1991), Disclosures about Fair Value of Financial Instruments.

  17. 17.

    SFAS standard 119 (1994), Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.

  18. 18.

    SFAS standard 115 (1993), Accounting for Certain Investments in Debt and Equity Securities.

  19. 19.

    SFAS standard 133 (1998), Accounting for Derivative Instruments and Hedging Activities.

  20. 20.

    A more radical proposal, designed to get rid of accounting based on the intention of the management and extend fair value accounting to all financial instruments. Although the FASB was in favour, banks were fervently opposed to it.

  21. 21.

    For the qualities and weaknesses of fair value, see also Cornett et al. (1996), Casta and Colasse (2001).

  22. 22.

    For a summary of these criticisms, see Swenson and Buttross (1993), Cornett et al. (1996), Casta and Colasse (2001).

  23. 23.

    A number of studies have been carried out on the effect of accounting standards on volatility. For a summary, see Ballwieser and Kuhner (1994).

  24. 24.

    On the conceptual problems of Fair value with respect to the existence of active markets, see Barth and Landsman (1995), or Holthausen and Watts (2001).

  25. 25.

    However, recent studies have questioned the validity of the theory of efficient capital markets, opening up other avenues of research.

  26. 26.

    On work carried out on the banking sector, see Barth et al. (1996), Khurana and Kim (2003) and Nelson (1996). With regard to non-financial companies, see Simko (1998).

  27. 27.

    For further details, please refer to the Discussion Paper issued in July 2013 by the IASB and entitled ‘A Review of the Conceptual Framework For Financial Reporting’, DP/2013/1, 239p.

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Authors and Affiliations

  1. Dauphine Recherches en Management, University of Paris-Dauphine, CNRS-UMR 7088, Paris, France

    Jean-François Casta & Olivier Ramond

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  1. Jean-François Casta
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  2. Olivier Ramond
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Correspondence to Jean-François Casta or Olivier Ramond .

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Editors and Affiliations

  1. Paris-Dauphine University, Paris cedex 16, France

    Didier Bensadon

  2. Paris-Sud University, Sceaux, France

    Nicolas Praquin

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Casta, JF., Ramond, O. (2016). Financial Reporting and Fair Value: Where Do We Stand?. In: Bensadon, D., Praquin, N. (eds) IFRS in a Global World. Springer, Cham. https://doi.org/10.1007/978-3-319-28225-1_5

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