fair value accounting

Topics: Balance sheet, Generally Accepted Accounting Principles, Depreciation Pages: 5 (1570 words) Published: December 28, 2013
Fair Value Accounting 
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Standards
Fair Value Accounting
Fair value accounting contains a superior basis for financial reporting than the outdated historical cost model.  
FROM: SEP-OCT 2005 ISSUE | BY HAN DONKER
In recent years, international standard setters and regulators such as the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) have begun to favour the use of fair value accounting over historical cost accounting in financial reporting. A key reason for this shift in methodology is to improve the relevancy of the information contained in financial reports. The general principle underlying the shift is that up-to-date information improves investors' and regulators' abilities to make informed decisions. To date, the fair value concept is applied in several IASB standards, such asIAS 16Property, Plant and Equipment; IAS 37Provisions, Contingent Liabilities and Contingent Assets; IAS 38Impairment of Assets; IAS 39Financial Instruments; IAS 40Investment Properties; IAS 41Agriculture;IFRS 2Share-basedPayment; and IFRS 3 Business Combinations. In Canada, the Accounting Standards Board (AcSB) is considering the adoption of International Financial Reporting Standards (IFRS), which are based onfair-value accounting. Notably, the AcSB is working on a research project on behalf of the IASB to analyze various measurement bases for financial accounting. Part of the project focuses specifically on the use of fair value accounting, and the AcSB plans to release a discussion paper prior to the end of the year. Fair Value Concept

Standard setters define fair value as the amount for which an asset or liability can be exchanged between knowledgeable, willing parties in an arm's length transaction. In an active market, fair value equals observed market price. If there is no active market, fair value is an estimate of value in use. The FASB distinguishes between three levels for estimating fair value: Using quoted prices for identical assets or liabilities in active markets whenever that information is available (market values); If quoted prices are not available for identical assets or liabilities, fair value should be estimated using quoted prices of similar assets or liabilities (market equivalents); If quoted prices of identical or similar assets or liabilities are not available or not objectively determinable, fair value should be estimated using valuation methods based on present value techniques of future earnings, or cash flows and valuation techniques. Fair value based on the judgment of future cash flows is entity-specific, which means that the same asset can be measured differently for two companies because of different borrowing rates and managerial appraisals. Thus, the reliability of fair value estimates declines with the shift from liquid markets tonon-traded items. Models of Fair Value Accounting

Models
Unrealized Gains
Realized Gains
A. Equity Approach
Equity
Equity
B. Mixed Approach
Equity
Income
C. Income Approach
Income
Income
D. Full Fair Value
Income
(+ internally 
     generated
     goodwill)
Income
(+ internally 
     generated
     goodwill)

Essentially, we can distinguish between four fair value models with respect to the incorporation of realized and unrealized holding gains and losses. The key characteristics of each model — equity, mixed, income, and full fair value — are outlined below. With the equity approach, all unrealized fair value changes are admitted in a revaluation reserve. When the transaction is realized, fair value changes are disclosed in equity. Realized holding gains do not affect the income statement.IAS 16 is an example of this approach. With the mixed approach, unrealized fair value changes are admitted in a revaluation reserve, but realized fair value changes are reflected in the income statement instead of equity....
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