Fair Value Accounting Vs. Historical Cost Accounting For Valuation Of Non-Current Assets: A Case Study Of Wesfarmers

Theoretical Framework: Fair Value Accounting and Historical Cost Accounting

The process of Fair Value Accounting (FVA) has been gaining popularity from most of the accounting standards all over the world for financial reporting. Among them, the International Financial Reporting Standard (IFRS) has also considered the application of FVA for the accounting of non-current assets for the Australian Security Exchange (ASX) listed companies (Zack, 2013). It implies that IFRS has allowed the application of FVA in position of the use of Historical Cost Accounting (HCA) for the valuation of the non-current assets. It needs to be mentioned that the main aim of FVA is the development of correct financial statements so that they can reflect the true financial position of the companies. In this process, difference in opinion can be seen under the process of FVA and HCA (Christensen & Nikolaev 2013). This particular report aims at the analysis of the superiority of FVA over HCA for the computation of the value of non-current assets. Wesfarmers Limited has considered for this report.      

The framework of IFRS Framework 13 Fair Value Measurement contains all the information and details about the factors needed for the successful implementation of fair value accounting (iasplus.com, 2018). This particular standard puts the accounting obligation on all the ASX listed companies to use fair value accounting process for measuring the value of their non-current assets. As per this particular standard, the notion of ‘exit price’ can be used for defining the aspect of fair value. Under the process of fair value accounting, a market-based measurement is taken into consideration rather than entity based measurement. Another essential standard in this aspect is IFRS 5 Non-current Assets Held for Sale and Discontinued Operation as it provides the direction for the accounting treatment of non-current assets. This particular standard states that there is no need to charge depreciation on the assets held for sales and their valuation needs to be done under the basis of fair value accounting after deducting the selling cost (iasplus.com, 2018). After that, the accountants are required to present them separately in the financial statements. Lastly, companies are required to follow all the required standards for separately disclose them.        

Some specific differences can be seen between FVA and HCA. Accountants consider FVA as the improved version of HCS as FVA does not have the drawbacks that can be seen in the accounting of HCA (Blankespoor et al., 2013). The most important aspect under FVA is the initial price paid while buying any assets or liability. For this reason, these initial prices of assets and liabilities does not have the ability to fluctuate the price in the balance sheet while this fluctuation can be occurred in case of HCA. The main reason is the consideration of all the changes in the price of assets and liabilities by the process of FVA. For this reason, under the process of FVA, the financial statements of the companies reflect the correct financial position of the businesses (Shalev, Zhang & Zhang, 2013). The whole fact indicates towards the consideration of the price volatility of the assets and liabilities while HCA does not do it. Thus, based on the above discussion, it can be said that the accounting process of FVA has superiority over HCA for not depending on any subjective valuation of assets.      

IFRS Standards for Accounting of Non-Current Assets

Advantages: The advantages are as follows:

• FVA provides the companies with major assistance in the reduction of assets in the market. Companies can ensure their survival in weak economy with the help of this strategy (Barth, M. E., Gómez-Biscarri & Kasznik, 2012).
• In the presence of FVA, companies can get the accurate value of their assets and liabilities as it takes into account the major increase and decrease in the value of assets and liabilities. Thus, the investors can know the fair financial position of the companies (Palea, 2014).
• With the implementation of the accounting of FVA, companies can track the values of the assets and liabilities where the correct value is not easy to obtain under the accounting process of HCA. This aspect increases the popularity of FVA (Magnan, Menini & Parbonetti, 2015).
• Financial managers and the accountants do not get much scope to do manipulation in the values of assets and liabilities in the presence of FVA as actual value is used for tracking the sales of these assets and liabilities (Palea, 2014).

Disadvantages: The disadvantages are as follows:

• It is required for the business organizations to get recode of the historical value of the assets and liabilities for the measurement of accuracy. Under FVA, there is not any system of recording the historical values and it is a major disadvantage (Cairns, 2012).
• With the application of FVA, companies allow large fluctuations in the value of assets and liabilities many times in a year and it is tedious to record all these fluctuations. It can be considered as a major disadvantage (Bell & Griffin, 2012).
• The investors are not always able to notice the application of FVA in the financial statements and thus, it creates major dissatisfaction in the investors. They can only seen the reduction of income of the company (Bougen & Young, 2012).

Hence, the above discussion shows the presence of both advantages and disadvantages in the application of FVA and all these aspects are required to be taken into consideration.      

The financial statements of Wesfarmers is perfect for measuring the superiority of FVA over HCA as this company can be seen among the top 100 companies under ASX. The following discussion shows the valuation of non-current assets of Wesfarmers under FVA:

Investments in associates and joint venture is the first non-current assets of Wesfarners in 2017 Annual Report. It can be noticed in note 18, page 127 that for the measurement and recognition of this non-current asset, Wesfarmers use their cost value after the addition of post-acquisition charges (wesfarmers.com.au, 2018). Thus, it can be seen that the company follows the IFRS standard of IAS 1(54) (e). It needs to be mentioned that all the changes under this assets has been considered as per FVA measurement.

Deferred Assets is the next listed non-current asset in the balance sheet of Wesfarmers. For the calculation of this asset, the company has complied with the IFRS standard of IAS 1 (54) (o), (56). Compliance with this standard has made the company to recognize and measure the asset at the date of the development of balance sheet (wesfarmers.com.au, 2018). It implies that the company recognizes the value of this asset after considering all the necessary changes that is not done under HCA.

Property is the next listed non- current asset in the balance sheet of Wesfarmers. For this valuation, the company has compiled with the IFRS standard of IAS 1 (54) (a) as the company has considered all the necessary aspects like impairment, depreciation, replacement cost and others while recognizing and measuring this asset. It is a process of FVA (wesfarmers.com.au, 2018).

Plant and Equipment is the next non-current asset in the financial statement of Wesfarmers. For the valuation of this asset, the company has adopted the same IFRS principle like above that is IAS 1 (54) (a). It implies that the company has considered all the fluctuations in the value of this asset while measuring and recognizing and it is a part of FVA accounting (wesfarmers.com.au, 2018).

Goodwill is the next non-current asset listed in the balance sheet of Wesfarmers. It is clearly stated in note no. 8 of the financial statements that the company has complied with the policy of FVA for the valuation of goodwill and the company has complied with the IFRS standard of IAS 1 (54) (c). In this case also, the company has considered all the changes in the value of goodwill. The same valuation system can be seen in case of the next non-current asset of Wesfarners that is Other Intangible Assets (wesfarmers.com.au, 2018).

Comparison of Fair Value Accounting and Historical Cost Accounting

The last item under the non-current assets of the balance sheet of Wesfarmers is Derivatives. It can be seen in the financial note no. 16 that the company has adopted the strategy of FVA in order to value their derivatives on the date of contracts. In addition, the company also uses fair value measurement for re-measuring them. It needs to be mentioned that the company has complied with the IFRS principle of IAS 1 (54) (d) and IFRS7 (8) for the valuation of financial derivatives. The company also uses FVA for the hedging of these derivatives (wesfarmers.com.au, 2018).

The values of the assets in the balance sheet and other financial statements have large effect on the financial health of the companies and the investors use these values in financial statements for making major investment decisions. These values help in the determination of the credit worthiness of the business organizations. Thus, it is expected for every business organizations that their financial statements reflect the correct financial position of their businesses (Barth, M. E., Gómez-Biscarri & Kasznik, 2012). There is not any exception of this fact in case of Wesfarmers. From the above discussion, it can be observed that the company follows the principle and standards of IFRS for the implementation of FVA accounting. It needs to be mentioned that there would be significant difference in the values of the non-current assets in case Wesfarmers adopted HCA standards. Under HCA, the financial statements of the company would fail to convey the correct financial position as it would not take into consideration all the changes in the value of the assets. As a result of this, it would not be possible for the financial statements of the company to reflect the correct financial position of the company and this aspect would lead to the incorrect decision-making process by the investors (Palea, 2014).         

Conclusion

The above discussion states that it is crucial for the business organizations to select the correct accounting method for the financial success of them. For this reason, the companies are required to scrutinize both the advantages and disadvantages of the accounting methods. The above discussion sheds light in the fact that one can get all the details related with use of FVA for the companies listed under ASX. The above discussion discusses about both the advantages and disadvantages of the adoption of FVA. It can be seen from the above discussion that the prepetition of advantages are more than the disadvantages. From the analysis of the financial statements of Wesfarmers, it can be observed that the company has complied with the standards and principles of FVA in order to measure the value of their non-current assets in their different financial statements. It can also be seen that the adoption of HCA would create significant impact on the value of the non-current assets. Thus, based on the above discussion, it can be concluded that companies should permanently replace HCA with FVA for the valuation of non-current assets.

References

2017 Annual Report. (2018). Wesfarmers.com.au. Retrieved 30 March 2018, from https://www.wesfarmers.com.au/docs/default-source/default-document-library/2017-annual-report.pdf?sfvrsn=0

Barth, M. E., Gómez-Biscarri, J., & Kasznik, R. (2012). Fair value accounting, earnings management and the use of available-for-sale instruments by bank managers (No. 05/12). School of Economics and Business Administration, University of Navarra.

Bell, T. B., & Griffin, J. B. (2012). Commentary on auditing high-uncertainty fair value estimates. Auditing: A Journal of Practice & Theory, 31(1), 147-155.

Blankespoor, E., Linsmeier, T. J., Petroni, K. R., & Shakespeare, C. (2013). Fair value accounting for financial instruments: Does it improve the association between bank leverage and credit risk?. The Accounting Review, 88(4), 1143-1177.

Bougen, P. D., & Young, J. J. (2012). Fair value accounting: Simulacra and simulation. Critical Perspectives on Accounting, 23(4-5), 390-402.

Cairns, D. (2012). The use of fair value in IFRS. In The Routledge Companion to Fair Value and Financial Reporting(pp. 25-39). Routledge.

Christensen, H. B., & Nikolaev, V. V. (2013). Does fair value accounting for non-financial assets pass the market test?. Review of Accounting Studies, 18(3), 734-775.

IFRS 13 — Fair Value Measurement. (2018). Iasplus.com. Retrieved 30 March 2018, from https://www.iasplus.com/en/standards/ifrs/if

IFRS 5 — Non-current Assets Held for Sale and Discontinued Operations. (2018). Iasplus.com. Retrieved 30 March 2018, from https://www.iasplus.com/en/standards/ifrs/if

Magnan, M., Menini, A., & Parbonetti, A. (2015). Fair value accounting: information or confusion for financial markets?. Review of Accounting Studies, 20(1), 559-591.

Palea, V. (2014). Fair value accounting and its usefulness to financial statement users. Journal of Financial Reporting and Accounting, 12(2), 102-116.

Shalev, R. O. N., Zhang, I. X., & Zhang, Y. (2013). CEO compensation and fair value accounting: Evidence from purchase price allocation. Journal of Accounting Research, 51(4), 819-854.

Zack, G. M. (2013). Fair Value Accounting. Financial Statement Fraud: Strategies for Detection and Investigation, 117-128.