FAIR VALUE IN DIFFERENT INDUSTRIES

Fair value accounting is a financial reporting approach which companies are
permitted or required to report or measure an on-going basis on certain liabilities and assets at
estimated prices they would receive if they were to sell the assets (King, 2008). In under fair
value accounting, companies report losses when the fair value of their liabilities increase or
assets value decrease. The losses reduce companies’ reported net income and companies’
reported equity. Although fair values have an impact in US Generally Acceptable Accounting
Principles (GAAP) over 50years, accounting standards that permits or require fair value
accounting have increased both significantly and in number. In September 2006, FASB
(Financial Accounting Standard Board) issued a controversial and important standard,
Statement of Financial Accounting Standards (FAS 157) that provides significant and more
comprehensive guidelines to assist companies in estimating fair value (Hitchner, 2013).
The FAS 157 have faced criticism in response to credit crunch. The reported losses
are said to be misleading because of their temporary nature and will reverse when market
returns to normal. The reported losses adversely affect market prices leading to further losses
and increasing the risk of financial system. It is difficult to estimate fair values and thus the
figures derived are unreliable. The criticism although are valid, they are overstated or
misplaced by its advantages and important respects (Carmichael, & Graham, 2012).
The FAS fair value accounting approach benefits investors. It permits and allows
companies to report amounts that are updated on on-going basis. Loss and gains resulting
from change in fair value indicate economic events that investors and companies may find
worthy in additional disclosures. It limits companies’ power of manipulating their income
because gains and losses on liabilities and assets are reported as they occur not as a result of

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

4
transaction. It permits companies in reporting accurate, comparable and timely amounts as it
would on other accounting approaches.
The fair value accounting measurement goal is to estimate best possible price on
which the current position they hold changes hands in orderly transactions based on current
conditions and information. The main issue with FAS is whether the firms do estimate fair
values with no discretion and accurately (Carmichael, & Graham, 2012). Fair values are
typically less in accuracy and more discretionary when they are adjusted mark-to-model
value or mark-to-market values. While adjusting mark-market values, firms have to make
adjustments for market dissimilarity or illiquidity of the position being fair valued and the
adjustment maybe large and judgemental. While estimating mark-to- model values, firms
have choices on the model to use and the input to use while applying the model.
The alternative to FAS is more of amortized cost referred as accrual accounting. It
uses historical information about risk adjustment discounts and future cash flows rates from
inception positions to accounting them throughout firms live, income statements and balance
sheets. Due to its use of historical information, this form raises issues, the firm can manage
its income through selective realisation of unrealized gains and losses on position and it is
referred as gains trading. The net value and firm portfolio’s risks are obscured by incepting
positions at different times which are accounted by using different discount rates and
historical information leading to inconsistent accounting. As long as the firm is holding
positions, income is persistent and becomes transitory when the positions mature.
GAAP requires is referred to a mixed attribute as it uses various measures in
accounting for financial instruments. It contains most of traditional financial instruments like
bank loans held for debt, deposits and investments and are reported as amortized cost. It has a
few financial instruments including FAS115 trade securities, fair value hedge and nonhedge

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

5
derivatives, and value hedged items under FAS113 and the instruments from which the fair
value is derived from FAS 159 and they are later reported on a balanced sheet with unrealized
losses and gains included in net income. For other financial instruments, there is a
requirement of two amortized cost and fair value accounting, loans held-for-sale are recorded
at fair value or low cost under FAS 65. Available for-sale-securities on FAS 115 and cash
flow hedge on FAS 133 are recorded on the balance sheet at a fair value.
Mixed attribute model allows firms to choose on their preferred measurement
attribute for a position by how they classify the position. It has prompted significant amounts
transaction structures that are accounting- motivated. In FAS 115 a firm may choose to
classify security as available for sale, held to maturity or any one of trading and therefore can
obtain any of the three treatments. Mixed attribute model explains the risk of financial
situation and net value in respect to amortized cost or worse than it. It can make effective risk
management of the speculative institutions.
Due to severe limitations, the FAS of all financial institution, financial instrument are
preferred to either be pure amortized cost model or current mixed-attribute accounting model.
Amortized costs are useful checks for specific types of investments and on fair values and
other decisions, however, FASB requires firms to disclose their amortized cost of financial
instrument. Fair value accounting with amortized cost disclosure is essentially the reverse of
current mixed-attribute accounting with fair value disclosure under FAS 107.
International Financial Reporting Standards

The implementation of International Financial Reporting Standards (IFRS13) states
that during fair value measuring, its objective is estimation of price on which an orderly
transaction to transfer a liability or sell an asset would take place at the measurement date
between market participants under current market conditions (Realdon, 2013). The exercise is

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

6
similar with situations during which entities make other estimates on financial reporting
purposes including measuring provisions according to IAS 37 provisions, contingent assets
and contingent liabilities. Mostly the financial reporting measurement involves uncertainty on
timing and amount of cash flow in future. The valuation involves significant judgement and
can lead to different valuation techniques providing different results. This is caused by inputs
used and adjustments to those inputs differing depending on the technique that was used but
the difference does not mean the techniques were incorrect.
Fair value is the price that is received to transfer a liability or sell an asset in an
orderly transaction. IFRS 13 always seek to increase comparability and consistency in fair
value measurement and its related disclosures through a ‘fair value hierarchy’. The hierarchy
categorizes inputs that are used in valuation techniques in to three levels. This hierarchy gives
priority to quoted prices I the active markets for identical liabilities and assets and
unobservable inputs are given the lowest priority. When inputs used to measure fair value
have been categorised to levels of fair value hierarchy, the measurement is categorized to an
entirety in the lowest level input which is significant to the entire measurement.
The best and highest use of non-financial asset takes in account the usage of the asset
that is legally permissible, physically possible and financially feasible. In physically possible,
it takes to account the physical characteristics that market participants takes to account when
pricing- (size of the property or location)- (Realdon, 2013). A legally permissible use takes
all the legal restrictions of an asset use that market participants takes in account while pricing
the asset. Financially feasible use takes to account whether the use of a legally permissible
and physically possible generates adequate cash flow or income in producing an investment
return on which market participants are required from the investment if the asset is put in that
use.

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

7
After the determination of the best and the highest use of an asset, some valuation
matters must be considered. It is a requirement to evaluate appraisals that reflect the effect of
a reasonable anticipated change of what is legally permissible. If change in use can be
obtained through the assumption of appraised value, the valuation must reflect the profit
margin and the cost associated with obtaining of approval for the change in use
transformation of the asset and also covering the risk that the approval might not be granted.
The entity should also evaluate all inputs used in valuation of similar assets with similar
uncertainties (Wang, Ye, Shen, & Bai, n.d.).
The best and highest concept is not just relevant to property interest that are carried at
fair value but also with impairment testing of an investment property interest that is carried
on cost where impairment is measured by fair value Lessing sell cost(Feldman, 2005). ISA 36
impairment of assets has stipulated that impairment arises when the recoverable amount of an
asset is less than its carrying value. IFSR also state if either of the amounts exceeds the
carrying amount of an asset, the asset is not impaired and no need to estimate other amounts.
The fair value is a reflection of the assumption market participants would use while pricing
an asset.
While determining the best and highest use of non-financial assets, it is necessary to
determine whether the best and highest use of that asset of the property interest is within a
stand-alone basis. The fair value of such an asset with best highest combination as compared
with other assets is determined on its use with other complementary assets. In contrast, fair
value of a property that provide maximum value when placed on stand-alone basis is
measured basing it on its price that would be received after selling the property on stand-
alone basis. When determining whether maximum value by market participants, it is basic to
consider the judgement on specific circumstances and facts.

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

8
It is a requirement to assess if an appraisal complies with IFSR 13 to determine if the
appraised value is an important measure of fair value on financial reporting. The assessment
would assess if the most advantageous market or principal has been considered. It should also
look if adjustments valuation data are significant to overall fair value and that it is based both
on observable and unobservable inputs. It should check the appropriate market participants
have been identified and making assumptions that market participants would utilise pricing
the asset. It should consider application of appropriate judgement in assessing best and
highest use and whether future cash flows that are associated with the use are appropriately
adjusted (Wang, Ye, Shen, & Bai, n.d.).
Appropriate valuation techniques should be used in measuring fair value and required
to be appropriate to the circumstance. The application techniques under IFSR 13 include,
market approach which is a valuation technique that use prices and other information that are
generated by market transactions involving comparable or identical assets. Cost approach
reflects the amount that would be required in replacing service capacity of an asset. Lastly
income approach converts future amounts in to a single current amount that reflect current
market reflection on those future amounts. A single valuation technique may be appropriate
while some cases calls for multiple valuation technique (Feldman, 2005).
Cost approach is seldom used in establishing the fair value investment property
applying more on fair valuing owner-occupied property. The decision on the approach to use
depends on specific circumstances and facts, but in all cases, fair value measurement should
put in to consideration all other observable market transactions by maximizing on the use of
observable market input. The objective to use a certain technique or multiple is appropriate in
circumstances with sufficient data. IFSR 13 requires constant application of valuation
techniques used to measure fair value. Change in application of valuation technique, are
appropriately only when the change will result in to a measurement (Simatova, n.d.).

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

9
There is a need to apply the fair value hierarchy to real estate’s appraisals and it
prioritizes the inputs in a fair value measurement, in level 1 inputs, prices are quoted from
active markets for identical liabilities and assets which an entity can access on the
measurement date. The quoted market price gives the most reliable evidence on fair value
and it is used without adjusting the available measure fair value with limited exceptions.
Level 2 inputs are observed directly or indirectly and include input other than the level 1
input that is observable for the liability or asset. The inputs include; quoted prices for similar
or identical liabilities or assets in an inactive market and quoted prices for identical liabilities
or assets in a market. It also includes inputs other than observable for liabilities and assets, for
example; credit spreads, implied volatilities, interest rates observed at commonly quoted
intervals (Wang, Ye, Shen, & Bai, n.d.).
Level 3 inputs include unobservable inputs for the liabilities and assets. Unobservable
are used in measuring the fair value the extent that these relevant observable inputs are
unavailable leading to situations that give little if any market activity for the liability or asset
measurement date. The entity develops unobservable inputs derived from the best
information available during the circumstance. During fair value measurement of non-
financial asset, it is taken to account the ability of a market participant to generate economic
benefits through using the asset in its best and highest or by selling it to another market
participant that will utilize the asset at its best and highest use (Sart, 2010).
Due to inactive market for identical asset, it is rare for real estates to be classified in
level 1 of the fair value hierarchy. In market conditions where there is active purchase and
sales of real estate, the fair value measurement can be classified as level 2. However, the
determination depends on the circumstances and facts including significantly adjusting the
observable data. In this context, IFSR 13 provides a specific example on real estate on stating
that level 2 inputs is the price per square metre to derive the property interest from observable

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

10
market data. In active and transparent markets, the real estates would be accorded level 2
provided no significant adjustments have been carried on observable data(Crane, & Levy,
2009).
In less transparent and inactive real estate’s market, there is believe that that it is
unlikely that real estate would be classified in level 3 rather than level 2. While selecting
appropriate input of a fair value measurement from multiple available values, some maximise
on the use of observable data rather than unobservable data. In inactive markets, there should
be no presumption that all transactions in the market are not a representative of fair value just
because the market volume has decreased or it is inactive. Entities are required to make
individual circumstances and facts while making the assessment. The entity should have a
reasonable basis in concluding on current observable market price which can be ignored
based on view that it presents a distressed value or liquidation (Merbecks, n.d.).
IFSR 13 requires an entity that discloses information that helps users of its financial
statements to access fair value measurements by using significant unobservable inputs (level
3) its effect on measuring loss or profit or any comprehensive income during the period. The
users should also access liabilities and assets that are measured of fair value both at non-
recurring and recurring basis in the financial position and the valuation inputs and techniques
used to develop the measurements. The disclosures exemptions include assets on which fair
value recoverable amount is less than the cost of disposal. It can also be exempted when plan
assets measured at fair value in accordance with employee benefits (Simatova, n.d.).
While many concepts in IFSR 13 consistent are with current practice, certain
disclosure and principles could have significant impact on construction and real estates. In
many cases, the concept of best and highest use and premise valuation may not be
significantly different from recent practice; nevertheless, careful considerations are required

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

11
in identification of the situations in which they have a significant impact. Considerable
judgement is required during application of fair value measurement concept that is included
in IFSR 13, such as, valuing alternative use, determining high and best use, applying fair
value hierarchy and determining the valuation premise. Any management needs a good
knowledge on the concepts before making judgements on fair valuation measures (Merbecks,
n.d.).

Australian Accounting Standard Board

The AASB makes the Australian accounting standards and its interpretations are to be
applied by, government in preparing financial statements for the general government sector
and the whole government. Corporation’s act 2001 also requires some entities to use this
form of fair valuation. Entities both in public and private sector involved in profit or non-
profit sectors also should prepare general purpose financial statement. AASB 1053
establishes differential reporting framework that consist of two tiers with reporting
requirements in preparing general purpose financial statements (Sart, 2010).
Tier 1- Australian Accounting Standards is publicly accountable for –private profit
sectors entities are required to confirm with Tier 1 requirements and therefore they are
required to conform to IFRS. Tier 2- Australian Accounting Standards with reduced
disclosure and its requirements consists of recognition, presentation and measurement
requirements of Tier 1. But it has substantially reduced disclosure compared to Tier 1.
Australian Accounting Standards have some requirements that are specific entities and they
are located in IFRSs or any Australian standards. The requirements in most instances are
either restricted to public or not-for-profit sectors and contains additional disclosures that
address regulatory, domestic and other issues (Badenhorst, 2014).

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

12
AASB 7 financial instruments disclosure, fair value of a liability is reflected by the
effect of its non-performance. Examples of non-performers risks include and not limited to
entity own credit risk and it is assumed to remain the same as before and after liability
transaction. The fair value of liability reflects an effect of non-performance risks as portrayed
by its basis of its account unit. During fair value liability measurements, an entity takes in
account the effects of its credit standings or risks and all factors that influence the likelihood
of fulfilment of the obligation. The effect differs in relation to the liability causing it.
Any entity holding a group of financial liabilities and assets is exposed to credit risks
and market risks of each the counter parties. If the entity manages that group of financial
liabilities and financial assets on net exposure basis, to either credit of market risks, the entity
is permitted to apply a standard measuring fair value exception. The entities are allowed to
use the exception when required to measure those financial liabilities and assets at a fair
value at the end of reporting year (Badenhorst, 2014). They can use it while providing
information on group financial liabilities and assets basis to the key management personnel.
The exception is also used during managing group liabilities and assets on net exposure basis.
Valuation techniques that are used in measuring fair value should maximise use of
relevant observable inputs while minimising the use of non-observable inputs. Markets with
observable inputs on liabilities and assets include; principal-principal markets, dealer
markets, brokered markets and exchange markets(Crane, & Levy, 2009). The entities select
inputs that consistently match the characteristics of the liability or asset that market
participants can take an account of in a transaction of the liability or asset. If a liability or an
asset is measured at a fair value, has an ask price or a bid price, the price within the bid is
used as the fair value irrespective of whether the input is categorized in fair value hierarchy.
In bid prices, the standard does not preclude any use of mid-market pricing and other pricing
convections used by market participants.

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

13
Present value techniques focus on discount rate adjustments and expected cash flow
technique. Present value techniques measures fair value according to circumstances and facts
of the liability and asset. Present value measurement is a tool that that links present amounts
to future amounts using a discount rate. It is applied while using present value technique in
measuring the fair value measurement of liability and asset from perspective participants at a
given measuring date. The value technique differs in capturing methods where discount rates
and cash flows reflect market participants while pricing liability or assets.
County equity risk premium is an approach that is less commonly used by considering
default spreads in additional to standard deviations. Fair value of liability is based on the
transferring price on the obligation to the market participant of the measuring data. Primary
advantage of fair value is accurate liability and assets on on-going basis of a user’s company.
The fair value a company ability to manipulate reported network and prevents challenges to
companies reported financial report. It adversely affects down market without valuation
markdown(King, 2008).

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

14

References

Badenhorst, W. (2014). Fair Value Measurements of Control Premiums. Account Perspect,
13(3), 173-188. http://dx.doi.org/10.1111/1911-3838.12030
Carmichael, D., & Graham, L. (2012). Accountants’ Handbook, Special Industries and
Special Topics. Somerset: Wiley.
Crane, M., & Levy, M. (2009). Fair Valuation of Trade Claims. Business Valuation Review,
28(4), 181-185. http://dx.doi.org/10.5791/0882-2875-28.4.181
Feldman, S. (2005). Principles of private firm valuation. Hoboken, N.J.: John Wiley & Sons.
Hitchner, J. (2013). Financial valuation. Hoboken, N.J.: Wiley.
KMerbecks, U. Valuation of (German) Defined Benefit Plans – Introducing Financial Theory
to Financial Accounting. SSRN Electronic Journal.
http://dx.doi.org/10.2139/ssrn.2154574ing, A. (2008). Executive’s guide to fair value.
Hoboken, N.J: Wiley.
Realdon, M. (2013). Credit risk, valuation and fundamental analysis. International Review Of
Financial Analysis, 27, 77-90. http://dx.doi.org/10.1016/j.irfa.2012.10.001
Sart, F. (2010). Fair valuation of universal life policies via a replicating portfolio. Journal Of
Applied Analysis, 16(1). http://dx.doi.org/10.1515/jaa.2010.007

Running Head: FAIR VALUE IN DIFFERENT INDUSTRIES

15
Simatova, M. Does Fair Value Matter for Valuation of Real Estate?. SSRN Electronic
Journal. http://dx.doi.org/10.2139/ssrn.672442
Wang, Y., Ye, H., Shen, G., & Bai, Y. ICCREM 2014.