Finance

fair value accounting in india An alternative approach to measurement that seeks to capture changes in asset and liability values over time. The International Accounting Standards Board (IASB) defines fair value as "... an amount at which an asset could be exchanged between knowledgeable and willing parties in an arms length transaction". Under the fair value measurement approach, assets and liabilities are re-measured periodically to reflect changes in their value, with the resulting change impacting either net income or other comprehensive income for the period. The result is a balance sheet that better reflects the current value of assets and liabilities. The cost is greater volatility in periodic reported performance caused by changes in fair value. FAS 157 define fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This definition of fair value reflects an ideal “exit value” notion in which firms exit the positions they currently hold through orderly transactions with market participants at the measurement date, not through fire sales. Currently the definition of fair value stands as “Amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.   If quoted in an active market then objective would be the price at which transaction would occur at the balance sheet date in most advantageous market and methods applied would be published price quotations when available, use market quoted rate in valuation techniques or bid price for asset held –    If not quoted in an active market then objective would be transaction price in arm’s length transaction motivated by normal business considerations and method applied would be valuation techniques (recent market transactions, similar instruments, DCF analysis etc.), use commonly used and reliable valuation technique or use market based information. -In accordance with the series of guidelines issued by the Reserve Bank of India between 1995-2000, fair value accounting has been applied only on the ‘held for trading’ securities in banks’ investment portfolio in India till today. Accordingly, this research paper makes a modest attempt to examine whether fair valuations in banks’ trading books bring about an increased volatility in banks’ stock returns over the time period 1994-1995 to 2007-2008, using a sample of Indian banks and bank index, i.e., BSE BANKEX, and autoregressive and multiple linear regression techniques. Studying adopting a new approach towards fair value accounting in India are reviewed here;- 1. According to the Accounting Standards Board of the Institute of Chartered Accountants of India 113 Fair value is a market-based measurement, not an entity-specific measurement. For Some assets and liabilities, observable market transactions or market information might be available. For other assets and liabilities, observable market transactions and market information might not be available. However, the objective of a fair value measurement in both cases is the same to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions. A fair value measurement is for a particular asset or liability. Therefore, when measuring fair value an entity shall take into account the characteristics of the asset or liability if market participants would take those characteristics into account when pricing the asset or liability at the measurement date. Such characteristics include, for example, the following: (a) The condition and location of the asset; and (b) Restrictions, if any, on the sale or use of the asset. The effect on the measurement arising from a particular characteristic will differ depending on how that characteristic would be taken into account by market participants. The asset or liability measured at fair value might be a stand-alone asset or liability (e.g. a financial instrument or a non-financial asset); or a group of assets, a group of liabilities or a group of assets and liabilities (e.g. a cash-generating unit or a business). Whether the asset or liability is a stand-alone asset or liability, a group of assets, a group of liabilities or a group of assets and liabilities for recognition or disclosure purposes depends on its unit of account. The unit of account for the asset or liability shall be determined in accordance with the Ind AS that requires or permits the fair value measurement. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal market at the measurement date under current market conditions regardless of whether that price is directly observable or estimated using another valuation technique. In case of transaction a fair value measurement assumes 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 under current market conditions. A fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place either in the principal market for the asset or liability or in the absence of a principal market, in the most advantageous market for the asset or liability. When there is no observable market to provide pricing information about the sale of an asset or the transfer of a liability at the measurement date, a fair value measurement shall assume that a transaction takes place at that date, considered from the perspective of a market participant that holds the asset or owes the liability. That assumed transaction establishes a basis for estimating the price to sell the asset or to transfer the liability. In case of market participants an entity shall measure the fair value of an asset or a liability using the assumptions that market participants would use when pricing the asset or liability, assuming that market participants act in their economic best interest. An entity need not identify specific market participants. Rather, the entity shall identify characteristics that distinguish market participants generally, considering factors specific to the asset or liability, the principal market for the asset or liability and the market participants with whom the entity would enter into a transaction in that market . A fair value measurement of a non-financial asset takes into account a market participant's ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use. The highest and best use of a non-financial asset establishes the valuation premise used to measure the fair value of the asset, as follows: (a) The highest and best use of a non-financial asset might provide maximum value to market participants through its use in combination with other assets as a group or in combination with other assets and liabilities. (b) The highest and best use of a non-financial asset might provide maximum value to market participants on a stand-alone basis. If the highest and best use of the asset is to use it on a stand-alone basis, the fair value of the asset is the price that would be received in a current transaction to sell the asset to market participants that would use the asset on a stand-alone basis. The fair value of a financial liability with a demand feature (e.g. a demand deposit) is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid. In Exposure to market risks the fair value of a group of financial assets and financial liabilities managed on the basis of the entity's net exposure to a particular market risk (or risks), the entity shall apply the price within the bid-ask spread that is most representative of fair value in the circumstances to the entity's net exposure to those market risks. An entity shall ensure that the market risk to which the entity is exposed within that group of financial assets and financial liabilities is substantially the same. For example, an entity would not combine the interest rate risk associated with a financial asset with the commodity price risk associated with a financial liability because doing so would not mitigate the entity's exposure to interest rate risk or commodity price risk. When using the exception any basis risk resulting from the market risk parameters not being identical shall be taken into account in the fair value measurement of the financial assets and financial liabilities within the group. An entity shall use valuation techniques that are appropriate in the circumstances and for which sufficient data are available to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs. The objective of using a valuation technique is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions. Three widely used valuation techniques are the market approach, the cost approach and the income approach An entity shall use valuation techniques consistent with one or more of those approaches to measure fair value. 2. IFRS uses fair value as a measurement base for valuing most of the items of financial statements. The use of fair value accounting can bring a lot of volatility and subjectivity to the financial statements. It also involves a lot of hard work in arriving at the fair value and valuation experts have to be used. Moreover, adjustments to fair value result in gains or losses which are reflected in the income statements. Whether this can be included in computing distributable profit is also debated. 3. Ball (2006) notes that the fair value orientation of IFRS could add volatility to financial statements. This volatility takes the form of both good and bad information; the latter consisting of noise that arises from inherent estimation error and possible managerial manipulation. According to Ball IFRS stipulates that fair value is “the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction with some slight variations in wording in different standards. 4. In 2008, the U.S. Securities and Exchange Commission conducted a large in scope consultation in relation to fair value accounting and of its application to financial institutions. During the consultation, the Commission considered 186 comment letters, opinions presented during the Commission’s three public roundtables, and recommendations developed by the two most recent U.S. federal advisory committees on fair value accounting measurements. The overarching conclusion of this consultation was that most investors and other users of financial reports denote the view that fair value accounting gives to the investor “additional insight into the risks to which the company may be exposed and the potential liquidity issues the company could face if it needed to sell securities rather than hold them for the long-term. 5.According to ERON Fair-Value Measurements, would have companies determine fair values by reference to market prices on the same and, where these prices are not available or appropriate, present value and other internally generated estimated values. Enron extensively used estimates for its external and internal reporting. A description of its use and misuse of fair-value accounting should provide some insights into the problems that auditors and financial statement users might face when companies fair valuations. Enron first used level 3 fair-value accounting for energy contracts, then for trading activities generally and undertakings designated as “merchant” investments. Simultaneously, these fair values were used to evaluate and compensate senior employees. Enron’s accountants (with Andersen’s approval) used accounting devices to report cash flow from operations rather than financing and to otherwise cover up fair-value overstatements and losses on projects undertaken by managers whose compensation was based on fair values. Based on a chronologically ordered analysis of its activities and investments, I believe that Enron’s use of fair-value accounting is substantially responsible for its demise. 6.According to Tanupa chakraborty University of Calcutta Fair value’ of an asset or a liability refers to the amount at which such an asset could be exchanged, or the liability settled, between knowledgeable, willing parties, in an arm’s length transaction. Although the growing irrelevance of historical cost-based accounting numbers in the financial statements, in the wake of developments in financial markets and advancements in technology, has triggered off the debate on fair value accounting a decade and a half ago, some issues still stand in the way of extensive application of fair value accounting framework. One such issue is the excessive level of volatility in the financial statements induced by fair valuations and its resultant impact on the flight of capital from the firm’s equity. In accordance with the series of guidelines issued by the Reserve Bank of India between 1995-2000, fair value accounting has been applied only on the ‘held for trading’ securities in banks’ investment portfolio in India till today. Accordingly, this research paper makes a modest attempt to examine whether fair valuations in banks’ trading books bring about an increased volatility in banks’ stock returns over the time period 1994-1995 to 2007-2008, using a sample of Indian banks and bank index, i.e., BSE BANKEX, and autoregressive and multiple linear regression techniques. 7.According to Swamy, Vighneswara and S, Vijayalakshmi (2012) ,  African Journal of Accounting the impact of Fair Value Accounting on the banking industry in general and Indian Banking in particular in the light of the move towards convergence to International Financial Reporting Standards across the globe. In the light of criticism against fair value accounting for amplifying the subprime crisis and for causing a financial meltdown, the article has analyzed the nature and impact of Fair Value Accounting in view of the recent announcement of the Indian version of IFRS i.e Ind AS by the regulators in India and its impact in relation to the contentious issues like; systemic risk, contagion and its impact on investors. Further, the article highlights the areas in which Indian banking industry is required to focus before and after the implementation of Fair Value Accounting and their consequences on the financial statements of the Bank. 8. According to Adrian Oberli the Journal of Private Equity the implications of fair value accounting practices on LBO returns. Nevertheless, the question of how to account for private equity funds’ unrealized investments remains highly controversial. This article empirically examines whether fair value accounting provides more accurate valuations and enhances comparability with public databases. The results show that time lags in private equity reporting have to be considered in return attribution and that leading buyout return indices have become more correlated since 2000 with the use of fair value accounting. 9. According to Wayne Landsman from on Accounting, risk management and prudential regulation  fair value accounting is used for determining bank regulatory capital and when making regulatory decisions. In financial reporting, US and international accounting standard setters have issued several disclosure and measurement and recognition standards for financial instruments and all indications are that both standard setters will mandate recognition of all financial instruments at fair value. To help identify important issues for bank regulators, I briefly review capital market studies that examine the usefulness of fair value accounting to investors, and discuss marking-to-market implementation issues of determining financial instruments' fair values. In doing so, I identify several key issues. First, regulators need to consider how to let managers reveal private information in their fair value estimates while minimizing strategic manipulation of model inputs to manage income and regulatory capital. Second, regulators need to consider how best to minimize measurement error in fair values to maximize their usefulness to investors and creditors when making investment decisions, and to ensure bank managers have incentives to select investments that maximize economic efficiency of the banking system. Third, cross-country institutional differences are likely to play an important role in determining the effectiveness of using mark-to-market accounting for financial reporting and bank regulation. 10. According to  Sanders Shaffer   fair value accounting’s usefulness, the potential impacts it may have on financial institutions and any broader macroeconomic effects. Materials reviewed as part of this analysis include public bank regulatory filings, financial statements, and fair value research.  He says that implementing fair value accounting more broadly may not necessarily provide financial statement users with more transparent and useful reporting. Additionally, financial stability may be negatively impacted by fair value accounting due to the interconnectedness of financial institutions, markets and the broader economy. 11. According to Prof. M. Yadagiri and Mr. P. Rajender under IFRS, financial assests are initially recognized at fair value. Subsequently, loans and advances and investments that the entity intends to hold till maturity are measured at amortized cost using the effective interest method, and all other financial assests are measured at fair value. 12. According to IFRS 13 describes the fair value concept and how to implement it. As it applies when another IFRS requires (or permits) the application of the fair value concept, this standard does not extend the scope of fair value in accounting. Fair value is not always identical to market value, even though priority must always be given to observable data why using a mathematical model to estimate fair value. 13. According to R. Christopher Small from a Forum on Corporate Governance and Financial Regulation A fair value is the price at which two willing parties would exchange an asset or settle a liability. Starting after the savings and loan crisis in the late 1980s, the Financial Accounting Standards Board (FASB) has increased the extent to which financial instruments are recognized at fair value (see Godwin, Petroni, and Wahlen 1998). In 2010, the FASB proposed to require that all financial instruments be recognized at fair value, with limited exceptions for receivables and payables and some companies’ own debt (FASB 2010). The proposal was controversial, with over 2,800 comment letters submitted, the vast majority of which objected to the fair value measurement of loans, deposits, and financial liabilities. The FASB is redeliberating. 14. according to padmini srinivasan Indian Institute of Management Bangalore  thefair value relevance of consolidated financial statements and cash flow statements in the Indian Stock market. In the recent years several new disclosures have been mandated in India including the cash flow statement and the preparation of consolidated financial statements. The motivation for the additional disclosures has been internationalization ofaccounting standards as well as better transparency. Very few countries provide information on both stand alone as well as consolidated financial statements, which makes it unique in the Indian context to study the relative importance of these statements. This study provides evidence on consolidated financial statements and the preparation of cash flow statement.his findings are that consolidated accrual earnings and cash flows statements have no significant association with market adjusted stock return. On the contrary, the parent only earnings show significant positive relationship with the stock returns. Our results are quite contrary to the existing literature on the fair value relevance from other counties and throws light on the way markets react to the information in an emerging market like India. These results have a policy implication for the regulators especially as we are moving towards adopting the International Financial reporting standards. 15. according to Karl V. Lins firms altered their risk management policies when fair value reporting standards for derivatives were introduced. A substantial fraction of firms (42%) state that their risk management policies have been materially affected by fair value reporting. Firms are more likely to be affected if they seek to use risk management to reduce the volatility of earnings relative to cash flows and if they operate in countries where accounting numbers are more likely to be used in contracting. We document a substantial decrease in foreign exchange hedging and in the use of nonlinear hedging instruments. Finally, firms that take active positions are more likely to be affected by fair value reporting. Taken together, our evidence indicates that requirements to report derivatives at fair values have had a material impact on derivative use; while speculative activities have been reduced, sound hedging strategies have been compromised as well. 16. According to Bloomer, Jonathan Geneva from the Papers on Risk & Insurance - Issues & Practice. The impact of “fair value” accounting as encompassed in “International Accounting Standard 39: Financial Instruments; recognition and measurement” and in the current insurance project of the International Accounting Standards Board. It outlines the background and developments in this area together with a summary of the present position. There is no present consensus on an appropriate basis for insurance accounting and from 2005 the industry will almost certainly have to deal with a mixed model for accounting which would have assets accounted for at fair value whilst liabilities are primarily accounted for as at present. The standard setters' current goal would be to have a full fair value reporting system in place by 2007. This research paper covers the issues in respect of capital and products that this position gives rise to. Despite the uncertainty surrounding the development of a new standard, it is apparent that the insurance industry will have to deal with very significant changes in its financial reporting and these changes have potentially major consequences for the nature of the business. Insurance companies need to continue to pay attention to the on-going accounting debate over reporting standards and ensure that an industry voice is heard in the determination of a standard which reflects the present business reality and economic position and is also truly useful to the users of financial statements.