Corporate Accounting: Applicability of Fair Value Accounting and its Influence in Financial Crisis

This essay sheds light on the applicability of fair value accounting and the influence of the same in the financial crisis in the contemporary world. The case study compares fair value disclosures of Woolworths Group Limited and Wesfarmers Limited.

Running head: CORPORATE ACCOUNTING
Corporate Accounting
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Table of Contents
Part A: Essay....................................................................................................................................2
Part B: Case Study...........................................................................................................................5
References:......................................................................................................................................9

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Part A: Essay
Introduction
Fair value accounting is considered as the accounting process where the assets and
liabilities are measured based on their current market price1. Over the years, an argument has
occurred related to the use and usefulness of fair value accounting for the private as well as
public companies. This essay sheds light on the applicability of fair value accounting and the
influence of the same in the financial crisis in the contemporary world.
Discussion
The main use of fair value accounting is the reporting of the useful information about the
assets and liabilities of the companies to the users of the financial statements. However, the
presence of major arguments can be seen in the use of fair value accounting in the public and
private companies. It needs to be mentioned that fair value accounting assists in providing more
transparency than the historical cost accounting. The relevance and reliability of fair value
accounting can be proved by criticising the historical cost accounting as it is considered that
historical cost if reliable and relevant only on the day they are recorded. The presence of both
reliability and relevance is there in the fair value measurement as the users can get the most
recent information of the assets and liabilities from fair value accounting2.
The income statements of the private and public companies under fair value accounting
also deliver the economic income of those companies as it reflects the change in the firms’
1 Lu, Hung-Yuan (Richard) and Vivek Mande, "Does Disaggregation Of Fair Value Information Increase The Value
Relevance Of The Fair Value Hierarchy?" (2014) 26(1) Research in Accounting Regulation
2 Siekkinen, Jimi, "Value Relevance Of Fair Values In Different Investor Protection Environments" (2016)
40(1) Accounting Forum

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values over the time. This is because fair value accounting helps in producing more relevant as
well as comprehensible financial information about the company’s assets and liabilities which is
supportive to the shareholders and other stakeholders for making effective decisions about the
assets, liabilities and income of the firms. For this reason, it can be said that the fair value
accounting in the corporate accounting of the private and public companies provides efficient
values of the assets and liabilities; and the performance of the management and risk exposure can
be gained from the income statement under fair value measurement. However, as per many of
the critics, the use of fair value accounting in the private and public companies provides the
managements with the scope of manipulation so that they can show the result that the
management would like to show3.
According to many critics of fair value accounting, this valuation technique was majorly
responsible for the world financial crisis due to the fact that the fair value accounting contributed
towards the difficulties in the measurement of the value of the subprime positions4. As per their
claims, fair value accounting led to extreme leverage used by the banks at the time of boom and
contributed towards the downward spiral during the period of recession, creating pressure on the
banks to value the assets at fire-sale prices. This aspect created an extremely lower valuation of
the assets which created danger for the lending. At the same time, many opponents of fair value
accounting believed that the fair value accounting damaged the critical basis of financial
reporting that includes verifiability, reliability and traditionalism. It implies that the presence of
these attributes influenced the subprime crisis5.
3 Du, Hui, Sherry Fang Li and Randall Zhaohui Xu, "Adjustment Of Valuation Inputs And Its Effect On Value
Relevance Of Fair Value Measurement" (2014) 26(1) Research in Accounting Regulation
4 Song, Xiaofei, "Value Relevance Of Fair Values-Empirical Evidence Of The Impact Of Market Volatility" (2015)
14(2) Accounting Perspectives

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Conclusion
It can be seen from the above discussion that fair value accounting plays a crucial role in
expressing the reliable as well as relevant financial information of the assets and liabilities of the
companies. Both the private and public companies can provide their users with the correct
information about the assets, liabilities and income of the organization.
5 LaCalamito, Thomas, "Fair Value Accounting's Role In The Recent Financial Crisis" (2013) 4(3) International
Journal of Economics and Accounting

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Part B: Case Study
The two ASX listed organisations that have been selected for analysing the fair value
disclosure information include Woolworths Group Limited and Wesfarmers Limited, which are
the two retail organisations dominating the sector in Australia in terms of revenue and market
demand. The detailed comparison of their fair value disclosures is presented as follows:
Woolworths Group Limited:
After critical evaluation of the annual report of Woolworths Group Limited in 2018, it
has been identified that the organisation mainly uses the historical cost approach for preparing its
consolidated financial statements. However, there are certain exceptions to this approach, which
include fair value, derivative assets and liabilities along with certain financial liabilities. The
organisation measures the following line items at fair value in its consolidated financial
statements:
In case of revenue, it is gauged at fair value of consideration received or receivable based
on its recognition criteria. Moreover, it has been identified that the organisation has recognised
trade and other receivables at fair value in the initial stage and they are gauged subsequently at
amortised cost using the method of effective interest after deduction of impairment allowance6.
For the investments of the organisation in listed equity securities, they are designated in
the form of financial assets at fair value through other comprehensive income. In the initial stage,
the investments are realised at fair value net of the cost of transactions and in the later periods,
they are gauged at fair value with any variation realised in other comprehensive income. The
6 Annual Reports - Woolworths Group (2019) Woolworthsgroup.com.au
<https://www.woolworthsgroup.com.au/page/investors/our-performance/reports/Reports/Annual_Reports>

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organisation records its borrowings initially at fair value after deduction of attributable
transaction cost and subsequently, they are disclosed at amortised cost7.
Some of the financial assets and financial liabilities of the organisation are gauged at fair
value at the end of each reporting year. These items are divided into three levels depending on
the extent to which the inputs related to fair value measurement are observable. Level 1
measurements indicate those measurements obtained from quoted prices in active markets for
similar assets and liabilities. Level 2 measurements represent the ones obtained from inputs
except quoted prices observable for assets or liabilities either directly or indirectly8. Finally, level
3 measurements signify the measurements obtained from valuation techniques including inputs
for asset or liability not reliant on observable market data.
Wesfarmers Limited:
After careful assessment of the annual report of Wesfarmers Limited in 2018, it has been
identified that like Woolworths, it measures its trade receivables initially at fair value after which
recognition is made at amortised cost utilising the effective interest method after subtraction of
impairment allowance. Moreover, the organisation realises all loans and borrowings at fair
values after deduction of directly attributable transaction costs. For derivative financial
7 Edey, Harold C, Accounting Queries (Routledge, 2014)
8 Menicucci, Elisa, Fair Value Accounting (Pirámide, 2014)

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instruments, they are measured at fair value on the date of contract and accordingly, subsequent
re-measurement of fair value is conducted9. Like Woolworths, Wesfarmers uses the three-level
method for categorising all fair value measurements and disclosures.
However, from the above figure, it is evident that Wesfarmers has not provided detailed
segregation of the different financial assets into the three identified levels, which Woolworths
has provided or disclosed in its annual report. In addition, it is to be borne in mind that
Woolworths has measured its business expenses and contingent provisions based on fair value.
On the other hand, Wesfarmers Limited gauges its transactions depending on historical records10.
Along with this, it has been found that Woolworths measures goodwill on acquisition at fair
value. However, in case of Wesfarmers, the transfer of goodwill on acquisition is measured at
historical cost.
Therefore, by considering all the above aspects, it could be stated that certain similarities
could be observed in fair value disclosures between Woolworths Group Limited and Wesfarmers
9 Wesfarmers.com.au, Reports (2019) <https://www.wesfarmers.com.au/investor-centre/company-performance-
news/reports>
10 Socías Salvá, Antonio, Financial Accounting (Pirámide, 2014)

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Limited. However, there are few differences in terms of business expenses and contingent
provisions and goodwill on acquisition. This is because Woolworths measures these items at fair
value, while Wesfarmers measures these items at historical cost approach.

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References:
Annual Reports - Woolworths Group (2019) Woolworthsgroup.com.au
<https://www.woolworthsgroup.com.au/page/investors/our-performance/reports/Reports/
Annual_Reports>
Du, Hui, Sherry Fang Li and Randall Zhaohui Xu, "Adjustment Of Valuation Inputs And Its
Effect On Value Relevance Of Fair Value Measurement" (2014) 26(1) Research in Accounting
Regulation
Edey, Harold C, Accounting Queries (Routledge, 2014)
LaCalamito, Thomas, "Fair Value Accounting's Role In The Recent Financial Crisis" (2013)
4(3) International Journal of Economics and Accounting
Lu, Hung-Yuan (Richard) and Vivek Mande, "Does Disaggregation Of Fair Value Information
Increase The Value Relevance Of The Fair Value Hierarchy?" (2014) 26(1) Research in
Accounting Regulation
Menicucci, Elisa, Fair Value Accounting (Pirámide, 2014)
Siekkinen, Jimi, "Value Relevance Of Fair Values In Different Investor Protection
Environments" (2016) 40(1) Accounting Forum
Socías Salvá, Antonio, Financial Accounting (Pirámide, 2014)
Song, Xiaofei, "Value Relevance Of Fair Values-Empirical Evidence Of The Impact Of Market
Volatility" (2015) 14(2) Accounting Perspectives

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Wesfarmers.com.au, Reports (2019) <https://www.wesfarmers.com.au/investor-centre/company-
performance-news/reports>