ASEM IFRS SEMINAR
Shanghai, 25-26 March 2006
Fair Value Measurement
Dr Allister Wilson
Technical & Audit Partner
Ernst & Young, UK
Senior Advisor to the
EUROPEAN COMMISSION
1
Capital market activity: the balance is shifting
2005
2004
2003
China
Construction
Bank
Belgacom
China Life
Number of 20 largest IPOs that are outside US
19
14
16
Number of 20 largest IPOs that are companies
outside the US
19
16
19
Japanese IPOs
157
171
121
Chinese IPOs, cumulatively raising over $12
billion in each year
114
142
94
Number of exchanges on which top 20 IPOs
were completed
9
11
11
Largest IPO
2
Approach to accounting is changing
 ‘Traditional accounting’:

mainly historical cost

primary focus on the income statement

focus on transactions and their impact on earnings

matching and prudence concepts important

realisation principle central to revenue recognition

balance sheet much more of a residual
3
Approach to accounting is changing
 IASB and FASB are shifting the emphasis:

primary focus now on assets and liabilities
An asset is a resource controlled by the entity as a result of past
events and from which future economic benefits are expected to
flow to the entity
A liability is a present obligation of the entity arising from past
events, the settlement of which is expected to result in an outflow
from the entity of resources embodying economic benefits
4
Approach to accounting is changing
 IASB and FASB are changing the approach:

primary focus now on assets and liabilities
• This means that the accounting process now revolves
around the initial recognition, initial measurement,
subsequent measurement and derecognition of assets and
liabilities
5
Approach to accounting is changing
 IASB and FASB are changing the approach:

conventional accounting concepts are being
discarded:
• matching, prudence and realisation

‘fair value’ is replacing ‘historical cost’

‘relevance’ is more important than ‘reliability’
6
The introduction of fair value
 We still have a mixed model
 However, virtually all assets and liabilities are
measured at ‘fair value’
 Only significant exceptions are property, plant and
equipment, intangibles and inventory, although the
impairment test periodically rebases these at fair value
7
Virtually the entire balance sheet is
affected by fair value measurement
 Investment property
 Financial instruments
 Biological assets (agriculture)
 Commodity stocks
 Employee benefits
 Provisions
 Share-based payments
 Business combinations
 Impairment
8
Approach to accounting is changing
… but, what is fair value?
Fair value is “the amount for which an asset or liability
could be exchanged between knowledgeable, willing
parties in an arm’s length transaction”
9
What is fair value?
The IASB and FASB are exploring other options, such
as:
 Net realisable value
 Replacement cost
 Value in use
10
Approach to accounting is changing
… something for you to think about
How do you measure the ‘fair value’ of assets and
liabilities – particularly when there are no observable
active and liquid markets?
11
The IASB’s fair value hierarchy
Observable
(quoted) market
prices for identical
assets or liabilities
if not available, use
observable (quoted) market prices for
similar assets and liabilities
if not available, use other valuation techniques
12
The introduction of fair value
The result of this is that:
 inevitably, substantial emphasis is being placed on
the use of valuation models
 which means that ‘fair value’ is really ‘calculated
value’, ‘mark to model’
 ‘performance’ is essentially the change in balance
sheet net assets from one period to the next
13
31/03/01
28/02/01
31/01/01
31/12/00
30/11/00
31/10/00
30/09/00
House of
Lords
decision
31/08/00
31/07/00
20
30/06/00
120
31/05/00
40
30/04/00
60
31/03/00
29/02/00
31/01/00
31/12/99
Fair valuation of own debt
Base rate changes
100
80
Closes to
new
business
0
14
Performance Reporting
Five primary financial statements:
 Statement of financial position at the beginning of the year
 Statement of financial position at the end of the year
 Statement of recognised income and expense (SORIE)
 Statement of changes in equity
 Statement of cash flows
15
Impact on revenue recognition
Current approach under IAS 18 – based on critical event
theory and the realisation principle:

the entity has transferred to the buyer the significant risks and
rewards of ownership of the goods;
the entity retains neither continuing managerial involvement to the
degree usually associated with ownership nor effective control
over the goods sold;

the amount of revenue can be measured reliably;

it is probable that the economic benefits associated with the
transaction will flow to the entity; and
the costs incurred or to be incurred in respect of the transaction
can be measured reliably


16
Revenue recognition
Proposed new approach
 based on changes in balance sheet assets and liabilities
 realisation principle no longer relevant
 revenue is the change in net contractual rights and performance
obligations
17
The dangers of fair value
The more fair is introduced as the primary basis of
measurement:
 Accounts will become more unreliable and less
understandable
 There will be an increasing disconnect between internal
and external reporting
 Accounts will no longer a means of market communication
and companies will use non-GAAP measures to
communicate with the market
18
Contact Information
Allister Wilson
Ernst & Young LLP
+44 20 7951 1443
awilson@uk.ey.com
www.gaap.co.uk
19