Business Environment
Introduction
The changing business environment has raised the need for the firms to adopt new accounting standards that are being globally adopted. But at the same time, there are differences in accounting method adopted by the firms at international level.
In relation to this, some of the firms adopt historical cost accounting (HCA), while some of the firms follow fair value accounting (FVA) that impact their accounting transactions and values and also financial performance. Wesfarmers, an Australian retail firm, also follows FVA at moderate extent that also impact the financial transactions and values significantly.
This report also focuses on the advantages and disadvantages of FVA as compared to HCA for valuing their non-current assets and justifiesits use as accounting approach within the organization based on IFRS compliant Wesfarmers Company’s 2017 annual report and peer reviewed academic research.
FVA& HCA
HCA is useful to measure the value of the items based on the original cost when the firm acquires the item. This approach does not consider the current market value of the item in determination of its value. This measurement approach is considered by the US under generally accepted accounting principles (GAAP).
On the other hand, FVA is used to determine the value of items based on current market value because it consider the existing market conditions and changes that may also impact the cost of the items.
FVA adoption by Wesfarmers
From the annual report 2017 of Wesfarmers, it is evident that the firm has considered the revaluation of its investment related to associates and specific financial instruments at fair value (Annual Report, 2017, p.99). In addition, Wesfarmers recorded costs of clearing discontinued ranges and depreciation on non-current assets in annual report 2017.
For this, it has written down the value of these assets at fair value while acquiring these assets (Annual Report, 2017, p.29). Risks and rewards of ownership can be transferred to buyer during goods delivery that provides reliable measurements. Wesfarmers recognizes the revenues after completing payment and holding possession of the non-current assets (Annual Report, 2017, p.104).
Advantages and disadvantages of FVA
Advantages:
FVA has several advantages over HCA approach that makes them more valuable for the Wesfarmers to value the costs of non-current assets. It presents the current market perspective of the items that provides the real picture of the position. At the same time, it also considers the current economic conditions that provide the right valuation of the non-current assets to make better decisions related to investment (Magnan et al., 2015).
In relation to the advantage of FVA than HCA. FVA method does not consider outdated information that makes it more reliable as compared to HCA . All the information that is considered in FVA is based on current perspectives of the market that makes it more valid and authentic in the measurement of the value of non-current assets.
With the help of FVA approach, Wesfarmers enables to determine the actual value of fixed assets that shows the real position of the firm to the stakeholders and support them to make informed decisions regarding the investment within the firm (Trajkovska et al., 2016).
At the same time,no consideration of current and fair values of the non-current assets in HCA causes confusion among the investors and misguide the management in making decisions leading to financial loss to the firm. In addition, it does not consider any profit obtained from the real value of the asset caused by deflation and any loss in the real value of asset caused by inflation.
On the other hand, the use of FVA approach shows more relevance to decisions of the financial statements users. Furthermore, FVA also provides advantage of timelines and transparency to Wesfarmers in making valuation of non-current assets.
FVA allows the firm to consider the market changes like changes in government policies, economic reforms, social changes, upgrading of technologies and legal reforms (Skoda and Gabrhel, 2015). The consideration of market changes in accounting is the required due to changing nature of the market.
If any firm does not consider these changes, it may impact the decisions making significantly and lead to wrong strategic and operational decisions. At the same time, in HCA, historical realities are basis of the development of the financial statements that cause wrong estimation of assets.
HCA approach does not provide proper provision for depreciation. HCA may mislead the management of Wesfarmers to record the incomes on the basis of historical realities. It is because such reporting may cause overstating in inflation that may lead to unethical practices in the accounting practices.
HCA considers the combination of holding profit and loss with operating profit and loss. But for presenting the actual picture of operational performance, it is required to make separation of holding profit and loss and operating profit and loss (Škoda and Sláviková, 2015).
At the same time, FVA considers both cash items and non-cash items based on current market values while HCA considers cash items based on current value and non-cash items based on historical value that may cause problem for the company to make a proper match in accounting of non-current assets and create inappropriate position of the firm.
HCA technique is not effective as FVA because it does not provide reasonable estimation of the financial performance of the firm. Wesfarmers uses FVA approach to consider the accounting standards regulated by IFRS.
It is also advantageous for the company to use this method for avoiding sales discrepancies through asset valuation based on market conditions in current time (Elfaki et al., 2015).
It allows the firm to use all required accounting standards by covering all types of assets to assess their value that is not possible through HCA method. The use of FVA method allows the firm to receive the best value of the asset sales and liability transfer at the measurement date. This leads to fair transaction and transparent outcomes.
Disadvantages:
FVA is not effective as compared to HCA in terms of reliability because the principle of original price of the item is considered in HCA that increases the reliability of the data recorded in the balance sheet. At the same time, FVA requires regular and full update of all variables to determine the cost of the item.
On the other hand, there is no such need of update in HCA for the valuation of non-current assets. In addition, FVA does not provide objectivity and cost stability like HCA that cause difficulty for Wesfarmers to evaluate the costs of items effectively.
In addition, FVA considers the changes in the costs of non-current assets due to changes in market conditions. All these changes make the valuation of the costs of the items volatile that cause instability in determining the values and increase the extra work for making adjustments.
At the same time, the use of HCA allows the firm to get the benefits of objectivity as it is effective to record the original costs of the assets when they were obtained. In addition, the use of FVA enforces the firm to re-evaluate the value of the non-current assets at regular level due to market changes affecting depreciation costs and repairing costs (Alaryan et al., 2014).
It is noted down that non-current assets have long life that causes the needfor the company to re-evaluate them on continuous basis for longer period. It is troublesome for the accountants as it consumes time and resources to re-evaluate those assets regularly.
There may be dissatisfaction among the stakeholders on using FVA as accounting approach. It is because the current market conditions may impact the income level and asset values that may affect the returns for the investors. It may cause dissatisfaction among the stakeholders due to adverse conditions for the returns at the time of valuation.
In addition, FVA is not significant to provide accuracy in valuation because it causes variation in the actual value of the non-current assets and financial performance also (Brînză and Bengescu, 2016).
Furthermore, there is no consideration of trends in the changes in value of the assets on the basis of historical aspects that may cause wrong decisions. It is possible through the use of HCA approach that allows the firms to use the trends based on historical data and make decisions appropriately.
Sometimes, it may be possible that the use of FVA method may cause misleading information for Wesfarmers due to frequent change in the value of the item. The changes in value and earnings of the firm may mislead the investors due to changing information of market position of the company (Betakova et al., 2014).
It may cause difficulty for the auditors to evaluate the financial position of the firm because of changes in the values of assets and earnings of the firm. Auditors face difficulty in evaluating the value of assets of the firm due to their dynamic nature as they need to regularly revaluate the firm’s asset value causing need of extra resources and time.
It is not easy for the firm to survive in a critical economy as firm uses FVA method in accounting. It is because this method enforces the firm to make asset reductions that make it difficult to overcome from adverse economic situation. Apart from this, the firm cannot track the results based on historical trends that may reduce the reliability of the outcomes of valuation of assets(VanBiljon,2016).
In spite of these disadvantages and limitations of FVA approach, it can be stated that this approach provides several benefits to the company in reporting the value of non-current assets. It provides fair and transparent way of measuring the value of the non-current assets that provides real picture of the position of the firm and guides the investors in fair way for making investment decisions (Ombati and Shukla, 2018).
FVA is a better technique than HCA because of considering the changing market conditions that is significant perspective of current business context. The changing market conditions need to be considered while making the investment decisions as the consideration of these changes enables the firm to evaluate the asset values properly and on real time basis.
Conclusion
Finally, it can be summarized that Wesfarmers uses the fair value accounting method for the valuation of non-current assets effectively and at large extent. It has become mandatory for the firms to use FVA method rather than HCA in the valuation of the assets due to dynamic nature of the market conditions in the global world.
The consideration of FVA provides advantages related to fair and transparent measurement and proper guidance to the investors to make fair investment decisions while measuring the value of the firm.
However, this method causes some limitations and disadvantages including dissatisfaction of the stakeholders, auditing issues, lack of reliability, no benefits of historical aspects in value measurement and lack of tracking that reduce the effectiveness of the method.
But, the fair value accounting approach is more significant than HCA approach due to its implications in current business environment. So, it can be stated that there is need to replace HCA approach by FVA due to its more benefits as compared to HCA in accounting.
References
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Annual Report (2017) Retrieved from https://www.wesfarmers.com.au/docs/default-source/default-document-library/2017-annual-report.pdf?sfvrsn=0
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Škoda, M., &Sláviková, G. (2015).EXPLORING THE LINKS BETWEEN FAIR VALUE ACCOUNTING AND FINANCIAL CRISIS.Management (16487974), 27(2).
Trajkovska, O. G., Temjanovski, R., &Koleva, B. (2016).FAIR VALUE ACCOUNTING-PROS AND CONS. Journal of Economics, 1(2).
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Appendix
(Source: Annual Report, 2017, p.29
(Source: Annual Report, 2017, p.104)
