Topic:Implications of Fair Value Accounting: The Case of Fiji Sugar Corporation1.

0 Introduction The essential characteristics of accounting are: the identification, measurement, andcommunication of financial information about economic entities to interested parties.Financial statements are the principal means through which a company communicates itsfinancial information to those outside it. Financial statements are of no importance withinthemselves; the importance of financial statements lies in information they provide tostatement users. (Shamkuts, 2010, pg 4) U sers of these financial reports include investors, creditors, managers, unions, andgovernment agencies. The selection of the measurement base, used in preparation of financialstatements, is one of the most significant problems of accounting. For example, investors maywish to know the amount of income earned over a given period of time. Various amounts of income would be determined, depending upon the method used to measure income as severalmethods are available. Measurement is a key aspect of financial reporting. (Shamkuts, 2010, pg 4) The traditional basis of accounting has, for a long time, been historical cost. Over the pastfew years financial accounting has been moving away from measuring certain assets andliabilities at historical cost and more toward fair value. Fair value accounting has been acontroversial topic to date and there has been ongoing debate regarding its applicability as ameasurement base, its implications in the financial market, volatility in the markets and theissue of reliability.Fair value accounting was brought under the limelight as a result of the Global FinancialCrisis in 2008. The crisis that was triggered in the U nited States spread like a plague to allcountries in the world. The U S subprime mortgage collapse, shattered confidence in major global financial institutions, led to massive crashing of equity prices, frozen credit market,and wounded the stock prices (ADB, 2009, pg 9) .Many critics of fair value accounting stated that fair value accounting is at the core of thecrisis, while the proponents state that fair value has been wrongly judged; a messenger of thecrisis is labeled as the contributor. A detailed discussion on this debate, together with an overview of what constitutes the global financial crisis is presented in a later segment of the paper.The main aim of this research paper is to analyze how Fair Value Accounting has had seriousimplications in the Pacific. The work consists of three segments. The first segment is devotedto the overview of fair value accounting, including its definition, impact on financialstatements, and its advantages and disadvantages. Detailed comparison between HistoricalCost Accounting and Fair Value Accounting is also presented. The second segment talksabout recent financial crisis and role of fair value accounting in it. Specific cases of Fiji arealso highlighted to show fair value accounting implications. The third segment, which isresearch-based, investigates the serious implications of fair value accounting in Pacific withreference to a case study on Fiji Sugar Corporation [FSC] . The paper first will look at thetheoretical underpinnings of Fair Value Accounting.

Theoretical Underpinnings This section evaluates the development of FVA under the notion of the new paradigm beingin the process of gaining legitimacy. Whether fair value achieves legitimacy depends largelyon whether it can be proven to be appropriate. This implies, of course, that historical costmay have been appropriate for previous times but is losing legitimacy. Decision Usefulness Perspective [Theory] The objective of financial reporting as per FASB is to provide information that is useful to present and potential investors and creditors and other users in making rational investment,credit, and similar decisions .This theory stresses that it can only be judged by its predictive power; the ability to makeinformed decisions about the future based on the usefulness of the information provided at present. The decision usefulness approach calls for a forward-looking position rather than a preoccupation with the past. Apart from the stewardship function, investors are alsointerested in knowing about the increases and decreases in the value of their investments asrepresented by the net assets of the company (Godfrey, 2006, pg 155). I n this paper, fair value is being analyzed from the decision usefulness perspective. True Income Theory True I ncome Theory arose from the normative theory development. True I ncome theoristsconcentrated on deriving a single measure for assets and a unique (and correct) profit figure.However, there was no agreement on what constituted a correct or true measure of value and profit (Godfrey, 2006, pg 52). This became an issue since there were various measurement bases that could be applied in accounting. I n addition, various accounting standards just provide a guideline on how balance sheetitems can be measured without exactly telling the preparer of the financial statements whichmeasurement to apply. This is based on the judgment of the preparers; a move away from thecomputation of true income figure. I n this paper, an attempt is made to show that the adoption of fair value, to some extent, hastried to solve that problem and to calculate a more true profit figure compared to historicalcost; a shift in focus from outdated values to current values Agency TheoryLegitimacy TheoryGoing Concern TheoryA Theory of Justiceor cost attach TheoryConservatismEfficient Market Theory FVA relies on

efficient market theory , namely that short term price = value and thatconsequently income, assets and liabilities should be adjusted in real time to reflect same 2 .0 Literature Review 2 .1 The Shift from Historical Cost Accounting to Fair Value Accounting To critically analyze the shift from historical cost to fair value accounting, it becomesimperative to understand the underlying view of accounting and financial statements.The traditional view of accounting was that of stewardship which emanated from the need of investors to know what managers do with the capital funds entrusted to them. This is the perspective that gave rise to the role of historical-cost basis in financial reporting because the price that a manager had paid for an asset, coupled with documented evidence, is anindication of specific uses of funds. Funds not used remain in a liquid (cash) account and theinvestors will, therefore, be able to account for the uses of all the funds they provided to thecompany. Hence, the concept of stewardship has traditionally been backward looking because it aims at providing information to answer the question of w hat did you, themanagement, do w ith my money? ( khalik, 2008, pg 16) I n contrast, the present view of accounting is that of decision-usefulness. This is the perspective that gave rise to fair value accounting which is a forward-looking basis of reporting because the market value of an asset (whether observed or estimated) is thediscounted net cash inflows expected to be generated from using the asset. I nvestors makedecisions based on expectations and, to that extent, fair value is in agreement with investorsviewpoint. Hence, the concept of decision-usefulness is forward-looking because it aims at providing information to answer the following question of ho w the management decides touse the funds and w hat the management expects to get for that use of those funds? khalik,2008, pg 16) 2 . 2 Comparison of Historical Cost Accounting and Fair Value Accounting

The Conceptual Framework of Accounting identifies relevance and reliability as the primaryqualitative characteristics of useful financial information. While both are theoreticalingredients of ideal information, a tension exists between relevance and reliability in practice.Based on the tradeoff, a comparison has been made between historical cost and fair value asfollows; Relevance I nformation is relevant when it is capable of making a difference in a decision. I t must have predictive value - help users to predict the ultimate outcome of the past, present and futureevents. I t must have feedback value - help users to confirm or correct prior expectations. Andfinally it must have timeliness - be available to decision makers before it loses its capacity toinfluence their decisions. Historical Cost Fair Value Historical Cost Unless thevalueoffixedassetsareassumedtoremain same over time, historical costinformation is relevant only upon obtaining theasset Since historical cost information measuresremain unchanged over time, users do not getvaluable feedback about appreciation anddepreciation following the purchase of theasset. Fair Value Allow users of financial statements to obtain atruer and fairer view of the company's realfinancial situation since it reflects the prevailing economic conditions, the changes inthem and reflects the current market price of asset/liability Figure 1: Comparison between HCA and FVA under the concept of Relevance

Reliability Information is reliable, when it is verifiable, is a faithful representation, and is reasonablyfree of error and bias. Verifiability occurs when independent measurers, using samemethods, obtain similar results. Representational faithfulness means that the numbers anddescriptions match what really existed or happened. Neutrality means that a company cannotselect information to favor one set of interested parties over another. (Shamkuts, 2010, pg 17)

Historical Cost Fair Value Historical Cost Is based on actual transactions, the recordedamounts are reliable and verifiable and freefrom management bias and manipulation,appraisals or any other valuation techniques Fair Value Fairvalueestimatesbasedoninactivemarkets,subjectiveinputdataandestimations/judgmentsbymanagementmayproveto beunreliable.[referFairValuehierarchy]Providesmanagementwiththeopportunitytomanipulatetheaccounting numbers Figure 2: Comparison of HCA and FVA under the concept of Reliability

FAIR-VALUE ACCOUNTING: A BETTER REFLECTION OF REALITY Example:Fair-value accounting prices an asset based on its current value. So, for example, if my stock investment, purchased for $1,000, falls in value to $400, then fair-value accounting wouldshow that investment on my financial statements at $400, not the original cost of $1,000.Those who contend fair-value accounting exacerbated the financial crisis, argue that it brought turbulence to the financial system because companies were forced to take billions inwrite-downs on their balance sheets, as housing prices fell and mortgagebacked securitiescrashed. These reduced valuations caused financial institutions to look less solid to bank regulators. I t was argued, by some, that if banks did not have to follow fair-value accounting(and thus avoid those write-downs), then this crisis would have been averted.However, this is simply a case of blaming the messenger. Fair-value accounting is not thecause of the current crisis. Rather, it communicated the effects of such bad decisions asgranting subprime loans and writing credit default swaps. Even with the difficult issuessurrounding measuring the fair value of loans and investments in an illiquid market, as wehave seen recently, fair-value accounting only brings transparency to the market. Thealternative, keeping those loans on the books at their original amounts, is akin to ignoringreality. U se this as explanation in the semina This to be included in later partTo fully understand the role of fair value in the financial crisis, it is necessary to first knowwhat constitutes the global financial crisis. The subprime mortgage crisis triggered by adramatic rise in mortgage delinquencies and foreclosures in the U S had major adverseconsequences for banks and financial markets around the globe. The crisis, which has itsroots in the closing years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses in financial industry regulation and the global financial system. Thesubprime mortgage crisis is an ongoing economic problem manifesting itself throughliquidity issues, which accelerated in the U nited States in late 2006 and triggered a globalfinancial crisis during 2007 and 2008. (Masood, 2010, Pg 52) According to Wikipedia, the immediate cause or trigger of the crisis was the bursting of the

U nited States housing bubble which peaked in approximately 20052006. Housing bubbles,in their late stages, are typically characterized by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, andother economic indicators of affordability. This may be followed by decreases in home pricesthat result in many owners finding themselves in a position of negative equitya mortgagedebt higher than the value of the property. When this is the case, subprime mortgagor wouldfavor the notion of defaulting on the mortgage rather than paying it; hence the financial crisisdevelops.The reason lies in the description of a subprime mortgagor. A subprime mortgagor willusually have a poorer credit history, a lower and less stable income, and be able to offer littleor no deposit on house loan. So, they are at a much higher risk of default. I f this was the case,then, why was subprime mortgage offered in the first place? There are two simple reasons firstly, offering subprime mortgages increase a banks number of potential customers.Secondly, a bank can charge a higher interest rate to make up for the greater risk involved atthe individual customer level. (Forster, 2010, Pg 39