Historical Cost Accounting and Systemic Risk

Question: Discuss about the Historical Cost Accounting and Systemic Risk. Answer: Introduction: According to Jack (2015), the economic and the accounting definition of fair value states, that the fair value is any value estimated at market price, expected to be received from the selling of an asset or to be transferred as a liability in a particular point of time. The concept is not new in nature it was primarily developed to overcome the deficiencies in the historical cost accounting technique. The system was aimed to present the assets and the liabilities based on current market price in the financial reporting rather than exhibiting them as an item of acquisition cost. This method was particularly used to maintain and disclose the financial statements based on the fair valuation of assets and liabilities (Nber.org., 2016). The method was particularly useful for countering the negative effects of inflation and changes in the value of currencies over the years. This was particularly evident during the global financial crisis in the year 2008. In the traditional financial reporting method, the fair value was not possible to be determined. For example if the company has purchased 2 acres of land for an amount of AUD 75,000 15 years back. The different company has purchased another 2 acre of land situated beside the earlier land but for an amount of AUD 100000. In case the company where following historical costing method the first company is observed to show a less amount of asset than the latter although both the lands have same amount of area and located at the same place. In order to address this type of issues fair value accounting method was introduced and this was particularly evident to tackle debacles during the global financial crisis (GCF) (Magnan et al., 2015). According to Greenberg et al., (2013), the global financial crisis has identified that fair value accounting has lost its necessary benefits as the prices of the active markets they are not available. This situation had made a complex vision making procedure for the companies in the assessment of fair values and hence modifications where implemented to make changes in the implemented details. Although it was observed that fair value accounting did not had any negative implications on GCF and it further provided the investors with an opportunity to know about the subprime positions office company. The fair value accounting system has a positive impact on BHP Billiton as over the years the company has been able to gain more confidence of the shareholders by presenting this particular disclosure in areas related to remuneration and financial derivatives. Although the negative impact has been seen by realizing a loss of USD 107 million through fair value accounting, which was unrealized, the previous years financial statements of the company (AASB, 2013). It was also observed that during the global financial crisis the SME and the banking sector did not suffer for writing of its assets or undervaluation of the same. It was further observed that banks, which were exercising a higher discretion in ascertaining the fair values, were also involved in presenting overvalued assets (Aasb.gov.au, 2016). Discussion For showing the importance of fair value, treatment the chosen company is BHP Billiton Limited. This particular business is observed to have a high amount of noncurrent assets and as per the sedation given by IFR is this type of business needs to revalue its asset on regular basis. As per international financial reporting standards the involvement of the risk of impairment losses, possibility of gain by devaluation and capital assets plays a vital role in mining industry. Hence, for a fair demonstration of the financial statements the evaluation or impairment of the assets should be shown wherever necessary. It is also important to understand that the concept of fair value accounting stands on it three tier hierarchy. The first tier shows the most accurate measurement related to the fair values in the active market (Beisland Frestad, 2013). The second tire is categorized based on those assets where the distinguishable prices are unutilized or the active markets are absent. The third tire is categorized as the assets where there is absence of significant amount of input and it is done using the internal anticipation method and internal models of the evaluation process (Bischof et al., 2013). The principle of fair value treatment highlights on the importance of measurement process and time required to evaluate the assets and liabilities of a particular company at a fair price. Particular standard is essential for segregating measurement process of equities, assets and liabilities. In a mining company like BHP Billiton, it is also useful for providing guidance for different types of non-financial assets such as equipments, machinery and vehicles used for transportation of the coal. Some of the pros of fair value accounting, with relevance to mining industry such as BHP Billiton Limited includes addressing of noticeable up for it or downward activity in the market value of the competitors. Fair value is helpful in determining the proper price of the items during inflation arising from the estimated prices of the future products. It is also helpful when there is a major change in the foreign exchange rates and manufacturing costs of the raw materials. With relevance to minin g industry, fair value treatment is particularly useful for determining the highly valuable capital projects and in developing of existing acquisition and construction of the mines. This particular method is used to determine that diminution in the volume of minerals of the reserves in the coal mines. This is particularly helpful when there are significant alterations in the interest rates and changes in the government policies, social changes and various types of environmental laws (Christensen Nikolaev, 2013). The cons of fair value accounting, is often seen with managers who use this method for personal benefit. In several cases it has been observed that managers select market prices for the items which can show the forms profitability higher than actual. The various cases the fair value of expenses related to the assets are often ignored or not considered. This makes the asset look more profitable which is actually untrue. With respect to mining company such as BHP Billiton, the stocks and investments are dynamic in nature and fluctuate rapidly in a short period. In such a situation the fair value computation becomes complex in nature and accuracy is not ensured. Due to this problem, the company often ends up exhibiting higher value asset in a particular instance and in the next moment, this leads to financial loss. The annual report of BHP Billiton Limited mainly states the treatment of fair value accounting in the changes in the derivatives of the company. The annual report also states that a desirable knowledge of both intrinsic values and technical requirements of the individual customers is reflected through the fair value of its products. The annual report of BHP Billiton clearly states that the remuneration provided by the company produces 41% of the face value from the fair value amount. This is a significant point to be considered as an importance of fair value disclosure of the company. The fair value adjustment and disclosure done by individual committees and assess the known as Kepler Associates (Lee Park, 2013). The annual report of the company clearly states that the fair value treatment is shown in the long-term incentive scheme. The long-term incentive scheme computation of fair value is done based on multiplication of its value of the award with the fair value factor of 41% as per the present design of the plan. The company further disclosed that the property plant and equipment has been recorded as the cost of contracted from the activated depreciation and the impairment charges. This particular cost is the fair value of the acquired asset at the time of acquisition and consideration and the company further states that this includes the direct cost of procuring the asset to the location and considering the future cost of closure of the same. The company has further declared that bill and the intangible assets have been also computed based on fair value accounting method (Bhpbilliton.com, 2016). The interactive corporate report of the company states that the fair value is not responsible for considering the forfeiture of conditions over the awards. The company's corporate report further suggested that it incurred a loss of USD 107 through fair value disclosure, which was unrecognized in the financial statement of 2013 and 2014. With relevance to the previously discussed levels of categorization of change and treatment of asset, BHP Billiton Limited is positioned at third tier of the hierarchy (Bhpbilliton.com, 2016). Conclusion The discussions mentioned in the report states the importance of exhibiting fair value in the financial statements of any organization. It has been further stated that surgical accounting method was not sufficient to adhere to the needs of financial reporting and hence fair value method was introduced. The various controversies and the arguments related to this method was addressed over the time by collaboration of Australian accounting standards Board with IASB, which resolved several issues pertaining to fair value accounting during the global financial crisis. The new standard of fair value accounting has provided the accountants report the financial items more accurately and present the statements with more uniformity. Reference List AASB, C.A.S., 2013. Fair Value Measurement Aasb.gov.au.(2016).Retrieved13September2016,fromhttps://www.aasb.gov.au/admin/file/content105/c9/AASB13_08-15.pdf Beisland, L. A., Frestad, D. (2013). How fair-value accounting can influence firm hedging. Review of Derivatives Research, 16(2), 193-217. 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