Exploring the Impact of Fair Value Adoption in Malaysian Companies

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The purpose of financial statements is to report useful information to the users. Under the conceptual framework, relevance and reliability are identified as two of the primary qualitative characteristics of accounting information(FASB 1980). This two criteria enhance the usefulness of financial report. As such, identifying the measurement concepts of assets and liabilities that most suitable for financial accounting is one of the general interests to the standard setters, practitioners, and academics.

The historical cost accounting (HCA) is defined as the original cost of an item ignoring inflationary issues. Under the General Accepted Accounting Principle (GAAP), the historical cost is the original cost of an assets that buyer paid. It was once the most important feature of accounting. However, in the dynamic global environment where valuations can change in the blink of an eye, the historical cost financial statements may no longer be relevant because they are not able to give accurate information on current value. Joint Working Group (JWG) of Standard Setters (FASB,2000) found that Fair Value Accounting (FVA) is a superior model as it reflects the effects of current economic conditions, and changes in fair values reflect the effect of changes in conditions when they take place. However, debate on fair value accounting remain controversial, mainly due to the trade-off between the relevance and the reliability of reported fair values (Ryan, 2008) Many researchers have proved that assets and liabilities measured at fair value present better "decision-useful" financial information than historical cost.

The Concept of Historical Cost Accounting


The overall aim of this research study is to investigate the impact of the implementation of FRS139 on Malaysian companies' accounting and reporting practices as well as the extend and characteristic of adoption of fair value option. It is hoped that this study be able to provide some preliminary indications on the impact of the FRS139 on the existing accounting practices and on key performance indicators. For those companies that choose to adopt Fair Value Option, this study will identify the underlying reasons, which could be beneficial to the Malaysian Institute of Accountants (MIA) and Malaysian Accounting Standards Board (MASB). Specifically, at each company and their parent company's level, this study seek to consider the degree to which companies are likely to experience material differences in reported earnings and financial position as a result of FRS139. This will be achieved by looking at the following objectives:

To identify assets and liabilities which are recognized under FRSs but not recognized

under previous GAAP

To identify assets and liabilities which are not recognized under FRSs but were

recognized under previous GAAP

To examine the reclassification, if any, that were recognized under previous GAAP as

one type of asset, liability or component of equity, but are a different type of asset,

liability or component of equity under FRSs

To examine the effect of changes in the measurement rules of assets and liabilities in

adopting FRSs

To examine the extent companies are taking advantage of exemption to full retrospective

applications of all FRSs

To examine the notes to the interim financial statements of selected companies to

determine the extent to which companies have applied FRS to the interim reporting

We hope to be able also to identify the number of companies adopting the FRSs before

2006 and their underlying motivations; to identify the number of companies NOT adopting the

FRSs in 2006 and their reasons for not doing so; to report on the problems, if any, encountered during the implementation phase and to forward their recommendations and suggestions to MASB in relation to FRS guidelines.


The findings of this study will be able to highlight some critical issues to the accounting

regulators such as the Securities Commission (SC), professional bodies like the Malaysian

Institute of Accountants (MIA), standard setters (MASB) and the investing public. Issues like

problems dealings with the implementation process, availability of technical expertise, level of awareness and preparedness will provide some feedback and help these bodies come with some aids or guidelines as IFRS becomes prevalent world wide. The sample use in this study is limited to companies listed in the Main Board and Second Board of Bursa Malaysia only. It is the intention of the study to exclude private companies as these companies do not have to comply with FRSs.

Background of studies

The evolution of fair value concepts and measurement

The concept of applied fairness to financial report can be traced back to the United Kingdom's Joint Stock Companies Registration and Regulation Act of 1844, which required the preparation of "full and fair" balance sheets. The 1856 Act relegated financial disclosure requirements to model Articles of Association, which stipulated that a "full and fair" balance sheet should be drawn up so as to give a true and correct view of the company's financial affairs. However, the Act provided no guidance on the underlying accounting principles to be applied. Moreover, being relegated to the model Articles meant that the disclosure requirements were optional.

The subsequent development of generally accepted accounting principles (GAAP) was left to the accounting and auditing professions, and in particular to the professional bodies established during the remainder of that century. Within the GAAP framework, concepts of fairness, truth and correctness validated historical cost accounting (HCA) with its emphasis on objective, reliable and verifiable values.

The concept of fairness in its current "true and fair" form first appeared in the UK Companies Act 1948 and is retained in the updated Act of 2006, which requires directors to be satisfied that the accounts of their company "give a true and fair view of the assets, liabilities, financial position and profit or loss" (section 393). Traditionally, the historical cost convention underpinned income determination and the valuation of assets and liabilities. Objectivity, reliability and verifiability were given priority over relevance in the interpretation of what constituted a true and fair view.

Initial moves away from historical cost towards market value can be traced to June 1947 with the issue of Accounting Research Bulletin No. 29 Inventory Pricing by the Committee on Accounting Procedure (CAP) of the AICPA. The bulletin required inventory to be valued at the "lower of cost or market" (LCM). "Market" was defined as the more relevant of either "current replacement cost (by purchase or production)", or "net realizable value", depending on whether or not the inventory was held for sale. Accounting Research Bulletin No. 43 Restatement and Revision of Accounting Research Bulletins, issued in June 1953, confirmed the LCM rule.

Further departures from HCA were advocated in Accounting Research Study (ARS) No. 1 The Basic Postulates of Accounting, issued in 1961 by the Accounting Principles Board (APB, which replaced the CAP in 1959) and ARS No. 3 A Tentative Set of Broad Accounting Principles for Business Enterprises issued in the following year. Both ARS No. 1 and ARS No. 3 advocated market price, as opposed to historical cost, as the primary basis of financial measurement. However, the APB considered the proposals to be "too radically different from present GAAP for acceptance at this time" (APB, 1962). The Board subsequently commissioned a compilation of those generally accepted accounting principles, issued in 1965 as ARS No. 7 Inventory of generally accepted accounting principles for business enterprises. An interesting feature of that inventory is the absence of any explicit endorsement of the concept of fair value.

A shift towards fair value accounting was later canvassed by the Accounting Principles Board with the issue in August 1970 of its Opinion No. 17, which advocated that the cost of developing unidentifiable intangible assets be charged to income when incurred. It also advocated that the cost of developing intangible assets within an entity not be recognized as an asset on the balance sheet.

In December 1984 the Financial Accounting Standards Board (FASB, which succeeded the APB in 1973) issued Statement of Financial Accounting Concept No. 5 (SFAC No. 5) Recognition and Measurement in Financial Statements of Business Enterprises, which identified the use of five measurement attributes: Historical cost, current cost, current value, net realizable value and present value. The last three of those attributes are consistent with fair value measurement concepts and thus provided a theoretical framework for further moves towards fair value accounting, which took place over the following years through a series of FASB pronouncements, the more significant of which are summarized in the following paragraphs.

Statement of Financial Accounting Standards No. 133 (FAS 133) Accounting for Derivative Instruments and hedging Activities, issued in June 1998, defined the FV of an asset (liability) as: "The amount at which an asset (liability) could be bought (incurred) or sold (settled) in a current transaction between willing parties; that is, other than in a forced or liquidation sale". Note that this definition makes no distinction between entry and exit prices. The two can only be the same when transaction costs are zero and/or ignored.

In June 2001 APB Opinion No. 17 was superseded by FAS 142 Goodwill and Other Intangible Assets, which required goodwill to be annually tested for impairment with reference to fair value.

FAS 157 Fair Value Measurements, issued in September 2006, redefined FV as: "The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date". This revised definition is well construed, but the accounting lexicon continued to hold different definitions of FV, dispersed among many pronouncements with limited guidance on their application within the GAAP framework.

FAS 157 differed from FAS 133 in four significant respects. First, the stipulation "other than in a forced or liquidation sale" was replaced by "in an orderly transaction". The superseded wording is redundant when assets and liabilities can be traded in efficient markets in an orderly fashion. Replacing "between willing parties" with "between market participants" further emphases that FVs are established with reference to market prices, rather than a seller's anticipated price. FV is a market-based, as opposed to entity-specific, measurement. Replacing "in a current transaction" with "at the measurement date" recognizes that market prices are time-specific. Finally, FAS 157 is explicit in defining FV in terms of exit, as opposed to entry prices. It is silent on the treatment of transaction costs, although a reasonable interpretation is that FVs are defined as exit prices, net of transaction costs.

In February 2007 the FASB issued FAS 159 The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115. This statement allows entities to measure many financial instruments and certain other items at fair value. It is expected to expand the use of FVM, which is consistent with the Board's long-term measurement objectives for accounting for financial instruments.

International Accounting Standard Board (IASB) FV definition is also one of extensive accepted definitions. In the IASB's framework (IASC, 1989), FV is referred to but not defined.1 It is defined in the report of the IASC Steering Committee on Financial Instruments (IASC, 1997, chapters 7, 5 & 6) as a selling price (the offer price) rather than a buying price. In later standards International Accounting Standard (IAS) 16 Property, Plant and Equipment (1998) defines FV in detail as "the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm's length transaction".2 This is substantially consistent with the concept that emerged earlier in the literature of the FASB. IAS 39 [later to be designated International Financial Reporting Standard (IFRS) 39] Financial Instruments: Recognition and Measurement, issued in April 2004, defined FV as "the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction". This definition is essentially the same as that of IAS 16, with its focus on exit prices in an arm's length transactions.

The evolution of new standard IFRS 9

The International Accounting Standard Board (IASB) issued IFRS 9 Financial Instruments on 12 November 2009. This accounting standard will eventually replace IAS 39 Financial Instruments : Recognition and Measurement. IAS 39 has been criticized as a complex standard since the standard issued. Especially in 2008 after the global financial crises, some commentators had asserted that IAS 39 was the core of this financial crisis. Thus, the world leaders had called on the accounting profession to improve the accounting standard.

IFRS 9 is a "Work in Progress" standard. It introduces new requirements for classifying and measuring financial assets and liabilities that must be applied starting 1 Jan 2013, with early adoption permitted. IFRS 9 is a simplification of IAS 39 and adopts a single approach to determine whether a financial asset is measured at amortised cost or fair value, replacing the many different rules in IAS 39. (Ernst & Young, 2009)

FRS 139 in Malaysia

FRS 139 Financial Instruments : Recognition and Measurement, is a standard issued by the Malaysian Accounting Standards Board (MASB) that establishes the principles for recognizing and measuring financial assets and financial liabilities. It is similar to the International Accounting Standard 39 (IAS 39).

At first, FRS 139 was set to roll on 1 Jan 2006. However, in order for Malaysian Companies to have more time to get prepared for FRS 139, on 23 Feb 2006, the MASB announced that FRS 139 would only be effective for annual periods beginning on or after 1 Oct 2006. Eventually, Malaysia has just made the Fair Value Accounting Standard FRS 139 effective from 1 Jan 2010. This means that all listed companies in Malaysia are required to comply with FRS 139 from the financial periods beginning on or after 1 January 2010 (KPMG, 2009), with early adoption permitted. This deferment had made Malaysia 5 years behind the international community in adopting Fair Value Accounting.

On the adoption of FRS 139, many off balance sheet financial instruments like interest rate swaps, foreign currency forward contracts, commodity futures, etc will be accounted for on the balance sheet. FRS 139 requires such financial instruments to be measured at fair value at each reporting date. Changes in fair value are normally recognized in the income statement. As such, it is expected to have a material impact on the Financial Statement.

However, FRS 139 will be demised and replace by another standard ie IFRS 9 Financial Instruments in 2012. This indicates that Malaysia who had just started with FRS 139 on 1 Jan 2010 would become obsolete in a very near future.