Question

Accounting standard AASB 13 Fair Value Measurement defines fair value 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.

What are the strengths and weaknesses of fair value as compared with other measurement methods such as historical cost? Refer to the qualitative characteristics of financial information outlined in the conceptual framework in your response.

Answer 1

Fair value is often used in accounting for various valuation purposes. For example: Fair value of trading investments, Fair value of available for sale securities, Fair value of land and buildings.

Strengths:

· Fair value is more relevant to end users since it represents the market value. The book value of asset is historical cost and is not much relevant in terms of decision making

· Fair value helps in forecasting the future value of business since the assets rate are market rate driven

· It improves understandability and helps in understanding the financial statements in a much better way than with historical cost

Weakness:

· The fair value method may not be reliable and unbiased. It will involve some element of judgement and affects the reliability of the financial statements

· Fair value affects the comparability of financial statements since each firm may adopt a different fair valuation method and thereby meaningful comparison is not possible

· The fair value method may not be consistently applied year on year basis leading to inconsistency in its application.