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The company AGL energy limited which is referred for discussing the Fair Value accounting concept is one of the largest companies of Australia which is also listen on ASX. It is discussed in the report that AGL Energy limited flows AASB 13 which is the Australian accounting standard for Fair value Measurement and the company is managing its risk factors by following this concept. It measures the prices of its assets and liabilities with the help of current market conditions.
The company started following this concept from the year 2013 and used for recording the changes in the values of derivatives of the company. It was recognized that the changing in the fair value of derivatives was $595 million before tax and it was $417 million after tax. The report also discusses the controversies which are faced by the Fair Value measurement concept and the reasons for the occurrence of the financial crisis in the world. The report ends with the evaluation and comment on the usage and application of the concept and its related issues in the financial accounting. Fair value is a subjective value which reflects the market value of assets and liabilities and it is very difficult to determine the same. The criticism which is related with fair values will be discussed in the research report. Its role in the financial crisis across the world will be discussed. The report also discusses about the impact of AASB13 on the financial statements of AGL Energy Limited.
“The accounting standard setters have adopted what we call a mixed measurement model when it comes to measurement in accounting. With a recent trend toward measurement of items at fair value, measurement has become very controversial. The political nature of accounting has been highlighted in recent events such as the global financial crisis.”
Describe fair value accounting
A mixed measurement model in accounting is the method in which a combination of different methods are used to measure the assets and liabilities of the business as there is no set method for the measurement of all the assets and liabilities together. When the mixed measurement model is adopted, it provides flexibility to the financial reports of the business like a fair value is chosen for the asset by referring to the market of an asset. It is very difficult to choose a fair market value for any asset as the prices fluctuates in the market. Mixed measurement approach provides advantages to the accounting of assets and liabilities but there are also the disadvantages like using mixed measurement approach makes it difficult to compare the financial reports of different companies as every company uses different approaches which is best suited to the organisations (Pinto & Pais, 2015).
This concept does the impairment of assets which is given in the Australian Accounting Standard Board (AASB) 136. This standard is basically applied to the financial reports belonging to the periods on or after January 2010. The objective of this standard is to ensure that the assets are not carried at more than the recoverable amount. The assets need to be booked at the amount which is lower than the recoverable amount. The carrying amount is the amount which is used to book the assets in the financial statements at the cost which is derived after removing the depreciation whereas the recoverable amount is the amount at net realisable value which can be the fair value or market value. When the carrying amount is more than recoverable amount, the asset is recorded at the recoverable amount and the difference in the value is said to be ‘Impairment of Asset’ (A, 2009).
The measurement basis of assets can be made in two categories:
Historical cost:when the assets, liabilities, income and expenses are measured at historical cost, there no changes reflected in the prices but the impairment of assets is reflected.
Current value: It includes the fair value and value for assets and liabilities
Fair value is the price which is received while selling the asset or which is paid to transfer the liability. It estimates the cash flows of the future, the time value of money, the price for the uncertainty in the cash flows and liquidity (Andrews, 2014).
Discuss Fair value accounting
AGL Energy Ltd is taken for explaining this concept in detail. It is the company which is focussed for delivering its innovative services to meet the expectations of the customers in the global environment. The company follows the impairment of assets and feels that it is not right to follow the same as it brings the difficulty in comparing the financial statements but it increased the net shareholder value in the last few years. In 2016, AGL limited identified the impairment of $795 million of assets before tax and $640 million after tax. The gas assets of AGL fell due to the fall in the global oil prices and this is what leads to impairment to assets (Andrews, 2014).
No organisation follows a single measurement approach nowadays. It is used as per the flexibility of the business like cost measure is used in the going concern business as it provides margins on the turnover while the fair values are used for valuing the marketable investments for more reliability. The Australian Standard AASB 13 relates to the Fir Value Measurement which is under the section 334 of the corporation Act 2001. This standard defines the fair value and brings disclosures about the same. Fair value is a market based measurement concept. The objective of the Fair Value measurement is to measure the price of the asset to sell the asset or transfer the liabilities under the present conditions of the market. It can be taken as an exit price on the date of measurement for the one who holds and asset and owes a liability. This fair value is measured by assuming the prices of the assets and liabilities used in the market by the participants in the market, the risk factor is also considered while assuming the prices. This standard applies to the annual reporting periods which begin on and after 1 January 2013. In the case of non-financial assets the value of the asset is maximised and its highest and best use is estimated to calculate the fair value of a non-financial asset (Hsu & Lin, 2016).
During the recent global financial crisis, the fair value measurement concept faced controversies in accounting methods. People had doubts that what should be portrayed by fair value accounting. It was also believed that the Fair value concept contributed to the mortgage crisis and people like the auditors, accountants or investors were uneducated about the fair value accounting. This changed the measurement criteria of financial statements. The amount of fair value is determined on the basis of historical costs for the items whose prices do not advance with the time like books, equipments or films and for the active products like clothes, electronic materials, etc. which get changed with the time. The controversy is that whether the things depreciate in their value to time or they become more valuable because of their limited availability. Fair value affects the decisions of investments and management which is also considered one of the biggest reason for the crash of Wall Street 1929 and in the global financial crisis of 2008 (Laux & Leuz, 2010).
Another controversy is determining the future value of an asset in investments and in the trading of stocks. The fair value of an asset can seem as opportunity at one moment or financial loss in the moment. In spite of these controversies, fair value is adopted by the markets today as the basis of measurement. Fair market value reflects the effect of the current market conditions on the financial instruments. It brings more transparency and reliability in the non-liquid markets. The two main controversies of using fair value accounting are its application in illiquid markets and how the model should be used to determine the fair value (Liao, et. al., 2013).
Evaluate fair value accounting in AGL limited
AASB or IASB standards can be taken as the framework which provides guidance on the usage of different concepts by the companies. There are many controversies or the problems which occurs in these applications but they form as the basis of measurement.
AASB 13 is the Fair Value measurement which provides the estimation of fair value on the basis of the values prevalent in the current market which might create problems sometimes as the information about market values are not present t all the times.AGL applies AASB 13 in valuing its assets and services. It also uses derivative financial instruments so that its risks with the prices of energy can be managed properly and also to manage the risk to the changing interest rates and the foreign exchange rates which happens in the normal duration of the business. The ultimate purpose and aim of the company is to transact derivatives so that all the related risks can be managed which involves price risks, interest rate risks and the foreign exchange risks (Limited, 2016). The fair value of derivatives and its movements are recorded with the respect to Australian accounting Standard AASB 139 which is Financial Instruments: Recognition and Measurement. There is a lot of complexity in the exposures to the price risks and in the derivatives portfolio in the P & L account. In AGL Limited, the changes in the fair value of derivatives are recognised in the profit and loss for the year ended 30 June 2016. And the change was $595 million before tax and $417 million after tax which also involves a change in the long term electricity supply of $349 million before tax and $244 million. According to AASB 139, the change involves the fair value movements of $82 million before tax and $57 million after tax and the contract had the reduced fair value of $267 million before tax and $187 before tax. The final change in the fair value of derivatives was $237 million before tax or $166 million after tax (Limited, 2016).
From many years, AGL is using the underlying profit to track the performance of the company which is estimated and calculated by eliminating the important items and the movement of fair value in the derivative financial instruments from the profits of the company which is calculated according to the Australian Accounting Standards. Because of this, a proper comparison is made between the financial performances of different financial years (Palea, 2014).
Impact of AASB 13 on the financial statements of AGL Limited
AGL believes that Operating EBIT provides good understanding of the financial performance by excluding the important items and the fluctuating changes in the fair value of the financial instruments by comparing the financial performance of the company between different financial periods. The financial statements of the company are prepared and measured at fair value; by keeping historical costs as the basis except those assets which are available for sale and which are derivative financial assets. AGL limited applied and followed AASB 13 first time in the 2013. This is the source of direction and guidance for the measurements done on the basis of fair value. The company did not make any latest or new disclosures with respect to AASB 13. It is seen that AASB 13 had no effect or significant impact on the amounts which are identified in the financial statements of the company (Menicucci & Paolucci, 2016).
Comment on the measurement concept followed in AGL limited
The measurement process depends on the type of company, its procedures, investors, creditor’s employees and other stakeholders because they help in assessing the assets and liabilities which contributes in the future cash flows of the company. The users which read or use the financial statements of the company AGL Limited measures the fair value of the derivatives of the company which is currently followed in the market. When a measurement instrument is selected for any asset or liability, it is to be taken in consideration that how the future inflows of the business will be settled. Like the assets of AGL Limited generate cash flows when they are shared with other assets and the users follows the cost based approach to recognize that how the cash flows are generated through assets. The process of measurement by the business of AGL Limited shows that the information is true and justified (Pinto & Pais, 2015).
It is seen that the fair value accounting is often debated on its appropriateness for the financial instruments. It also provides a way for many controversies. The impact which is created by the fair value measurement on the company can be positive as well as negative but it is created by the forces of the markets. To reflect the market conditions, the best way is to measure the fair value of the financial instruments but the present conditions of the market raises a question that whether the fair value measurement concept is appropriate for the non-financial items or not. The investors of AGL limited receives benefit when the company discloses its views on the impact of market illiquidity in their reporting of financial terms and statements. After discussing about the benefits or disadvantages of the concept of fair value accounting, it is quite clear that though the concept is not perfect and does not provide accurate results and it is also not possible to determine the contribution of the fair value accounting concept to the companies and to the whole field of accounting, it is the present method of determine the prices of assets and liabilities which is widely used by the companies while dealing in the market. The global financial crisis of 2008 created a need for exploring more into the field and understands it in the better way so that the limitations of the methods can be removed and the method can be made better and more effective for the companies (Preliminary, 2016).
One of the reasons for the use of the fair value accounting is the theory of finance which says that the prices which are currently prevailing in the market are the measures of the value. In AGL Limited the impairments of assets are identified if the carrying amount of the cash generating units is more than the recoverable amount (Procházka, 2011). Cash generating unit (CGU) is the smallest group of the assets which creates cash inflows which are independent of the other assets. Fair value excluding the costs is the amount which will be paid for the asset. According to (Andrews, 2014), The fair value accounting goes against the fundamental objectives of accounting as it insert and introduces more uncertainty in the markets and in the reporting of financial statements. This method might make it difficult for the shareholders to gain from the company and provides an opportunity for the companies to earn more. The fair value does not provide the help to the stakeholders and the companies to assess the price of the assets but it creates difficulties and creates uncertainties in the market (Zyla, 2012;2013).
It can be concluded from the report that Fair value accounting can be described as the price which is determined for the assets and liabilities by looking at the current market forces in the market. This is controversial as it does not depict the real value of the asset or liability. It does not consider the depreciation or the availability of the assets. The report is on the AGL Limited which is an energy company in Australia and it also follows the same method of accounting for preparing its financial statements. AASB 13 is applied which is the Australian Accounting Standard for Fair Value Measurement. The company began the application of the Fair Value in the year 2013 for transacting the derivatives for managing the risks related to it. This concept let the company to compare the financial statements of different years. It is seen that the financial crisis is somewhere the result of the fair value method of accounting, it is believed by many people that the concept is not yet clear to the people which creates many mistakes in the preparation of the financial statements of the companies but still it is one of the most important measurement basis for the markets.
From the study of the annual report of 2016 for AGL Limited., it is made clear that AASB are applied by the company and both the fair value and cost based approaches are used so that the assets and liabilities can be measured and they the differences can be made in comparison to the previous years.
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