HISTORY

Fair value was first introduced in Australia, the United Kingdom and the former UK
colonies. This concept was first used to calculate biological assets in plantation and farms
companies. The consideration is because the assets and business fields of these companies is
living things that will continue to grow and breed/multiply. If these companies use the book
value (historical cost), it is not fair because it does not reflects the actual economic value. From
here, a new calculation concept is found, namely fair value. The concept of fair value was then
adopted into international accounting standards and first applied in 2003 to assess biological
assets. Since then, public companies in Europe have used fair value to compile their financial
reports. With increasingly dynamic market conditions, and developing very rapidly, finally the
historical cost concept is considered no longer suitable, because it does not reflect market value.
Instead, the concept of fair value is used.
Before IFRS 13 is applied, there are many former accounting standards, the first is IAS
36, IAS 39 / IFRS 9, IAS 40, IAS 41, etc. The next is topic 820 in US GAAP (codified SFAS
157) until finally become IFRS 13. IFRS 13 determined as single source of measurement
guidance, clear measurement objective and consistent and transparent disclosures about fair
value.
The former definition of fair value was the amount for which an asset could be
exchanged or a liability settled between knowledgeable, willing parties in an arm’s length
transaction. But there are several weaknesses on the definition. The word EXCHANGE  It
did not specify whether an entity is buying or selling the asset, SETTLED  It was unclear
about what ‘settling’ meant because it did not refer to the creditor. KNOWLEDGEABLE  It
was unclear about whether it was market-based. WILLING PARTIES  It did not state
explicitly when the exchange or settlement takes place.
And then there is the IFRS 13’s new definition of fair value is the price that would be
received to sell an asset or paid to transfer a liability in an orderly transaction (while that’s not
in a force sale) between market participants at the measurement date. Price that would be
received to sell an asset or paid to transfer a liability is called exit price. Let me also stress fair
value is market based not entity based, so it takes market condition into account. Sell an asset
 It specifies that the entity is selling the asset. Transfer a liability  It refers to the transfer
of a liability. Orderly transaction  It is not a forced or distressed sale. Market participants 
It is clear it is market-based. Measurement date  It states explicitly when the sale or transfer
takes place.
IFRS 13 applied starting the first January of 2013, so that means that all guidance about
fair value measurements in other standards like IAS 39 or IFRS 9 has been superseded. The
objective of IFRS 39 is to define what fair value is, to set out a framework for measuring the
fair value and require disclosure about fair value measurement. So please be aware that IFRS
13 guides you how to set fair value and not when to apply fair value and that’s arranged by
other standard for example if you classify the financial asset as at fair value through profit or
loss in line with IFRS 9 then it is IFRS 9 that tells you when you can classify and measure that
fair value but IFRS 13 tells you how to set the fair value.
Fair value measurement requires an entity to determine all of the following: the first
one, the particular asset or liability that’s the subject of the measurement and it must be
determined consistently with unit of account. Secondly, for a non-financial asset that only the
valuation premise that is appropriate for the measurement so the use to which the asset is put
consistently with its highest and best use. Number three, the principle or the most advantage
market for the asset or liability. Number four, the valuation techniques, appropriate for the
measurement considering the availability of data, market participants, and the level of
hierarchy.
CONTROVERSY
The issues surrounding fair value accounting are numerous and many powerful forces
are opposed to its implementation. U.S. industry groups are pressuring the SEC and FASB to
significantly alter or suspend the accounting rule, saying it is undermining the government's
multibillion-dollar effort to stabilize the country's financial sector. When in the United States
there was a financial crisis triggered by the subprime mortgage in 2008, fair value was used as
a scapegoat or being blamed for forcing banks to report billions of dollars in write-downs, and
contributing to the meltdown of the capital markets.
Related parties and authorities then conduct a study to find answers to questions: is it
true that fair value is the cause of the crisis? The Security Exchange Commission (SEC) or the
capital market supervisor of the United States (US) immediately formed a team to conduct a
study in December 2008. Previously, in November, countries joined in the G-20 held a meeting
to conduct a similar study. The International Monetary Fund (IMF) also create the same
research. The study conclusions from them are the same: there is no evidence that can show
that fair value is the source of the crisis. "The crisis is not caused by financial reporting, but
because there is too much risk taking,"
Meanwhile, the results of the SEC study said, the crisis was not caused by fair value,
but by the failure of banks or financial institutions in the US because of probable credit losses,
doubts about the quality of assets, and decreased creditor and investor confidence. In short,
what happened was a management error. That is what happened until the crisis dragged the
world into the global financial crisis. There may be valid arguments coming from those
opposed to fair value accounting, but the reality is that fair value reporting is here to stay in
one form or another, and will be further expanded. The FASB is to moving incrementally
toward fair market value, if for no other reason than to enhance comparability with international
standards.
ADVANTAGE AND DISADVANTAGE
1. Investors relate to value, not costs, then report fair value.
2. With the passage of time, the historical cost becomes irrelevant in estimating the
financial position of an entity. Fair value accounting helps ensure more accuracy in terms
of current asset and liability valuations, so if price increases or decreases are expected,
then so as the valuations.
3. Fair value accounting reports assets and liabilities in ways that economically will pay
attention to them; fair value reflects the true economic element.
4. Accounting for fair value reports economic income; widely accepted Hicksian
definition of income as a change in wealth, changes in fair value of net assets in the
income-generating balance sheet. Fair value accounting is a solution to the problem of
accountants in measuring income, and is more desirable than the hundreds of rules that
underlie historical cost revenues.
5. Fair value is market-based measurement that is not influenced by entity-specific
factors.
DISADVANTAGE
1. It can create downward valuations.
If a business experiences a decrease in net income due to asset losses, it can create a
domino effect throughout an industry or a region. These downward valuations can often trigger
unnecessary selling because of market volatility. When fair value accounting is not used, then
downward valuations will not happen, and there will be more investor stability.
2. It can cause huge swings of value throughout a year.
Not all businesses benefit from this accounting method, especially those with assets
often fluctuating in value throughout the year. Take note that volatile assets could report
income changes that are not actually accurate in the long term, creating inaccurate gains or
losses in the short term.
3. Absence of a market price
If a market price for a given asset is not available in the active market, fair value
estimate that is supposed to provide the most reliable information is more difficult to obtain.
In this case, the usual procedure is to use “mark to model” accounting. This requires creation
of a more extended estimate which runs the risk of creating a deviation of price for a given
asset from its price if it was to be found in the market.
4. Manipulation
Opportunistic attitudes and dishonesty management can take advantage of the
assessment and estimation used in the process of manipulation and playing numbers to achieve
the desired income.