FINANCIAL accounting concepts can be daunting for laymen to grasp. In this article, we will explain one of the broad basic fundamental accounting concepts, that is, the fair value concept, in the simplest terms possible. This important concept is governed by the Malaysian Financial Reporting Standard (MFRS) 13 – Fair Value Measurement issued by the Malaysian Accounting Standards Board. The legal force on this standard is given under the Financial Reporting Act 1997.
Prior to the introduction of fair value concepts in financial reporting some decades ago, financial statements of public listed corporations were prepared based on historical cost conventions, where financial transactions were recorded at their acquisition or transaction cost.
The typical confusion the fair value (FV) concept brings is that it gives the impression to a layman that it resembles fair market value (FMV). They are not the same. Fair value for financial reporting is the price that one would receive to sell an asset and pay to transfer a liability in an orderly transaction between market participants at the measurement date, and in the case of non-financial assets, it shall be measured at its highest and best-use basis (HABU). Clearly, it denotes the exit price of an asset or liability.
The orderly transaction notion means that there was sufficient time to market and create interest among market participants in disposing of the asset or liability. It means that sellers aren’t forced to accept a price in a short period. At the same time, market participants are assumed to be independent of each other, knowledgeable, able, and willing to enter into the transaction. It further assumes that the transaction takes place in the principal market or, in the absence of one, in the most advantageous market. The principal market is where there is the greatest volume and level of activity.
Care should be exercised in interpreting the meaning of FV as it does not equate to FMV. The International Valuation Standard 104 – Bases of Value provides two definitions of FMV, that is:
(1) the price a willing buyer would pay a willing seller in a transaction on the open market; and
(2) the price at which the property would change hands between a willing buyer and a willing seller, neither under any compulsion to sell and both having reasonable knowledge of the relevant facts.
Both definitions indicate that the transaction or exchange between buyer and seller was not under duress, similar to FV as defined under MFRS 13. However, the key difference is that FMV may not need to consider market participants, while FV for financial reporting only considers buyers and sellers in the principal or most advantageous market. It also allows the value of non-financial assets to be valued on HABU basis, which is not necessarily the case under FMV.
An illustration is provided here to give clarity to the meaning of FV and FMV with the recent corporate exercise between Axiata and Digi. The merger structure of Axiata and Digi results in Axiata receiving 33.1% of the enlarged issued share capital of Digi and cash consideration of RM2 billion. The rationale of this transaction is based on an indicative synergistic value of around RM8 billion in current value.
Both Axiata and Digi are publicly listed corporations on Bursa Malaysia. The principal market for both corporations, in this case, is the stock exchange. However, in the absence of market participants, the RM8 billion indicative synergistic value will not be considered under FV, but the same can be regarded under FMV in structuring this transaction.
It is imperative for users of financial statements to understand the concept of FV for financial reporting and the difference with FMV. This clarity is essential to appreciate the value of financial statements better. The application of FV accounting has many advantages, among them are:
i) it requires enterprises to disclose more information as opposed to historical cost convention;
ii) it emphasises the relevance of financial information including a focus on providing decision-relevant information to investors;
iii) it allows for timely recognition of any value impairment;
iv) it can be useful to alert users if the corporate asset’s value trend is decreasing; and
v) it can give signals on the entity’s financial wellness.
It is hoped this article has enabled readers to gain a better understanding of one of the fundamental concepts in financial accounting. No doubt, at times, it can sound Greek but, with some effort, it can be rewarding and fulfilling.
This article was contributed by The Malaysian Institute of Certified Public Accountants (MICPA) member and Mazars associate director Roger Loh Kit Seng, and business & financial adviser Sukh Deve Singh Riar. The views reflected in this article are those of the authors and do not necessarily reflect the views of MICPA.
