1.1 Background developments
Traditionally, accounting standards have been developed by different countries on the basis of local legal, economical and cultural institutions frameworks (Elliott and Elliott, 2009, p. 158). As a result, the standard setting was very country specific. With the globalization process at work for the last 3-4 decades and increasing mobility of capital internationally accepted accounting standards have become necessary to facilitate cross border transactions and make financial reporting comparable between countries and companies thereby leading to a greater transparency for investors (Nobes, 2004). IASB has been set up as a private international standard setter with a mandate to create high quality accounting standards that shall have universal application all the world over (IFRS Foundation, 2011a). Acting within its mandate IASB issues standards regulating financial reporting mainly in the interest of capital market participants (IFRS, 2011a). However, it is also acknowledged by academics (e.g. Belkaoui, 2005) that accounting still depends on local institutional factors which remain in place despite the worldwide acceptance of IFRS during the last decade (e.g. Heidhues and Patel, 2012). The implication is that accounting standards by themselves cannot ensure high quality uniform financial reporting (Soderstrom and Sun, 2007). A number of other institutional factors play an important role in this respect such as a level of stock market development, legal and economic institutions, fiscal or market orientation of accounting. It is necessary to recognize the impact and interplay between these factors in order to understand the context in which IAS 40 has been adopted and how it affects the users and preparers of financial reports.
IAS 40 is a new accounting standard for investment property being part of IFRS. Being the first standard permitting fair value accounting for non-financial assets it is a result of a compromise between the needs and capabilities of market participants as well as different accounting traditions in that it gives the report preparers the choice to measure the investment properties using either the fair value model or the cost model. In addition to it, the standard gives the users the possibility to decide on use of internal or external valuation of the properties classified as investment property.
The economic significance of the standard is notable. The real estate prices has been on the rise for the most part of the last century and reached very high levels in many developed as well as developing countries. The following Tables 1 & 2 depicting investment property assets on the books of Japanese companies help understand the economic impact of of IAS 40 on the financial statements.
Source: Yamamoto, 2014
It can be seen that on average 35% out of 613 companies sample group of the firms listed on the Tokyo Stock Exchange have investment property on balance sheets, with more than 50% in real estate and construction industries.
Source: Yamamoto, 2014
While the previous Table 1 demonstrated number of companies with investment property, Table 2 shows value of investment property as a percentage of total assets, which is about 40%. However, the distribution is very uneven, ranging from 75% in Real Estate Investment Trusts to less than 1% elsewhere.
- Purpose and method
First setting the stage for different economical and accounting developments which led to IFRS proliferation, the paper reviews how IAS 40 fares in different environments, such as the UK, Germany and emerging markets. The underlying concepts of fair value accounting as opposed to historical cost accounting are studied in detail by review of academic literature.
In particular, this paper elucidates how the different forces in the market place have shaped the standard as it is and what broader accounting concepts, such as fair value, historical cost underpin the standard. It further studies the perceived strengths and perceived weaknesses of the IAS 40 Investment Property based primarily on the literature review with international critique on the standard. Certain empirical evidences are reviewed as well but as a secondary source. Also, recommendations from the literature review on how to improve the standard are provided.
Chapter 2 describes the developments which have led to rise of IFRS and briefly discusses the theory underlying these developments. Chapter 3 takes a close look at the standard IAS 40 itself, providing its main provisions. Chapter 4 contains a detailed review of the extant academic and business literature focusing on IAS 40 and relevant accounting concepts. Practical application challenges, especially in emerging markets are outlined in this chapter. Chapter 5 deals with recommendation for standard setters, policy makers based on the literature reviewed.
- Capital market developments over the last decades
Last three four decades have seen privatization and deregulation on a global scale (Zhang, 2011) causing transformation of the public and private businesses as well as flattening the barriers in international trade. These developments have been referred to as neoliberalism (p. 4). It has been argued that neoliberalism promotes human well-being by unlocking opportunities for entrepreneurs within an institutional framework of “strong property rights, free markets, and free trade” (Harvey, 2005, p. 2). According to the study, the most considerable change which have taken place was growth and increased mobility of capital over the last 3-4 decades and the effect of financialization of assets in global economies (Zhang, 2011). Financialization can be defined as “the increasing dominance of financial markets, financial motives, and financial institutions in the operation of domestic and international economies” (Epstein, 2005). The effect of the financialization is the development and expansion of financial instruments such as derivatives and gradual conversion of traditional tangible or intangible assets into financial instruments, through different financial innovations such as securitisation of government debts, off-balance sheet financing, packaging of mortgages into securities, options and many other financial derivatives. This financialisation helps convert any type of traditional fixed asset into a more liquid financial instrument. These developments in global economy explain why IASB started introducing fair value accounting for broader and broader classes of assets, including even traditional Property, Plant and Equipment. One downside of financialisation is (Boogle and Sullivan, 2009, p.22 ) that such system will inevitably have investors attention focused on short-term results which was evidenced during the last financial crisis of 2008-2009. IAS 40 and IAS 41 which is a standard on agriculture are the first standards allowing fair value accounting for non-financial assets. As such, these developments could be seen to give support to above arguments on financialization of assets.
- Local institutional framework
Having described the global transformation, which is the main driving force for transformation of accounting standard to support capital mobility and globalization, now it would be useful to review traditional institutional frameworks. In accounting one can observe two main models, the Anglo-Saxon and the Continental (Richard et al, 2014). These two models have different views on the objective of financial reporting as well as on principles underpinning financial statements. As shown in the Figure 1, understanding of the accounting traditions is very relevant to see why IAS 40 has been adopted and what its actual impact is upon the accounting in the countries which use it. This paper will look at experiences of a number of countries, among which are the UK and Germany which have been selected as prominent representatives of the two accounting traditions mentioned above.
In addition to it, the study of Al-Khadash and Khasawneh (2014) demonstrates that IAS 40 application and impact may have different effects in developing markets. Therefore, this paper will look at IAS 40 application in developing countries as well.
- UK accounting tradition
In contrast with the Continental tradition the Anglo-Saxon accounting is considered to be more open investor oriented, being underpinned by the developed capital markets.
In Anglo-Saxon tradition, accounting is regulated not so much by statute law but to a larger degree by court precedents and customs. Such system is called English common law and it is generally acknowledged that it provides for better corporate governance and investor protection than do civil law systems. As mentioned above, UK has very developed and liquid stock markets. A traditional way of getting financing for the UK based companies is to get listing on a stock exchange as opposed to bank financing which is more common way for the Continental Europe. In the UK even medium size companies are often listed on the stock exchanges. Another feature of the UK stock market is the dispersed nature of shareholding, unlike family or a dominating shareholder control common in some Continental European countries (Mallin, 2010). Such an ownership structure requires that financial reporting should reduce information asymmetry, and in this context mark to market revaluations can serve the purpose of conveying information about the assets’ current values to outside investors. Since UK listed companies have a large number of the outside investors who do not usually have any access to management information, it is very important for them to receive formal financial reports, in order to offset information asymmetry and thereby decrease the agency costs (Jensen and Meckling, 1976). It should be noted that IFRS is mainly based on Anglo-Saxon accounting tradition. It follows from the description above that fair value measurement being considered relevant for investors is accepted well in the UK accounting tradition and therefore the expectation would be that UK companies would embrace fair value model introduced by IAS 40 which will be confirmed by empirical studies reviewed later in this paper.
2.2.2 German accounting tradition
In contrast to the UK common law based system, Germany has a civil law system, which provides that there should be laws governing all major aspects of life including business situations. Unlike a flexible UK legal system, based upon precedents and equity principle German tradition is has much more rigid design. It is not a surprise that weaker shareholder protection which is a norm under civil law jurisdictions is has led to another important feature of the German market. It is a fact that the stock market development has been much weaker in Germany than in UK and a traditional way of business financing used to be through banks debts. Besides, unlike dispersed shareholding in the UK, more common form in Germany was a dominating shareholder be it the government, a bank or a founding family. This structure of the companies implies that controlling shareholder would not have relied so much on the formal financial reporting as they would have received access to management information and information asymmetry was not a big problem. Accounting literature review also casts Germany as an economy dominated by private companies raising capital from banks and using informal communication channels (see e.g. Leuz and Wüstemann 2004, Heidhues and Patel, 2012).
As Heidhues and Patel argue the main objective of the German accounting was to protect the interests of the creditors and ascertain taxes payable rather than provide information for stockholders (Heidhues and Patel, 2012). In line with EU directives Germany introduced IFRS since 2005. Analysing the problems related to the convergence in terms of cultural, legal and economic institutions, Heihues and Patel (2012) argue for “evaluation of accounting system in their national context” as it may be incompatible with the IFRS principles. E.g. Germany is still a bank oriented economy with historically strong trade unions, which have representation on the boards. It could be argued that IFRS is more tuned to the needs of Anglo-Saxon model, rather than German traditions. It could be expected therefore that institutional factors outlined above will continue to exert their influence upon German companies. In particular it will be seen in the accounting choices presented by the standard IAS 40. One feature of German accounting tradition having impact upon German practical application of IAS 40 is its strong preference for historical cost accounting as it is much more reliable compared to fair value accounting. Therefore it could be likely that German companies would choose cost model under IAS 40, which is confirmed by the empirical findings presented later in this document.
- IFRS broad concepts underlying accounting standards
As mentioned above IFRS have been largely based on the Anglo-Saxon accounting tradition (Chamisa, 2000, 275) which is strongly related to development of capital markets. As discussed in the paragraph IAS (which later have become known as IFRS) have been created in response to the developments in the global capital markets. International Accounting Standards Committee (the forerunner of today’s IASB) has become the recognised standard setter worldwide with IAS receiving endorsement of such organisations as IOSCO and EU.
Source: Picker et al, 2012
It can be seen that decision usefulness as defined by its relevance have been indicated as primary qualities of the accounting statements, while more conservative values verifiability and reliability have become enhancing characteristic of the second order.
It can be argued that in choosing between fair value and historical cost measurements of accounting information, the standard setters including IASB are guided by the conceptual frameworks which as seen above promotes the decision-usefulness as the primary quality of accounting information. However, in setting the standards with decision-usefulness as the objective, a standard setter faces a trade-off between the relevance and the reliability characteristics. As argued by Zhang (2011) in facilitating the capital mobility over last decades, both FASB and IASB have attached more importance to relevance as compared with reliability, thus paving the way for wider use of fair value accounting. This explains why the standard setter has indicated the strong preference for fair value measurement in IAS 40 rather than for historical cost measurement. The latter is still allowed, but it can be seen from the basis of conclusion (IFRS, 2011b) that it is a provisional measure until property markets are mature enough to allow fair value measurement. It is recognized that fair value measurement is more relevant for decision making, while historical cost is more reliable and verifiable. The hierarchy depicted above helps understand the standard setter’s preference for measurement basis in IAS 40.
3.1 Reasons behind separate accounting for investment property
In traditional sense, property is a long term asset supporting day-to-day operation of a company (Alexander et al, 2011, p. 279). It is used for manufacturing or administrative tasks however without intention to be sold. It has wear and tear as its resource potential is consumed and the accounting treatment is to charge depreciation in annual income statement.
On the other hand, investment is perceived as an asset generating return in the form of rent, dividends, interest or capital gains. In accounting sense the consumption of investment’s service potential takes place through impairment or capital appreciation (IFRS, 2011B, B1754). The properties are held for both purposes. Besides, the property prices have been on the rise over long term, therefore correct treatment is necessary. Before 1980s the accounting did not distinguish between the property for traditional use and property held as investment (Alexander et al, 2011, p. 279). However, with the growth of investments into property, the traditional approach was challenged primarily in the UK on the grounds that with growing prices going up and up, the service potential is not consumed and therefore depreciation charge was not appropriate. Of much more relevance for investors, it was argued, (Alexander et al, 2011, p. 280) was to know marked to market property prices.
- Standard history
IAS 25, Accounting for Investments, the predecessor of the current IAS 40 was in effect from 1987 through to 2000. In 2000 IASC issued IAS 40 Investment Property, as it is known today. It was developed to distinguish accounting for investment property from accounting for property, plant and equipment under IAS 16. It had allowed a choice of accounting measurement – either at cost or at revalued amount. It is interesting that issuing an exposure draft in 1999, IASC initially left only fair value measurement for investment property. This move, however, put it under pressure from a number of practitioners and national standard setters (Alexander et al, 2011, p. 280). Therefore IASB backtracked in allowing historical cost to remain as an alternative to fair value accounting.
- Present standard description
IAS 40 governs how investment properties are accounted and reported in the financial statements. The investment property is defined in the IAS 40 as: “Investment property is property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both” (IFRS Foundation, 2011a). IAS 40 provides that investment property may only be recognized in the balance sheet if it is likely that future economic benefits associated with this investment property will accrue to the company. The other condition is that the property cost can be reliably measured (IFRS Foundation, 2011a). The initial valuation of the investment property is to be done at the cost model, which includes the purchase price and costs directly associated with the purchase. For subsequent valuations under IAS 40 the reporting entity must choose ex-ante either the fair value model or the cost model. The model chosen ex-ante shall be used for all of the investment property of the firm. In indicating the preferred fair value valuation the standard setter has said that “switch from fair value model to the cost model is very unlikely to take place” (IFRS Foundation, 2011a). In line with IAS 16 accounting for Property, Plant and Equipment, the maintenance expenses for the property are to be accounted in period they occur (IFRS Foundation, 2011a). However, expenditure enhancing the value of the investment property is to be capitalized into the value of the property.
The standard explains in detail valuation methods allowed, if fair value accounting option is chosen. While in an ideal situation it states “that the best evidence of fair value will be given by comparable transactions of similar properties in a similar location and condition. However, with the low transaction volume in the market, it might be difficult to find comparable transactions. Nevertheless, the standard allows the fair value to be estimated by using other information when market values are not available” (IFRS Foundation, 2011a). The other methods could include transactions with dissimilar properties or application of DCF models.
One of the concerns raised during the standard discussion was that it is often difficult to distinguish between investment property and owner occupied property which falls under IAS 16 requirements. However, in its Basis for Conclusions on IAS 40 (IFRS Foundation, 2011b, p. B1743) the Board stated that a separate standard is required because characteristics of investment property are considerably different from those of owner-occupied property and fair value measurement is of relevance to the investors. Perhaps to address concerns like that, the IAS 40 has laid out a detailed procedure of distinguishing investment property from owner-occupied property which is summarized.
- Measurement under IAS 40
In its present version, the standard allows two valuation models – the fair value model and the cost model. Indicating that fair value model is the preferred treatment (Alexander, 2011, p. 283), the Board nevertheless allowed cost model for two reasons. One reason was to allow reporting entities as well as financial statement users some time for getting used to apply fair value concept. Another reason was to give time for countries with less developed property markets to mature. It can be assumed that countries with Anglo-Saxon accounting traditions would fare well with one model, however, the countries of the Continental accounting traditions and developing countries still need time to embrace fair value measurement.
3.4.1 Initial measurement
The standard provides that initial measurement is to be at cost, with further provision that initial cost of a property held under a lease shall be as required for finance lease standard IAS 17, i.e. “the lower of the fair value of the property and the present value of the lease payments” (IFRS Foundation, 2011a, p. A1226).
3.4.2 Cost model
As implied by the standard, if the company chooses the cost model for subsequent measurement, then property is treated much in the same way as under IAS 16 - property, plant and equipment. However, it still should provide disclosures as required by IAS 40 and in particular, the disclosure of the fair value of the property. Under cost model the investment property is accounted at cost less accumulated depreciation and less accumulated impairment losses.
3.4.3 Fair value model
It should be noted here, that IAS 40 along with IAS 41 are the first standards permitting fair value valuations for non-financial assets. This upholds the view expressed by Zhang (2011) of the IASB agenda to promote fair value accounting as much as possible in IFRS. Zhang and other researchers have leveled significant critique on the fair value accounting which will be reviewed in the later chapters. Besides, fair value is to be assessed in all cases, as in the case of cost model, the fair value is still to be disclosed in the notes. Fair value is governed by IFRS 13 where it is defined as the price of at which the assets can be exchanged between two knowledgeable, independent parties that are interested in the deal on an arm’s length basis (IFRS Foundation, 2011a). As IASB puts it “The best evidence of fair value is normally given by current prices on an active market for similar property in the same location and condition and subject to similar lease and other contracts” (IFRS Foundation, 2011a). When it is impossible then the fair value can be measured by choosing one of the following methods
1. Taking current prices of different kind of properties, for which an active market exists, with further adjustment to the value of the properties
2. Taking current prices of properties with similar characteristics, which are located at a less active market with further adjustment to the value of the properties. The adjustment is necessary to take into account different economic conditions
3. It can be calculated using present value model, by estimating future cash flows.
It is very interesting that losses or gains arising from the fluctuations in the fair value of the investment property are to be recognized in the profit and loss statement for the period.
There is a rebuttable assumption that reporting entities will be able to reliably measure the fair value of investment properties (IFRS Foundation, 2011, p. A1230). However, by way of exception, when the fair value cannot be measured reliably, either by market comparisons or using cash flow methods, the property can be valued at cost model in accordance with IAS 16 until disposal.
While valuation at historical cost is relatively easy, fair value model requires careful valuation of the property reported. The valuation of the property is always based on assumptions with many factors to be taken into consideration. There will always be elements of uncertainty and different valuators can arrive at different amounts for the same property. The market is also vulnerable to fluctuations over time. If the valuation is performed on the basis of comparison the property with similar properties then the results of assessment may be more reliable and the uncertainty in the valuation can be of less concern.
3.5 Improvement to IAS 40
In May 2008 IASB amended IAS 40 by enlarging the original scope of the standard (and in parallel the scope of IAS 16, ‘Property, plant and equipment’). The objective of this revision was to make properties under construction or development which upon completion will be investment properties subject to IAS 40 and not IAS 16 as was the case before. It is evident that it is difficult to apply fair value measurement to property under construction. The only method possible would be to use future cash flow projections and there could be problems with that (see Suzuki, 2012 for an example). However, the IASB decided that “with increasing experience regarding the use of fair value as the measurement basis since IAS 40 was issued, entities were more able to reliably measure the fair value of investment property under construction” (PwC, 2014).
- IAS 40 critique
Having laid the foundation of accounting concepts on which IAS 40 is based, as well as economic developments which have led to the wide adoption of IFRS, this chapter will review contemporary accounting literature regarding IAS 40. It would not be possible to provide full account without looking at such important elements as fair value measurement for non-financial assets and practical application of the standard in the UK, Germany as well as in the emerging markets. First this chapter takes a look at the theoretical foundation of IASB’s intention to promote decision usefulness – the value relevance of earnings information, the corner stone on which the whole thing rests and other positive critique. The second part of the chapter reviews at negative critique.
4.1 Summary of positive critique
The positive critique has one central theme- by including the choice for fair value accounting, the financial reports issued under IFRS and IAS 40 in particular produce more timely and relevant information for investors and hence, their value relevance and explanatory power increases.
The other points mentioned in the extant research are the limited opportunities for earnings management, which is caused by ex-ante management commitment to a certain accounting policy. Also better assessment of management performance is made possible. Recognizing different levels of economic developments IASB left a choice between fair value and cost models thereby catering for different needs. And the last point in this section is that empirical research confirms that external valuation adds value to the shareholder, as investors appear to be willing to pay premium for it.
4.1.1 Value relevance theory of accounting information
The story of value relevance research started with the Ball and Brown seminal paper published in 1968 (Ball and Brown, 1968), where the researchers investigated the usefulness of accounting earnings information. Before that the majority of the researchers were confident that accounting limited to following the procedures and accounting numbers did not have much economic value for investors. Though it is hard to believe today, but their paper was initially rejected by the journal (the Accounting Review). It is acknowledged today that the research of Ball and Brown which has proved economic usefulness of accounting earnings for explanation of stock behavior has become the foundation for so called value relevance research in accounting. Since then value relevance research has been conducted in the developed economies as well as in the developing countries and is still widely applied. As Klimszak (2012) explains while researchers from developed countries test different aspects of accounting theory, their counterparts from emerging markets usually focus on the comparison between developing and developed countries. Research on value relevance from developing countries tends to have two objectives. The first objective is to test if reported earnings have enough explanatory power for stock valuation in the developing country’s stock market. The other goal is to contrast the results of the test with those from developed countries
As argued, fair value measurement serves the purpose of increasing usefulness of accounting earnings information. By providing timely update on assets value it is deemed more relevant for the decision making process of users of the financial statements. By recording revaluation to property, managers communicate their inside information to outside stakeholders (Aboody et al. 1999). It is known that traditionally accounting was conservative and even today upward revaluations for non-financial assets are not allowed in some jurisdictions, most notably in the US (Aboody et al, 1999). However, in line with value relevance theory, some researchers argue that accounting earnings with upward revaluations allowed may have more explanatory power for the equity returns (Sharpe and Walker, 1975).
- Increased value relevance
As stated by the IASB in its discussion (IFRS Foundation, 2011b, p. B1749) “this is the first time that the Board has proposed requiring a fair value accounting for non-financial asset”. IASB further noted that while leaving cost option for the preparers or markets not yet ready to use fair value accounting, this accounting will better reflect economic model underlying the investment property, thereby it will provide value relevant information which is the main objective of financial reporting. However, as shown above, different countries have different traditions and preferences. Besides, an accounting debate on the choice between fair value and historical cost accounting is perhaps the longest and most prominent in the accounting dating back to the 1930s (Christensen and Nikolaev, 2012). In their study on the practical use of fair value accounting for non-financial assets, Christensen and Nikolaev (2012) research the “market solution” for the choice between the two alternatives allowed by IFRS. Their paper contains empirical results of valuation practices as applied to non-financial assets such as property, plant and equipment, investment property, and intangible assets. Two countries on the opposite ends of accounting spectrum have been selected: the UK and Germany. As was explained above traditional German GAAP has strong preference for historical cost accounting, while the UK GAAP in some cases permits (for PPE) or in other cases prescribes (for investment property) fair value measurement. As a result, IFRS expands the available valuation practices in both the UK and Germany. As IFRS allows both fair value and cost models for investment property, this free choice made by managers representing outside shareholders and other stakeholders demonstrates market preferences with respect to the models.
It is argued by many that fair value accounting is superior to historical cost accounting as far as qualitative characteristics described in the conceptual framework are concerned with the only, but very important exception, which is the reliability. Therefore it was perhaps the Board’s intention (Christensen and Nikolaev, 2012) that the IFRS adoption will unify accounting practices with movement towards fair value accounting for non-financial assets and away from the traditional cost accounting. Gathering data on valuation methods used in the UK and Germany following their IFRS adoption, the researchers (Christensen and Nikolaev, 2012) analyzed annual reports of 1,539 companies based in these countries. The valuation methods practiced by the companies sampled in the review have been identified from the accounting policy descriptions in the annual reports. The research covered accounting practices in three categories of non-financial assets: PPE, investment property, and intangible assets. The research has found that
(1) For PPE, only 3% of the companies in the sample used fair value measurement subsequent to the IFRS adoption. An even more surprising development was noted for the firms that used fair value prior to IFRS adoption: 44% of these entities chose historical cost accounting following the IFRS adoption.
(2) For investment property the research has found that companies use equally (50%-50%) fair value or historical cost accounting. But as expected the tendency to use fair value is more in UK than in Germany.
This research appears to have made important contribution as to the practitioners preference for one method over the other. It is important for standard setters’ decision-making process to have evidence from the report preparers and users. The research findings show that the choice to use fair value takes place when its benefits exceed the costs as evidenced by more usage of fair value accounting in investment property rather than for traditional PPE. On the other hand, the data gathered suggests that fair value use is still rather limited, implying that the practitioners view its benefits not worth the costs in a number of companies.
4.1.3 Limited opportunity for earnings management
It is well established by Jensen and Meckling (1976) that in agency relationship which a modern corporation is a representation of, the principal (the shareholders) engage the agent (the management) to manage the company on their behalf with delegating authority to the agent. Their famous paper reads that “If both parties to the relationship are utility maximizers, there is good reason to believe that the agent will not always act in the best interests of the principal” (p. 5). One of the documented techniques whereby agents (the management) may mislead the principals (shareholder or investors) is the earnings management defined as “the alteration of firms’ reported economic performance by insiders to either “mislead some stakeholders” or to “influence contractual outcomes” (Leuz et al, 2002). It can be done in various ways, in particular by voluntary changes in accounting policies to make results look better.
The standard provides that the choice between the accounting methods (historical cost or fair value) shall be articulated in the accounting policy description in the annual reports following IFRS adoption by reporting entities and subsequently the chosen method must be applied consistently.
If a company has chosen to use fair value for investment property accounting it should revalue the assets each time when book value and market value would differ materially from each other (IFRS, 2011a). To prevent opportunism from the management, once a company has chosen historical cost method, it may no more do upward revaluations.
A change in the accounting policy from one method back to another is a cumbersome process and needs to be substantiated to the users of accounting statements (Christensen and Nikolaev, 2012). As the method of fair value or historical cost accounting is to be committed to ex ante, it is unlikely to be influenced mainly by earnings management intentions. The potential problem with upward revaluations is that managers take decisions on whether to mark assets to market ex post after the impact of the fair value revaluation on the financial result has become known.
- Choice allowed to cater for different environments
Rather than positive or negative critique, the permission of alternatives between fair value and cost accounting can be considered recognition of the realities by the IASB. As known, in the exposure draft of the standard issued in 1999 (Alexander et al, 2011, p. 280) only the fair value option was mandated. However, the diversity of accounting practices are confirmed by many researchers. E.g. Christensen and Nikolaev (2012) have found that for investment property 23% of the reviewed German companies preferred fair value treatment while in the UK 77% of the reviewed companies have committed to fair value accounting for investment property.
This absence of uniformity among practitioners is exacerbated by the academic debate for or against the fair value accounting as which is still going on. Part of the researchers argue that historical cost accounting is outdated and irrelevant for decision-making process of outside investors, and therefore fair value accounting in one form or another should replace it. Some of the drawbacks of the historical cost accounting are its irrelevance during considerable price changes (inflation), its inability to recognize changes in assets values, and insufficient comparability (Belkaoui, 2005, Al-Khadash and Abdullatif, 2009). On all above points the fair value accounting which has been proposed as an alternative for historical cost accounting, scores better, especially in relation to financial instruments. In the sphere of financial instruments, fair value accounting has been viewed generally to be much more relevant than historical cost accounting, without the downside of its less reliability, especially in cases where active markets are available (Al-Khadash and Abdullatif, 2009). Therefore, fair values accounting is able to communicate real economic value (rather than past cost).
4.1.5 Better management performance evaluation
Christensen and Nikolaev (2012) note that managers tend to adopt fair value valuation in case it helps performance evaluation. And because economic value changes in investment property convey information regarding performance as capital appreciation is part of the business model in investment property it was predicted that fair value would be more used by real estate firms or real estate investment companies. Consistent with this prediction, the research has found that fair value was wider used in case it helps evaluate and facilitate performance measurement. Thus, the research has found that the companies with investment property as their primary business, the fair value choice tended to be more likely option. One reservation however, is that in the choice between fair value and historical cost, the historical cost is still more likely choice made by practitioners.
One more advantage of fair value option is its impact upon performance indicators. It shows when firms made bad choices and cause them to pull out of the bad projects, which was not possible under the historical cost regime. Or else, it shows real ROA, by reflecting true price of property. E.g. unused investment opportunities or opportunity costs can be used to evaluate management performance (Christensen and Nikolaev,2012).
4.1.6 External appraisals helps unlock value for investors and is a key for fair valuation
E&Y survey (2011) confirms importance of appraisal reliability for the efficiency of fair value accounting in respect of investment property.
Source: E&Y, 2011
The pie-chart confirms that DCF methods are most widely used compared to other methods, confirming that direct market observations play only secondary role.
Yamamoto (2014) reviewed the experiences of two countries – Japan and the UK in application of fair valuation to investment property. Both countries have large amounts of capital tied in the real estate (see Table 1 & Table 2 above).
It should be noted here that though Japan has not yet adopted IFRS its accounting rules are affected by IFRS. Following adoption of IAS 40, in 2010 Japanese GAAP was amended to require mandatory disclosure in the financial reporting of the fair value of investment property. The value of investment property in Japan is enormous. Therefore any changes in accounting rules governing reporting of these assets is very critical for Japanese investors in real estate sector. Yamamoto noted that before the GAAP was amended the outside investors had difficulty in estimating the fair value of investment property of Japanese firms. The recent changes in accounting rules mandating the disclosure of fair value of investment property made this information more transparent and helped reduce information asymmetry in the stock market.
Under traditional GAAP financial statements reported the value of investment property at its acquisition cost. As a result, only a small number of insiders knew the market value of the investment property. Put differently, a great deal of information asymmetry was the case in the investment property market. Disclosure of more current market value leads to public knowledge of the actual value of the investment property and helps efficient working of stock markets.
Following the introduction of fair value accounting for investment property, the increased importance has been attached to accurate valuation of the assets. IAS 40 provides for external as well as internal valuation of the investment property. This absence of uniformity was a bit of concern for some researchers. However, an external appraiser's valuation could be costly repeated exercise, as the real estate markets are often volatile. On the other hand in-house valuation may be subjective and skewed to give more favorable picture of the companies. Yamamoto’s research was aimed to analyse the actual practices of investment property valuation, the role of external assessors in the UK and in Japan and to understand the impact of external valuation upon investors’ perceptions.
Though some researchers cast doubts on the relationship between market value and fair value the International Valuation Standards (IVS) basically confirm that “The IVSB considers that the definitions of fair value in IFRS are generally consistent with market value” (p. 21).
Research into the reliability of the valuations by measuring the difference between the reported value and the actual sale price revealed the following range:
(1) most accurate estimates were provided by the external valuations;
(2) internal valuation reliability was improved by having it audited by a major audit company, still it was inferior to external valuation;
(3) internal valuation without audit of a major audit company was less accurate than valuations (1) and (2).
The research conducted by Yamamoto covered the 613 sample companies listed on the Tokyo Stock Exchange. Out of this sample 216 firms disclosed fair value of investment property in the financial statements in 2010. Out of this group 204 had disclosed their valuation methods applied to investment property with the results that
- 108 firms used external appraisers
- 96 firms did the appraisal internally
Analysis of this data showed that firms with larger unrealized gains more often chose external valuation, which could be attributable to the desire of the management to convey their better performance indicators and increased asset values to the shareholders.
Another outcome of the analysis was that the firms with higher financial leverage were more likely to choose internal valuation. This could be explained by the fact that these companies while obtaining loans have valuation reports in place. However, another possibility is that the management had incentive to skew information to meet debt covenants.
The final conclusion made by Yamamoto was that though theoretically the market should pay a premium for stocks where valuation is viewed more reliable, meaning companies which have its valuation done by external experts, nevertheless, a notable part of the companies made internal valuations. This is in sharp contrast with the practice in UK, where investors seem to pay a premium on external valuation. However, Japanese firms are different, and the question whether internal valuations will be accepted by the market remains a subject for further research.
The case of Hong Kong demonstrate that existence of competent valuator’s profession in a country facilitates fair value measurement, while the absence thereof would inhibit correct application of fair value under IAS 40. As the fair value accounting expands, in order to have confidence in valuation results the market participants should have awareness of what valuation methods are, what assumptions they are based on. As the economic environment becomes more sophisticated, an appraiser is required not only to come up with a value of property, but in addition to it, he should explain the reasoning with the objective to allow the report users to understand the case proposed. Agreed valuation guidelines help set a framework for an effective communication between appraisers and report users. As the active market is often absent and unlike financial instruments each property is unique, the income approach based on assessing future economic benefits flowing from the operation of the property gains importance.
Applying this valuation method, the appraiser assesses the future economic benefits flowing from the property and calculates present value of these future cash flows applying a discount rate that reflects the time value of money including inflation and risks. But identifying a proper discount rate is not easy. Some factors to be taken into consideration are as follows:
1. Expected inflation
2. Real return
3. Risk premium
4. Recapture premium
The potential investor would like to make sure that the invested capital will be maintained and that is why discount rate is important.
4.2 Criticism of fair value accounting as applied in IAS 40
The implementation of fair value measurement has incurred significant criticism on several grounds. Most prominent arguments discussed here include:
- Fair value accounting is very subjective, information becomes costly to report, it can be manipulated – the problems with reliability (Al-Khadash and Abdullatif, 2009).
- Absence of detailed industry guidance
- There is serious opposition to the fair value accounting as they perceived to bring the volatility in reported earnings, especially in the emerging markets (Al-Khadash, H.A. and Khasawneh, 2014)
- Pro-cyclical nature of fair value accounting leads to facilitating of financial leverage
4.2.1 Reliability of Fair Value Model for Investment Property is questioned
The question of reliability is a primary one for all stakeholders in respect of fair value accounting including investors, regulators, report preparers and auditors. As stated by Wilson (2001) “well established valuation models can produce significant variability in the range of reasonable fair value estimates for an investment property and even minor changes in the assumptions in the valuation models can significantly alter the results. In an ideal world with liquid and transparent markets this would not be a significant problem. However the real estate market is characterized by inefficiency and heterogeneity. Fair values of investment properties in many cases are based on valuations and not observed prices. For assets traded in illiquid markets the volatility in reasonable estimates of fair value can provide a vehicle for discretionary upward or downward adjustments of balance sheet and income amounts. Even in the absence of an enterprise’s intent to distort reported fair values, the variability of reasonable fair value estimates from enterprise to enterprise may significantly reduce the comparability of financial statements among enterprises”.
Because of the income volatility caused by application of fair value accounting on investment property and real estate Turel (2007) has argued that real estate businesses in Turkey do not tend to choose fair value method for their investment property valuation under IAS 40.
The values are based on the work of individual experts who have to estimate the marketability, or predict the cash flows and discount rates, for assets with very different characteristics. Danbolt and Rees (2008) argue that there are a lot of subjective factors, such as the appraising experts, their qualification and independence from the real estate firms which could affect valuation results. Danbolt and Rees (2008) finally come to conclusion that as far as investment property is concerned there is much more uncertainty regarding applying fair value accounting than is the case regarding financial securities. On these grounds fair value disclosures required by IAS 40 could be less valuable for decision making.
This is in line with the reasoning by Mazza et al (2009) who point out to the absence of active markets for such assets. In the case of the absence of active markets, the fair value is determined by applying internal models which could be very subjective and sensitive to assumptions.
- Difficulties in application IAS 40: absence of industry guidance
On the one hand the main rationale of IASB to put investment property outside the realms of IAS 16 was the different economic model which in case of investment properties differ considerably from the model of owner-occupied property. The other reason is that IASB views that changes in market values attributable to such properties are important for the users’ of financial statements. Therefore IASB issued a completely separate standard governing investment property (Collins, 2012). On the other hand in practical life the separation of investment property from owner-occupied one is not clearcut. In its basis for conclusion IASB (IFRS Foundation, 2011b, p. B1747) noted that the hotels and similar property classification is controversial and not fully understood by the financial report stakeholders, which was confirmed by commentaries on the exposure draft E64. Some participants view hotels as investments, on the other hand other participants view them essentially as operating businesses. While there was a request for a detailed rule to clarify the accounting approach towards hotels and some other property, such as restaurants should be treated as investment property or as operating business. Other concerns were in respect of quantitative guidance (such as a percentage) to define what is “insignificant” or “significant” in order to decide whether a property is owner-occupied or investment property.
It was expected that IASB refrained from giving specific guidance and suggested to apply general principles for property classification, which is in line with general IFRS approach being principles based standards. However, such approach creates some difficulties in legalistic countries such as Germany or France, which are not accustomed to common law system on which IFRS is based.
- Unrealised gains and losses are recognized in profit and loss statement
As Al-Khadash and Khasawneh (2014) argue with reference to the evidence from the Jordanian real estate market, the recognition of gains or losses arising from changes in the investment property values under fair value accounting in the income statement of the period will have considerable impact upon the financial statement of the companies:
1. Solvency (equity/assets ratio) may change upward if the market prices of the investment properties increase, which happens during booms in the economic cycle, however if market moves down, it may have adverse effect.
2. Shareholder’s equity will increase considerably as value of property changes if trend is up, however it may decrease in case the trend is down.
3. As a result volatility in the earnings will increase compared to historical cost model.
This is based on the fundamental principle behind the fair value which essentially represents a market price under normal conditions. In efficient markets, market price reflects the balance of the different views of all market participants concerning economic characteristics of an asset or liability and also forecasts regarding future cash flows.
Another concern with applying IAS 40 is the unrealized nature of profits and losses, arising from fair value accounting which is a controversial issue in accounting (EC, 2003).
The recognition of unrealized gains and losses has long been opposed by part of more conservative practitioners and academics. One method was to defer capital gains asset revaluation by taking them directly to equity, and thereby leaving the income statement intact. However, it seems that IASB has decided to extend the scope of fair value accounting and by virtue of which it has incurred a good deal of criticism (Zhang, 2011).
However, as was argued above, despite the downside of recognition of unrealized gains and losses, there are some advantages. In particular, the research into the role of unrealized gains and losses recognized under IAS 40 by Al-Khadash and Khasawneh (2014) points out to the increased explanatory power of enhanced earnings in valuation of stock prices at the Jordanian Stock Exchange. This was achieved by the inclusion of unrealized gains and losses in earnings which have been compiled on the basis of historical cost accounting. The impact on the incremental explanatory power of accounting numbers was assessed.
- Accelerating of financial leverage
Zhang (2011) argues that fair value model has a ‘pro-cyclical’ nature, which makes vulnerability of reporting entities to financial crises even worse. The main reason focuses on the increase in financial leverage. Periods of booms in property leads to higher valuations and corresponding increases of investment assets values in balance sheets. It enhances the companies borrowing ability and helps ensure that covenants such as debt to equity to be met. However, during the downturn of the markets this mechanism works in reverse as demonstrated by the US sub-prime mortgage crisis of 2007. As the investment property and other assets lost a notable part of their value, many companies and banks were forced to mark these assets to low ‘current market prices’.
The last financial crisis of 2008 ignited by the sub-prime crisis of 2007 has put markets under tremendous pressure and required government bailouts. Of course it would be exaggeration to blame the accounting rules, but it could be reasonable to note that by facilitating excessive borrowing they facilitated this process.
4.3. IAS 40 International dimension
As discussed in the beginning of this paper, so called “path dependence” is an important phenomenon in accounting. Though many countries have adopted IFRS, at least de jure, de facto application remains not uniform and local legal, economical and cultural institutions continue to impact the accounting activity. Therefore it is useful to note how IFRS and IAS 40 in particular fare in different environments. Professor Suzuki argues that while the benefits of IFRS appear to be obvious in facilitating capital movement across borders, as the companies would like to compare ‘apples with apples’. But his argument goes on to say that though “at first sight, it seems like a no-brainer” (Milnes, 2010) it could turn out to be a “proverbial horse of another colour”. The main problem with it is that the method’s main objective is to assess the market value of a firm as if it’s going to be sold and not on “understanding the reality of local businesses”.
The following figure provides overview of three GAAPs: German, British and IFRS demonstrating key differences and preferences.
4.3.1 IAS 40 in the UK and Germany
As Collins (2012) explains, the UK GAAP is going to change and that the new “Financial Reporting Standard applicable in the UK and Republic of Ireland (FRS 102)” will be in force starting from 1 January 2015. This is done in order to bring UK GAAP closer to IFRS in respect of investment property. Prior to this change, there have been some considerable differences between the UK GAAP and the IFRS. One particular change in the new standard FRS 102 related to the investment property has caused some controversy among accountants. Many UK companies have investment property on their statement of financial position.
Under UK GAAP companies with investment properties on their balance sheets are directed to carry these assets “at their open market value. Any changes in market value are taken to the revaluation reserve within the statement of total recognised gains and losses, unless a deficit (or the reversal of a deficit) on an individual investment property is expected to be permanent” (Collins, 2012).
Under the new standard revaluation gain or loss arising out of changes in the fair value of investment property are recognized directly to income statement. However, it is necessary to note that the revaluation gain arising out of positive change in fair value of investment property “will not be a realised profit available for distribution to shareholders”. The proposed accounting approach brings UK GAAP in line with IFRS, in particular in relation to IAS 40 Investment Property. It has been explained that direct impact of revaluation gains or losses on profit and loss is attributable to the fact that under the business model for investment property it should not be depreciated. In contrast to previous practice, all revaluation gains or losses are booked in profit and loss for the period. Nevertheless, as Collins notes “many accountants appear to disagree with this treatment with some accusing the proposed treatment as destroying the function of the profit and loss account by reporting unrealised gains”.
As confirmed by empirical data in Christensen and Nikolaev (2014) fair value is more widely applied in the UK than Germany. Perhaps, this could be explained by traditional preferences of German companies for historical cost accounting.
- IAS 40 in emerging markets
While many argue that at least in developed countries fair value accounting is seen as superior measurement to historical cost accounting, the situation could be different in emerging markets with less-developed institutions (Al-Khadash and Khasawneh, 2014). The question remains whether the fair value accounting can be effectively adopted in these countries. As Chen and Chan (2009) posit “while the adoption of IFRS fair value accounting standards is highly desirable for emerging economies, the process of adopting and implementing these requirements is expected to be especially challenging for them because they lack many elements of a well-functioning capital market that are needed in order to adopt and implement fair value accounting successfully”.
In Al-Khadash and Khasawneh (2014) the additional challenges facing these economies are summarized as follows:
(1) absence of active and liquid markets for many assets and liabilities, which implies that fair value accounting would most likely be based on estimates which are subjective and may be unreliable;
(2) high cost in obtaining information, less transparency;
(3) the recognition of revaluation gains or losses arising from changes in fair valuesimply that unrealized profits or losses are recognized in earnings thereby making them highly volatile and unpredictable.
Chart 2: Dubai real estate index
Source: Reidin, 2010
It can be seen that during the construction boom in the years up to the latest financial crisis the property prices and fair value revaluations in Dubai increased dramatically in the run up to 2008 with a subsequent fall in the late 2008.
The research of Al-Khadash and Abdullatif (2009) looks into the recognition of gains or losses arising from changes in fair value of investment properties, in the earnings statement. The motivation behind the research has been the concern that the recognition of these unrealized gains and losses in the earnings may have adverse impact upon financial statements leading “to undue increases in earnings volatility and investor confusion”.
In line with Dubai and some other Gulf nations, Jordan saw rapid rise in the value of investment properties as a result of increased high demand in the years prior to 2008. The price index rose over 300% during the mentioned period for certain property. It follows, that the use of fair value accounting to measure the investment properties would have had considerable impact on the performance of many Jordanian firms. Taking a conservative stance, in 2007 Jordan’s Securities Commission issued a new regulations related to the accounting standards of fair value accounting , which specify that " all the listed companies should use the cost model when applying the IAS 40 , Investment Property, and should just disclose the fair value of investment property in the related illustration in the financial statements" (SEC, 2007, quoted in Al-Khadash and Khasawneh, 2014). This ruling directs all listed companies to use the cost model as the only alternative when accounting for investment property. This regulation of 2007 was a response to inflating of the income statements of many listed companies in Jordan due to recognizing unrealized capital gains and losses arising out of revaluation of their investment property during the boom in the run up to the financial crisis of 2008. Their research provides very interesting information regarding the effect of unrealized gains or losses in a booming emerging market. Specifically, it examines the impact of what would have happened if fair value accounting under IAS 40 were to be applied in the earnings and the Earnings Per Share (EPS) of the listed companies in Jordan. To this end, a specific ratio is defined and calculated based on the data from annual statement of the companies in the sample. It should be noted here that the requirements of IAS 40 provide a unique opportunities which made possible research like that. Though the companies report their earnings using cost method, IAS 40 requires them to disclose fair value of their investment property in the notes to the financial statements. Availing themselves of this opportunity, the researchers computed EPS twice, first time they added back unrealized gains or losses and the second time they calculated EPS excluding such unrealized gains or losses. Finally, the EPS ratio was defined as follows:
EPSiIPit: is the earning per share when earnings include unrealized gains or losses of valuing investment property at fair value for firm i during period t.
EPSeIPit: is the earning per share when earnings exclude unrealized gains or losses of valuing investment property at fair value for firm i during period t” (Al-Khadash and Khasawneh, 2014).
As Table 3 demonstrates, applying fair value accounting has a considerable impact on the reported financial indicators and in particular on the EPS. The EPS ratio as defined above exceeds 1 for the period prior to and including 2008. However it falls well below 1 in 2009 implying that unrealized gains would have inflated earning and brought considerable volatility in the accounting figures.
Though the research discusses and analyses outcome of the implementation of fair value measurement under the IAS 40 in Jordan, it would not be unlikely that similar effect could be the case in other emerging markets.
Though the following case study commented mainly on IAS 41 dealing with agriculture, it is very relevant for this paper, as IAS 41 along with IAS 40 were the first standards allowing fair value measurements for non-financial assets. This critique of fair value measurement can be applied to property valuation as well.
The research team led by professor Tomo Suzuki has looked into the effects of IFRS application in the Indian subcontinent and some other asian countries. After extensive research the team has come to the conclusion that fair value model could have an adverse impact upon the participants of the reporting process. It was posited that rather than applying IFRS, local companies performances could be better evaluated and understood within the frameworks of local accounting.
The following Chart 3 illustrates the point well. Studying the fair value application under the specific standard IAS 41, professor Suzuki has reviewed the statements of some large businesses in Indonesia that produce palm oil. Under IAS 41’s fair value accounting, the major part of the profit hits earnings in the year the trees are planted, whereas in actual fact they are expected to come in 30 years time, which is the palm oil tree life. Fair value model says implies that for the rest period only tiny profits will then be booked into the income statements.
Chart 3: Plantation profit cycle
During interviews the companies auditors confirmed that the fair value model, based on discounting future cash flows could lead to bizarre first year profits. Upon presentation of these key issues to the governments of that region, the response of an agricultural official was: “This is Enron Accounting for AgricultureThe only difference is that it was a scandal at that time; now it is mandatory”.
Hans Hoogervorst, the current chairman of IASB addressing fair value accounting in December 2013 said that the standard led to this “bizarre result” (Hoogervorst, 2013). But wider implication is that researchers, practitioners, standard setters and regulators, especially from the emerging counties should understand that fair accounting application is a cause of notable concern.
IAS 40 and fair value accounting in emerging markets
The empirical research of Al-Khadash and Khasawneh (2014) briefly outlined above could be of interest to the practitioners, researchers and standard setters such as FASB and IASB as well as regulating authorities, especially in the emerging markets. It deals with a very debatable issue of applying IAS 40 and in particular fair value accounting in an environment characterized by less developed institutions and volatile markets. The financial markets in many developing nations are to a greater degree vulnerable to volatility compared to more developed markets. This is because fair value accounting implies valuation in an environment which features a great deal of uncertainty and as can be seen from the Graph 1 at times the behavior of many traders may drive the markets away from fundamental values.
As stated by IASB chair Hoogervorst (2013) “the current value of many of their assets is not of primary importance if they are being used in combination with other assets to produce goods or services. In most situations for going concerns, the fair value of Plant, Property and Equipment, or PP&E is of limited relevance. For example, it is not extremely relevant for a car manufacturer (or its investors) to know the present market value of its robots if the company intends to keep them producing cars. Moreover, valuing PP&E at fair value would in many cases also be very costly and would possibly open the door to earnings management. “There was one aspect of the Standards where we agreed that fair value accounting could lead to counterintuitive results”. Therefore a recommendation could be not to enforce fair value accounting in emerging markets.
Careful implementation of fair value for non-financial assets due to higher costs and less reliability
Based on their research findings outlined above, Christensen and Nikolaev (2012) recommend that standard setters should be careful in applying fair value accounting for some asset classes, primary of non-financial nature. Their empirical evidence suggests, that for non-financial assets, the practitioners “choice between the two alternative valuation methods lies with historical cost accounting: firms’ managers, who represent outside stakeholders, generally reveal preferences for historical cost accounting for a broad range of non-financial assets” (p. 25). The evidence gathered indicates that managers’ unwillingness to apply fair value accounting could likely be caused by higher costs of valuation required by fair value model rather than by disagreeing with the standards per se. Hence, one conclusion is that “fair value regulation can impose costs on the economy” (p. 25). However, another conclusion is to revisit the application of fair value beyond financial assets, and in particular standards IAS 40 and IAS 41.
Convergence rather than adoption for developing countries
Taking notice of the Suzuki’s research into impact of fair value accounting on developing countries, India has taken a cautious approach. ‘Salman Khurshid, Minister of Corporate Affairs of India, is cautious about these new accounting standards,’ Suzuki says,‘because it’s just changing the mentality of business people, encouraging them to focus only on short-term profit.’ (Milnes, 2010). It is recommended by Suzuki that, rather than outright adoption of IFRS, emerging markets should take gradual approach of converging to ensure local interests and sustainable development are not adversely affected by seeking short term gains. One problem is that global institutions such as the United Nations Conference on Trade and Development the World Bank and IMF exercise coercive power into pushing developing nations into adoption of IFRS.
Strong and competent appraisal service is the key to success of IAS 40
Last years in the aftermath of the financial crisis of 2008-2009 have been challenging, and the continuing economic uncertainty weighs down over real estate markets all the world over.
In order to strengthen investors confidence it is necessary to ensure reliability of valuation, as a key issue in applying fair value accounting for investment property. As E&Y survey (2011) confirms, “there is an ongoing demand for higher quality valuations and increased transparency, particularly, in view of the sometimes significant differences between sales prices and property valuations and valuation differences between valuers”.
E&Y hopes that applying of both International Valuation Standards and IAS 40 mandated disclosure of key assumptions will help reduce valuation uncertainty.
Recognizing unrealized profits in reserves rather than profit and loss account
A lot of concern is related to recognition of unrealized profits directly in profit and loss account. This requirement of IAS 40 has met dissenting views of academics and practitioners.
Perhaps a compromise could be possible based on UK GAAP, whereby these profits though included in profit and loss, should not be available for distribution.
‘One size fitting all’ problem
As demonstrated above, despite adoption of IFRS, many nations continue to exhibit their traditional features in accounting and financial reporting. The question arises whether one set of standards can meet the needs of markets as diverse as UK, Germany, Russia and Dubai?
This is a very broad question which can not be answered at this stage. While IASB appears to press ahead with expanding IFRS across the world, academic world is divided on this issue.
Hopefully, future research would be in a position to provide a reply to this challenge.
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