Forensics Journal - Stevenson University 2014

FORENSICS JOURNAL Is Fair Value Accounting a Fraud Risk? Courtney Moore to sell the asset in the market. Similarly, the company is also required to assess whether there is evidence of impairment for any of their financial assets, such as an estimated decrease in estimated cash flow from the asset. If so, the asset must be devalued to the extent of the lost value (Wells). Subsequently, the accumulated depreciation can be restated in two ways: (1) restate the amount of accumulated depreciation to the change in the fair value of the assets or (2) eliminate to the extent of the increase in fair market value (Wells). INTRODUCTION The Association of Certified Fraud Examiners (ACFE) defines financial statement fraud as “[an act] in which an employee intentionally causes a misstatement or omission of material information in the organization’s financial reports (e.g., recording fictitious revenues, understating reported expenses or artificially inflating reported assets)” (Association of Certified Fraud Examiners). According to the ACFE’s 2012 report, financial statement fraud cases comprised only 8% of the cases in 2012, but caused the greatest median loss of all types of occupational fraud considered at an average loss of 1 million dollars per case (Association of Certified Fraud Examiners). Financial statement fraud is so costly because investors rely on financial statements to make important financial decisions. Therefore, accounting standards must be stringent enough to eliminate loopholes that companies use to distort their financial statements. While both methods still depreciate the asset’s value over its useful life, the fair value method requires obtaining an updated value for the asset. Both International Accounting Standards and United States Accounting Standards set forth three levels of hierarchy on which fair value can be determined with highest priority given to the highestlevel inputs (International Accounting Standards Board 72). The IASB explains, “Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date” (International Accounting Standards Board 76). If an asset has an active market, like most publicly traded stocks do, the asset should be valued at such. Nevertheless, not all assets have a readily active market to value their assets in, and if no active market exists for that specific asset, the fair market value of a similar asset that can be readily traded in an active market will suffice under a Level 2 input (International Accounting Standards Board 81). Lastly, if the asset cannot be valued at either of the previous two levels, an entity can estimate the asset’s fair value using an alternate valuation technique such as a Level 3 input (International Accounting Standards Board 86). When addressing Level 3 inputs, IFRS sets forth a general rule that the value reflected must reasonably reflect what amount could be expected for the asset if sold (International Accounting Standards Board 87-89). The widespread application of fair value accounting principles has become a controversial topic because critics claim that fair value accounting contributed to the recent financial crisis (Centre for Economic Policy Research). While fair value standards may offer a more accurate picture of what a company’s assets are worth, applying the concepts identified by U.S. accounting standards and international accounting standards can be difficult. By examining the current laws and valuation methods in place for both international and U.S. accounting standards and the nature of financial statement fraud, it can be determined whether implementing fair value standards further would leave companies at risk for improper asset valuation. VALUATION OF FIXED ASSETS The two common measurements for fixed assets are historical cost and fair value. While International Accounting Standards (IAS) allows companies to choose between historical cost and fair value when valuing fixed assets, U.S. principles require that companies report their assets at historical cost. The International Accounting Standards Board (IASB) states that historical cost values fixed assets at “the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire the asset at the time of its acquisition” (“International Financial Reporting Standards”). The asset, when first purchased, is valued at the consideration the company paid to acquire it. Over time, a portion of the asset will be expensed and by the end of its estimated life, will have a value of zero. Most concerns have been expressed about valuing assets with no active market due to the recent financial crisis (KPMG). Critics of fair value accounting believe that during the financial crisis, fair value accounting inflated the value of assets to reflect a market value that was not appropriate due to the long-term nature of the assets held (Centre for Economic Policy Research). The general principles described give broad guidance to accountants, but the IASB also recognized the profession’s need for further guidance in this area. IFRS RECENT REGULATIONS Internationally Accepted Accounting Principles include IFRS 13, which was enacted to provide more clarity to companies on how to apply fair value principles to fixed assets. According to the international accounting firm KPMG, the standard does not introduce any new requirements for financial reporting. Instead, it provides more guidance on how the principles defined earlier can be applied, and addresses the detail that companies must provide for disclosures pertaining to the accounting methods used to value these assets (KPMG). Fair Market Value Accounting does not value an asset at its original cost. Instead, the asset is periodically revalued to reflect what the entity could receive if the asset were sold. Un \

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