A Fairwell to History

As historical cost accounting gives way to fair value, Europe's CFOs are bracing for turbulent times.

The countdown is on. The deadline for all EU-listed companies to adopt International Financial Reporting Standards (IFRS) — including controversial IAS 39 — is just around the corner. For the investor community seeking comparability of financial reports, that’s good news. But for many CFOs that will mean grappling with one of the most contentious issues in accounting today — fair value.

Of course, banks and other financial institutions have found themselves squarely at the centre of the fair value debate thanks to IAS 39, which requires them to record a range of financial instruments such as derivatives and bonds at fair value on the balance sheet. Any changes in the value of those instruments must then be fed through a company’s income statement, or else shown in shareholders’ equity, depending on the instrument. The impact could be big, particularly given that, up until now, many financial assets and liabilities have been held at historical cost rather than fair value, or else not recorded on the balance sheet at all.

But other types of companies besides banks are likely to feel the growing influence of fair-value accounting in the years ahead. Take IAS 40 for investment properties. Although this standard gives real-estate developers the choice of recording their assets at historical cost, in reality it requires them to adopt a fair-value approach, with gains and losses recorded in the income statement or shown in the notes. Then there’s IFRS 3 for business combinations, which prohibits “pooling of interest” accounting. The rule states that acquiring companies must measure the fair value of all acquired assets, including contingent liabilities, and the fair value of the amount paid, including equity, with the difference recorded as goodwill. IFRS 2 for share-based payments is a further example. The fair value of all employee stock options, for example, must now be determined at the grant date and expensed over the vesting period of the option. And so the list goes on. (See “Blast the Past” at the end of this article.) Indeed, the impact on the entire financial reporting “value chain” — from CFOs to auditors to investors and regulators — threatens to be far-reaching.

Marching Headlong

Martin Cubbon, group finance director of Hong Kong-based Swire Pacific, notes: “Fair value isn’t just creeping into accounting, it’s marching headlong. It seems to be the avowed intent of the IASB to pretty much standardise on fair value.”

At Swire, a HK$17.6 billion ($2.26 billion) conglomerate that owns a large real-estate business, as well as 46 percent of Cathay Pacific Airways and other businesses, the introduction of IAS 40 for investment properties is set to have a major impact. With Hong Kong having adopted the standard effective in 2005, any changes in the value of the company’s property portfolio will impact the profits of the whole group. In the past decade, annual swings in the value of the company’s investment properties have been as high as HK$9 billion, a figure that would wipe out profits entirely in some years, while doubling them in others.

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