An analysis of the extent and use of fair value by JSE Top 40 companies

Abstract

Fair value’s advantages, disadvantages and ideology have been debated thoroughly by academics and practitioners for decades. The few implementation papers which do exist are primarily concerned with developed economies. This gap is despite the prior literature acknowledging the likely difficulties of fair value use by less developed markets and economies. This paper contributes to addressing this gap by providing an analysis of the extent and use of fair value by Johannesburg Stock Exchange (JSE) Top 40 companies for the period 2013–2017.

This paper finds limited use of fair value by JSE Top 40 companies. On average, only 184 assets and liabilities make use of fair value each year and this has not changed significantly over time. Most fair value use is by the financial services industry (41%) and for financial instruments (80%). Critically, only 28% of all financial elements made use of Level 1 inputs, and only 15% were classified overall as Level 1 inputs. The findings suggest Level 1 inputs are not widely available for financial elements and are rarely available for non-financial assets. When fair values are used for non-financial assets, this is mainly for investment property, commodity-inventories and impairment tests.

Because of the reliance on Level 2 and 3 inputs, the results suggest fair value is a costly measurement basis to implement in South Africa and frequently requires management judgement. The consequence is that many fair values are susceptible to bias and manipulation.

Keywords:

• Fair value
• JSE, South Africa, IFRS 13
• measurement models
• IFRS

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 Mark-to-model techniques relating to fair values are estimated using non-observable inputs in valuation models (Haswell & Evans, 2018).

2 A technical analysis of IFRS 13 and its prescriptions is beyond the scope of this paper.

3 The terms originally used were floating (current) and permanent (non-current) assets.

4 Current value is similar to fair value.

5 The FASB (and the IASB through the convergence project) considered this concept during the development of their revenue standard. The question of what gives rise to revenue considered whether the finalisation of a contract or its execution earned revenue. The IASB concluded that the satisfaction of promises is what gives rise to revenue and not entering into favourable contracts (King, 2005).

6 Authors have noted the standard setter’s apparent push to keep and extend the use of FVA. This is supported by the increased number of assets and liabilities which may be measured at fair value despite its insignificant use for non-financial assets and liabilities (Christensen & Nikolaev, 2009) and its flaws (Penman, 2007; Ravenscroft & Williams, 2009; Haswell & Evans, 2018). There are, however, still many academics and standard setters in favour of FVA (Benston, 1982; Barlev & Haddad, 2003; Benston, 2006; Whittington, 2008; Zhang & Andrew, 2014; Hoogervorst, 2015).

7 Strong-, semi-strong- and weak-form efficient markets are classifications based on how well information is impounded into market prices. Strong-form efficient markets impound all information (public and private) into market prices almost instantaneously. Weak-form efficient markets only impound past price information into the current market prices (Fama, 1970; Milburn, 2008).

8 Although the same argument can be levelled against HCA where useful lives, residual values and depreciation/amortisation methods can also be manipulated by management.

9 Level 3 is the lowest level.

10 As the IASB define fair value as a market perspective value, it is argued that requiring management to estimate a fair value contradicts the IASB’s position on fair value.

11 Where an asset is revalued, it must be revalued to its fair value.

12 Financial instruments often require fair value at least at initial recognition and for two subsequent measurement models (i.e., fair value through profit or loss and fair value through other comprehensive income (IFRS 9).

13 Impairment tests require an entity to determine the recoverable amount, which is defined as the higher of the assets fair value less costs to sell and its value in use.

14 This does not necessarily mean that the companies applied fair value as the element’s accounting policy. This includes cases where fair value was used in, for example, impairment testing.

15 Note: as the JSE Top 40 does not represent an equal sample of companies from all sectors; this should be interpreted with caution.

16 Pure in that the element’s fair value was determined with reference to only 1 input level (See Section 3).

17 Refer to Table 1c.

18 Cases refers to the number of assets. As each asset may include more than one input, the input levels in aggregate exceed the number of cases.

19 452 of 770 financial elements

20 This balance of allowing alternatives must be carefully considered against the IASB’s original reason for being developed: comparability. For more on comparability and users of financial statements, see Durocher and Gendron (2011) and Barth (2013).

21 227 of 372

22 109 of 372

23 18 of (918-372)

24 This relates to the number of inputs. One asset or liability may have utilised more than one level input. Therefore, this figure is greater than the number of elements.