On relief value (deprival value) versus fair value measurement for contract liabilities: a comment and a response

Abstract

Horton, Macve and Serafeim (2011) (HMS) argue for the use of relief value for the measurement of certain types of liabilities, and that the replacement liability (an entry price) is normally the appropriate measure of relief. I had previously argued elsewhere for an exit price (normally, the performance value, PV). In this paper, I first try to clarify the terminology used, and then I show why PV rather than RL is usually appropriate for the industries in HMS' example and for some others. My scope is more modest than that of HMS because I do not address revenue/profit issues, which I think should be dealt with separately.

Keywords:

• deprival value
• exit value
• fair value
• liabilities
• relief value

Notes

See HMS section 3.1, where they note that the transaction costs would make RL lower and NTV higher.

Lennard (2002, p. 7) says: ‘So typically we would expect consideration received to be the relevant measure for a liability, just as replacement cost is for an asset’. Note that he says ‘consideration received’ not ‘current consideration’ or ‘replacement consideration’; and the whole drift of pages 6 and 7 is about historical consideration, as is the conclusion (p. 10) that his recommendation is ‘consistent with prevailing practice’.

As endnote 1.

As endnote 1.

Under IFRS 13 (paras. 24 and 25), fair value is an exit price but without adjustment for transaction costs.

This would be more likely when price changes are introduced, which had not been done at this stage of the HMS paper.

In his Appendix B, Lennard notes problems with the use of current entry values, and supports historical consideration on pragmatic grounds.

At one point (section 2) HMS refer to the RV being the deferred revenue, but this is in an introductory paragraph before price changes are considered, and the expression is not used later.

This is the exit value that a rational entity would pursue, i.e. the higher of net realisable value and value in use (discounted cash flows).

For example, under IAS 11, for a contract expected to make a loss.

See the wry discussion in HMS (section 1) on this adjective.

Annual Report 2010, p. 11.

HMS, in a note to me of 28.7.2011, raise many interesting issues for the analysis of Pomair, e.g. whether the unit of account should be the flight rather than the seat. Nevertheless, they come to similar conclusions to mine.

Admittedly, there is some confusion in IAS 37 between cost of release (para. 36) and cost to perform (para. 45), but in practice cost to perform is used.

Baxter (1971, chapter 9) analyses deferred tax on capital allowances, etc. as a valuation adjustment to the deprival value of assets rather than as a liability.

Relevance was discussed earlier. It is used by HMS and by me for selecting a measurement basis. It relates to what a rational entity would do.

For example, HMS include risk-bearing as well as interest. Geoffrey Whittington has also suggested to me that one needs to take account of risk and normal profit.

HMS do not think it is optimality that is the issue but the nature of some ‘unique and one-off’ type contracts that they have not yet analysed and where it is not just revenue recognition but also commitment to future cost that is at issue (note from HMS to me on 28.7.2011).

For example, in the impairment standards in US GAAP (as introduced by SFAS 121), and as a ‘Level 3’ basis in IFRS 13.