Tag Archive | Financial Accounting

Fair value accounting – a brief summary

I read an article from the Guardian  website last January, where a Bank of England official was suggesting that banks need to have separate accounting standards from other types of business. Some of the concerns mentioned were around the notion of fair value. This an extremely complex area, but I’ll try to summarise it here.

The basic idea of fair value is that certain types of assets and liabilities should be measured in the financial statements at a value which reflects what they could be sold for or settled for. In the main, the types of assets/liabilities concerned are referred to as financial instruments – e.g. debt, equities. There are two complex accounting standards which deal with how such instruments are measured according to fair value. IFRS 9  defines the what happens to the difference arising on fair value adjustment. Without going into too much detail, the fair value adjustment goes through the income statement/profit & loss account.  As mentioned in the Guardian article, this is normally fine when markets are causing the value of the assets to increase, but it perhaps less popular when markets are falling. And, of course there is the problem of ascertaining what exactly is “fair value”. IFRS13 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”. It also describes a hierarchy of how to measure fair value and outlines detailed disclosures which must be made in the financial statements. Of course, all this presupposes there is a reasonable way to ascertain fair value based on a market price or equivalent market price. And, as we know from recent years, there have been plenty of media reports about the complex nature of some financial instruments. I’m sure the debate on whether or not fair value is right for the banking sector will continue.

Single entry accounting

Elsewhere on my blog, I have written a post of the basics of the double entry accounting system. I had a comment on this post asking for some more information on single entry accounting – so here it is.

The basic idea of the double entry accounting system is that information is recorded twice. The system allows any business or organisation to get a picture of its incomes, expenditures, assets, liabilities and capital at any point in time. The double entry system is encoded into all accounting software and is the basis of all financial reports of businesses.

In the double entry system, any transaction is recorded from its source all the way through to the financial statements. For example, if a supplier is paid the following happens:

  • the cheque is recorded in a “day book” – normally a cash/cheque payments book
  • the suppliers balance is updated – in a personal ledger account
  • the bank balance is updated
  • by virtue of the previous two items, the assets (bank) and liabilities (trade payables) are updated
  • the financial statements (income statement and balance sheet) are updated.

In a single entry system, some of the above is not done. The best way to explain this is by an example. When I worked in small accounting firm some years ago, most sole traders kept what were single entry records. At that time (the early 1990’s) most small sole traders kept records in a manual form –  most had no computer anyway. The records would typically comprise  a book where all purchases/expenses were recorded, a book where all payment in and out of the bank were recorded and a book where all sales were recorded. Records of things like assets – how much was owed by customers or records of vehicles for example – and liabilities – how much was owed to suppliers for example – were not kept. Using these books, it is only possible to prepare an income statement. Thus, as the double entry system is not applied in full, i.e. transactions are not recorded through ledgers in this example, then the single entry system applies.

It is not possible to say that the single entry system means that only certain specific records are kept. It’s probably better to think of the single entry system of accounting as one which does not fully use the principles of double entry, but does allow profit to be calculated. In the example above, what we did was to build up a list of the assets and liabilities, as well as the capital of the business, to allow us to prepare an income statement (profit and loss account) and statement of financial position (balance sheet).

Fuzzy Accounting Enriches Groupon

You may have heard about Groupon going public. Seems some creative accounting is going on. Read the full article from the New York Times here
Fuzzy Accounting Enriches Groupon – NYTimes.com.

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