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European Journal of Economics, Finance and Administrative Sciences

ISSN 1450-2275 Issue 16 (2009)


© EuroJournals, Inc. 2009
http://www.eurojournals.com

Cost or Fair Value: FTSE 100 Response to IFRS IAS 16’s


Choice on Treatment of Property, Plant, and Equipment and the
Implications for US Companies

Kevin A. Diehl
Western Illinois University
E-mail: KA-Diehl@wiu.edu

Abstract
This research has two important purposes. First, it seeks to educate government agencies
yet to adopt IFRS on whether allowing the choice between two methods in accounting for
property, plant, and equipment enhances reporting from the potential for greater relevance
in balance sheet numbers or diminishes reporting from the reduced quality of earnings
comparability. Second, it informs financial executives where IFRS IAS 16 is to be adopted
in full on what to elect as that decision should not be changed without good economic
reason. The research requires reviewing the discussion of accounting policies within
companies’ annual reports. The sample group of companies involves the members of the
UK’s FTSE 100. This market index is perhaps the most well regarded of those countries
that have already implemented IFRS and therein IAS 16. All publicly traded companies in
the EU had to report under IFRS for 2005 and thereafter. Based on IFRS’ quest to improve
the relevance of at least balance sheets, the expectation was that fair value would be the
most prevalent choice for property, plant, and equipment. However, this expectation is not
the reality as only 11 percent of the FTSE 100 decided on the fair value method. The next
question is then whether any industry utilizes fair value above this average. If any industry
would, it would be one where management already relies on fair value for its operations
and therein has experience with and understanding of fair value. Thus, the financial
industry becomes the logical choice for this inquiry. Within the FTSE 100, the 24 financial
industry companies adopted fair value at the rate of 33 percent. The rest of the FTSE 100
then utilized fair value for property, plant, and equipment at the rate of 4 percent.

Keywords: IFRS, IAS 16, Property, Plant, and Equipment, FTSE 100, Cost or Fair Value,
Financial Industry, Real Estate Industry

Introduction
On March 12, 2002, the European Parliament enacted authority requiring all EU publicly traded
companies to utilize International Financial Reporting Standards from 2005 and onward. Thus, for
annual reports issued on or after January 1, 2005, EU companies for the most part reported with IFRS.
As one reason the EU adopted IFRS, the International Organization of Securities
Commissioners has supported one set of accounting standards for all countries’ publicly traded
companies. The objective is to eliminate massive transaction costs currently necessary for revising
financial statement results to make them comparable.
During the pursuit of one global accounting set of standards, regulators and supporters have
also worked toward providing less formulaic rules in accounting choices in favor of reporting the true
66 European Journal of Economics, Finance and Administrative Sciences - Issue 16 (2009)

economic reality. In the process of eliminating choices based only on form, standard setters sought
greater comparability. As the primary example, IFRS eliminates last-in, first-out accounting for
inventory, which should increase comparability as this standard generally leaves one treatment for
inventory.
However, this quest for comparability seems to end on entering the area of accounting for
property, plant, and equipment where companies are allowed the choice of historical cost or fair value
accounting. The following discusses the background, hypotheses, methods, results, potential
implications for the US, and generally the future.

Background
IAS 16 provides the choice for subsequent measurement of property, plant, and equipment after initial
recognition at cost. The two choices are cost or fair value for that subsequent measurement. However,
without regard to the choice, that amount is less any accumulated depreciation (not including any land)
and impairment losses. For the fair value, it is less subsequent accumulated depreciation and
subsequent impairment losses.

Hypotheses
HA: Because fair value is considered more helpful to financial statement users, most companies
will utilize the revaluation method to account for property, plant, and equipment.
HB: Because they have more experience with and therein potentially better understand the
importance of fair value accounting to financial statement users, almost all financial and
real estate companies will utilize the revaluation method to account for property, plant, and
equipment.

Methods
HA: FTSE 100 companies’ accounting policy disclosures within their annual reports are
reviewed to determine if they follow the IAS 16 revaluation method in accounting for
property, plant, and equipment. Here, the formula to ascertain the percentage of companies
involves the number of companies that follow that method over the total number of
companies in the FTSE 100.
HB: FTSE 100 financial and real estate companies’ accounting policy disclosures within their
annual reports are reviewed to determine if the IAS 16 revaluation method is utilized. Here,
the formula to ascertain the percentage of companies in these industries involves the
number of companies within those industries that utilize that method over the total number
of companies within those industries.

Results
HA: 11 percent of FTSE 100 companies utilize the revaluation method under IAS 16.
HB: 33 percent of the 24 FTSE 100 companies in the financial and real estate areas utilize the
revaluation method under IAS 16.
Only 4 percent of the other FTSE 100 companies utilize the revaluation method under IAS 16.
67 European Journal of Economics, Finance and Administrative Sciences - Issue 16 (2009)
Table 1: FTSE 100: Choice of Cost (C) or Fair Value (FV) for Property, Plant, and Equipment

Group FV Cairn C Johnson Matthey C Rolls Royce C


AB Foods C Capita C Kazakhmys C Royal Scotland C
Admiral C Carnival C Kingfisher C RSA Insurance FV
Alliance FV Centrica C Land Securities C Sabmiller C
AMEC C Cobham C Legal & General C Sage Group C
Amlin C Compass C Liberty Int. C Sainsbury C
Anglo Am. C Diageo C Lloyds C Schroders C
Antofagasta C Drax C London Stock Ex. C Scottish South. C
Astra. C Eurasian C Lonmin C Serco Group C
Autonomy C Experian C Man Group C Severn Trent C
Aviva FV F & C Inv. C Marks & Spencer C Shire C
BAE Sys. C Fresnillo C Morrison C Smith Nephew C
Balfour C Friends FV Smiths Group C
Barclays C G4S C Next C Standard Chart. C
BG Group C Glaxo C Old Mutual FV Standard Life FV
Billiton C Hammerson FV Pearson C Tesco C
BP C H. Retail C Pennon Group C Thomas C
British Air. C HSBC C Petrofac C Reuters C
ICAP C Prudential C TUI Travel C
Brit. Land FV Randgold Res. C Tullow Oil C
Sky Broad. C Inmarsat FV Royal Dutch Shell C Unilever C
BT Group C Inter Hotels C Reckitt Benckiser FV United Utilities C
Bunzl C Intertek C Reed Elsevier C
C&W C Int. Power C Rexam C Vodafone C
Cadbury C Invensys C Rio Tinto C WTB C
Wolseley C
WP. C
Xstrata C

Table 2: FTSE 100 Financial and Real Estate Companies: Choice of Cost (C) or Fair Value (FV)

Admiral Nonlife insurance C Legal & Gen. Life insurance C


Alliance Equity investments FV Liberty Int. Retail REITs C
Amlin Property & casualty C Lloyds Financial C
Aviva Life insurance FV London Ex. Investment serv. C
Barclays Financial C Man Group Asset managers C
British Land Retail REITs FV Old Mutual Life insurance FV
F & C Inv. Equity investments C Prudential Life insurance C
Friends Life insurance FV Royal Scotland Financial C
Hammerson Retail REITs FV RSA Insurance Full line ins. FV
HSBC Financial C Schroders Asset managers C
ICAP Investment services C Standard Chart. Financial C
Land Indus. & office REITs C Standard Life Life insurance FV

Implications
Because not many companies with potentially more experience in dealing with fair value in more areas
of reporting adopted the fair value method for property, plant, and equipment, the IASB should
consider eliminating that choice. Doing so would enhance comparability for property, plant, and
equipment that now could be in doubt.
Also, governments considering IFRS implementation should review whether allowing this
election provides more benefits through relevance than costs through decreased comparability and
greater expenses involved in the fair value method.
The fair value method has greater relevance as it provides more current numbers for property,
plant, and equipment than the cost method does. However, the fair value method also requires more
expenses than the cost method to get those numbers.
68 European Journal of Economics, Finance and Administrative Sciences - Issue 16 (2009)

UK companies have somewhat more experience with utilizing fair values in more areas of
reporting. However, only 11 percent of the FTSE 100 selected the fair value method for property,
plant, and equipment. This situation could show that the costs of the fair value method are greater than
its benefits. Companies in countries ready to implement IFRS should consider this fact in making the
choice between fair value and cost especially because this choice is made at the moment of
implementing IFRS and should not be changed without good economic reason.
After acknowledging this fair value choice trend, companies should also consider their industry.
If they are in the financial and real estate industries, then resorting to the fair value method could
become an even better option. 33 percent of UK FTSE 100 companies did adopt the fair value method
for property, plant, and equipment.

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