Strategy must drive 'Value' in IFRS financial statements.

• Author: Lopater, Claude
• Position: Global Views - International Financial Reporting Standards

International Financial Reporting Standards (IFRS), which will be mandatory for European Union (EU)-listed, Australian and Russian companies beginning in 2005, require entities to shift away from the "historical cost" method of valuing their assets to the "fair value" approach. Here is a look at the implications of this change, and how a company's business strategy will affect its choice of how to measure fair value.

IFRS makes constant reference to value: recoverable value, residual value, fair value, useful value. Entities are required to evaluate, for all assets, the future economic benefit that justifies the value attributed to it. They must establish cash flow projections and make assumptions about interest rates and other future events.

In the past, the basis of comparability was historical cost. Now, comparability depends not just on what was paid for assets, but what assumptions management makes about the future. Fair value of assets is thought to have the best predictive value.

All choices of value are wagers on the future. What does the wager rest on? What strategic vision and economic model? It is impossible to separate the "fair values" recorded by an entity from the entity's strategy. This requires more than interpreting the accounting rules; an entity must be transparent about what it intends to do in the future.

Choices and Assumptions

Fair values recorded in IFRS financial statements require an entity to make certain choices and assumptions, The key issues are:

1. Economic benefit. An asset is defined as a resource controlled by the entity that holds future economic benefits. The economic benefit linked to the asset corresponds to the potential that the asset has in contributing, directly or indirectly, to positive cash flows. Entities must, therefore, analyze the economic benefits in assets. For example:

   - what are they?

   - how should they be measured?

   - what information about them should be disclosed in the notes to the financial statements?

   - what indicators will be used to assess the benefits?

2. Identification of cash-generating units (CGUs). A CGU is the smallest group of assets that generates independent cash flows. They must be tested for impairment annually. The CGUs identified when IFRS is adopted will be the basis for impairment testing on a continuing basis. The identification of CGUs must be consistent with the company's strategic direction.

3. Cash flow projections. Impairment is tested using "value in use," driven...