Further, financial statements that are prepared in accordance with International Financial Reporting Standards use fair market value in the preparation of financial statements. Generally, international accounting standards permit the revaluation of property, plant and equity. This means that the buildings, land, equipment and other large value items are restated using the fair market value at the time of preparation of financial statements. The derivatives are measured using fair market value.
Derivatives are financial instruments that derive their value from the movement in commodity prices, foreign exchange rate and interest rates of an asset or financial instrument. Derivative contracts are described as paying a small percentage of the total amount of the asset that will be bought at a later date. This down payment means that the buyer promises to pay for the entire contract price when the maturity date arrives. However, the investor of derivatives is generally not interested to waiting for the maturity date. The derivative buyer wants to make a profit by selling the derivative at a higher price.
The hedging of such derivatives is also recorded using fair market value. The change in the fair market values of the derivatives is recorded as recognized profits and loses. The examples of derivatives that are good hedge alternatives are interest rate swap, forward contract, futures contract, option and foreign currency forward contract. On the other hand, the non –IFRS influenced financial statements do no require that the derivatives should use fair market value in the preparation of financial statements (Toporowski 2000, 12).
Also, financial statements that are prepared in accordance with International Financial Reporting Standards are more relevant. IFRS standard where the financial statements makes it compulsory for companies to present the balance, income statement and statement of cash flows using the fair market value approach makes the financial reports relevant. For, the fair value amounts of the financial statement items will surely make a difference in term of decision making. For, the fair market valued financial statements relevantly will influence the decision makers to invest more money in the business.
Also, the fair market value of the financial statements showing that the company has not been doing good for the past year or years of operation will relevantly aid the financial statement users to choose to withdraw their remaining investments in a company that has been losing money for the current accounting period as well as the prior accounting years (Culp 2001, 24). For, the fair market value of the items listed in the financial statements will make the economic decisions relevant.
The fair market value is very important in arriving at the earnings fair share information. The assets presented that do not use the IFRS standard of preparing financial statements where the fair market value is used would be presenting information that does not bear on the decision making activity of the stockholder, manager, customer, creditor, supplier or other very interested parties. For, example the fair market value of the assets, liabilities and shareholders’ equity is very relevant for a company that is closing down.
Relevantly, a or group of person will need the latest derivatives figures, also known as fair market values, that the stock market issues in every stock market session to decide whether to invest in more derivatives like the European dollar or to invest in gold. This same person or a company of persons will need the latest market values, also known as fair market value, sell his or her current derivative holdings (Adams, and Runkle 2000, 595). Whereas, using historical cost in the preparation of financial statements would be objective because it does not change as the years move on. For example, the accounts receivable of 100 from sale to a customer five years ago will still be the same amount of 100.
This is beneficial to both the creditor and the debtor. In the same manner, a loan of 1,000 three years ago because the company bought an office table would be the same amount of ? 1,000 today. This will benefit both the creditor and the customer. Another example is that expenses paid for renting an office two years ago amounting to ? 1,000 and recorded in the financial statements would still remain as ? 1,000 today. This accounting method is advantageous to both the rent payer and the rent payment receiver (Minehan, and Simons 1995).