IFRS (International Financial Reporting Standards) are used world widely, especially within the European Union and Australia. It is a multinational language in the world of business, more specifically in the sector of accounting. IFRS has revised the conceptual framework that the International Accounting Standard Board has issued. The purpose of the framework is to make sure that the lenders, investors and other creditors would receive useful information. In addition, it also gives the accountants a consistent financial model, when no Standards is applied. All of the IFRS standards are interesting to discuss, however today we are going to examine IFRS 13 – Fair Trade.
It has been defined 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 (an exit price).” () In other words, IFRS 13 is designed to explain how fair value is set where as IFRS 9 is proposed to guide when fair value is set. Fair value is market-based measurement but not entity-based measurement, which means it would take market conditions into account. Most of the entity nowadays choose to use fair value measurement instead of the historical cost measurement. As an example, Moët Hennessy Louis Vuitton (LVMH), is a French entity which uses the IFRS standards.
LVMH is one of the world’s biggest luxury product groups, which assembles 75 world-wide significant brands. The Group is divided into five different sectors: Wines and Spirits; Fashion and Leather goods; Perfumes and cosmetics; Watches and Jewellery; Selective Retailing. According to the revenue table established by the entity, in December 31, 2018 the sector ‘Fashion and Leather goods’ had the highest revenue (18,455 million EUR) which takes up to 39% of the total revenue; whereas ‘Watches and Jewellery’ had the lowest (4,123 million EUR) – 9% of the total revenue. In total, the Group made 31,201 million EUR revenue in 2018, which is a 12% increase compared to the previous year. In the year the largest portion of the revenue, 29 percent, comes from Asia (excluding Japan).
LVMH first started to use the IFRS since the analysis of the year 2004. The group has been analysing the past occurred events using IFRS 9 since January 1, 2016. In the year of 2018, the value of non-current asset increased by 2 billion euros, it is also signifying 68% of the total assets. The main change after applying the method is the recognition of the cost of Land, Property and Equipment (hedging), and in addition the fair value when the asset is for sale. According to the note 1.9 of the consolidation of financial statements, there are many assets and liabilities which are measured at fair value basis.
Property, plant and equipment (PP&E) are important factors for a company. They usually last for more than one year, therefore they are categorised as non-current assets. Referring to IAS 16, PP&E are measured at cost, initially. For LVMH, most of the PP&Es are stated at acquisition cost. The equity owns a number of assets in the statement of property, plant and equipment, they are land, buildings, investment properties, leasehold improvements, machinery and equipment, assets in progress and vineyard land and producing vineyards. Except for vineyard land, all other assets are defined at acquisition cost. It is officially published that vineyard land is recognized at the fair value on the balance sheet. If a variance is observed compared to the historical costs, it would be known as “Revaluation reserves”.
In addition to the vineyards, assuming the fair value falls under the acquisition costs, the subsequent loss is added to the income statement. In addition to vineyard lands, leases acquiring assets of the Group are measured when the market value is at low rate. It is also based on the future net present value of the payments. One thing that is shown on the property, plant and equipment table is ‘Buildings’. Similar to most companies in the U.K., buildings are categorised as investment properties (), thus it is capitalized at cost not fair value. As buildings are longer term non-current assets, it has been clarified that the useful life of the asset is 20 to 50 years and is depreciated at straight line basis. In my view, entities like LVMH would hold their PP&E for long use since they are making large benefits using them.
For this sector, LVMH group vineyard land together with assets acquired by financial leases were analysed by market value. One of the reasons why the Group have used the measurement is that it specifies an accurate appraisal for the assets. It gives the accountants and managers an exact direction of where they position in the market. On the other hand, since PPE takes a large portion in the non-current asset (26,323 million EUR), big decrease to the value would cause the company serious problems. It is hard to say that the assets would always have consistent or growing value. Therefore, if one year the market value of the asset drops under its historical number, there would be a loss in its net profit. Even though the chance of paying over the market value is not as high, since the economic growth is steadily growing; it is been concerned about the risk.
Inventories takes a large portion in a company’s asset value; they are finished good produced in the production process. According to IAS 2, inventories are realized at lower of cost or net realisable value and not allowed for fair value. It is to say, companies choose to sell its inventories at the lowest cost, given the choice of original cost and market cost. LVHM group implies that most of its inventories and work in progress follow IAS 2, which measures at lower of its costs and net realizable value; the costs include manufacturing costs and raw material purchasing. Similar to Property, plant and equipment, the sector ‘Wine and Spirit’ chose to use the fair value basis.
The reason why market value is used specifically for wine is that the production requires grapes for its raw material; more like purchasing from third parties. Even though harvesting grapes refers to agricultural land, it still does not belong to PP&E in the balance sheet, as they are biological assets. Measuring the cost of grapes is just like going to grocery shopping, you would find out that ingredients such as eggs would vary its price occasionally. This might due to environmental factors, high competitiveness in the market, etc. Therefore, fair value measurements must be used for producing wine. In the case of champagne and spirits production, it is a long manufacturing process, since they can only be sold after at least one year of holding; thus, they are categorised as current asset.
By comparing the use of the two methods of cost measurement used for inventories and work in progress, both of them have their own benefit. The reason why ‘Wine’ differs from other assets is that it a biological asset which requires harvest agriculture production. With accordance with IAS 41 ‘Agriculture’, biological assets are measured at fair value less estimated cost. As it is measured at fair value, it values the cost produced at the time. Referring back to the example of eggs, the change of fair value depends on the physical changes of the production.
This is an unstable situation for cost measurement, considering that the asset is a living thing, some conditions might be unpredictable. It has been suggested to request an investment property valuation method to make sure the cost of the market; in case the inventory is not over-valued and influence the profit. One problem the company would face when using fair value is the disappointment of the investors. Since many of the investors may not take into account the method of valuation, they would be unhappy with the loss on the net income. As a result, the investors might no-longer work together with the company.
Intangible assets are ‘abstract’ assets which does not involve physical substance. As reported by IAS 38, intangible assets are measured at cost initially as well as subsequently. These assets must be organized by an entity being a result of past events and forthcoming economic benefits are expected to flow from this asset. In order to recognize intangible assets in the statement of financial position, there are two conditions that it must be net: it is probable that the future economic benefits attributable to the asset will flow to the entity; the cost of an asset must be reliably measurable. The main intangible assets for LVMH are its brands and trade names.