The effect of using fair value accounting on fundamental analysis: Some evidence from the emerging economies

Abstract

The objective of this paper is to examine the effect of the use of the fair value model under IAS 40 of accounting for an investment property on the fundamental analysis of Barwa Company, a real estate developer company listed in Qatar Exchange. This examination of effect concentrates on whether or not this choice will have an impact on the fundamental financial analysis of the company and consequently on investors' decision-making. The research methodology depends on selecting balance sheet and income statement items that are affected by the adoption, then restating them by adjusting for the revaluation gain or loss recognized and comparing them to the original values. Profitability and financial market ratios are utilized to examine the impact on the accounting numbers. Ratios are calculated over 17 consecutive quarters from Q1-2007 to Q1-2011. The study finds that while the choice of the fair value model results in a small impact on balance sheet items, the effect on income statement items seemed to be significant. Among the accounting numbers affected, net income remains to have suffered the highest impact. Furthermore, all accounting ratios were affected by the choice. The ratios used are those of profitability and market value including profit margin ratio, the cost to income ratio, return on assets, return on equity, price/book value ratio and earnings per share. Interestingly, upward and downward market corrections for the company⁉s share price were not associated with the company's recognition of fair value revaluation gains or losses. This suggests that the share price of the company may not be driven by the company specific characteristics, rather by different market factors. The study contributes to the literature by examining the effect of the adoption of fair value rules in IFRS on the financial information as the study documents the direct effect of the use of the fair value model in IAS 40 on accounting figures in general and reported net profit or loss in particular. Moreover, looking at Fair Value Model (FVM) from the firm fundamental perspective is important for both standard setters and shareholders. For standard setters, the results of such inquiry help to verify whether the standard on fair value reached its goal of providing the capital markets with relevant and reliable accounting information that mitigates the information gap between the firm and outsiders. For shareholders, FVM is important from both investment and contracting reasons. From an investment perspective, IAS40 has an impact on the last line of the income statement, and shareholder decision on whether to buy, hold or sell, depends mostly on the informativeness of firm reported earnings. Second, FVM has an impact on the contractual arrangements with both managers and creditors.