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Fair Value Reporting Advantages and Disadvantages

Discuss the pros and cons of fair value reporting for investors? Why has this trend emerged, and how does asset value volatility seen during and since the Global Financial Crisis effect your views on this?
There have been many debates in previous decades amongst the investors, users of the financial statements, on whether fair value accounting is worth being used. According to IFRS 13, fair value is “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” (ACCA, 2016). Usage of fair value has advantages, however, it has disadvantages as well. This essay will discuss how fair value is more advantageous than disadvantageous and how it is carried out. It will also examine how fair value led Lehman Brothers, an American investment bank, into bankruptcy during the global financial crisis and why the trend of fair value has emerged in the recent decades.
As historical cost loses relevance with the passing of time, it is more appropriate to use fair value reporting as it considers current market prices and conditions. This provides investors with the most relevant estimates of the value of business (Gjorgieva-Trajkovska et al., 2016), and timely information which is important for making investing decisions (McEnally, 2007). Penman (2007) states that fair value accounting reports assets and liabilities through an economist’s view and therefore reports economic income – the change in fair value of net assets on the balance sheet. This is of interest to investors as they can make predictions of future earnings based on current information (Marra, 2016). On the other hand, Sundgren (2013) claims that there will also be fluctuations in fair values, leading to uncertainty of future inflows. Although this poses a disadvantage towards certain stakeholders, it is helpful to investors as high fluctuations could indicate high risk, which may reward them with high returns.
Another advantage of fair value reporting is the reliability and transparency of the method. More transparency means that the investors are able to get an insight into the real value of the company. This allows investors to make more informed decisions that will benefit the business (Bigelow, n.d.). Fair value reporting is reliable as it “can be checked in hindsight from available information about current and past market prices” (Betakova et al., 2014). This is beneficial for the investors as it means that they can be confident that their decisions are correct and that the finances of the business will not suddenly change.
Bubble prices can be an issue for investors as it may mislead them into making poor investing decisions. There is plenty of empirical evidence to show that bubble prices exist (Ryan, 2008). These price bubbles, according to Penman (2007), are introduced into financial statements through the usage of fair value accounting. He goes on to say that this causes bubble gains to reflect on the income statement, and these may, falsely, show the company as being healthy which could lull investors into a false sense of security. These bubbles also result in the investor receiving ineffective financial statements which will impair their decision making. An example of this would be where investors pay prices that far exceed their own valuation (Scheinkman and Xiong, 2003). This would make it tough for investors to earn a reasonable return on their investments. However, the research fails to consider the difficulties locating price bubbles or how investors can prevent themselves from being misled. It also fails to consider that bubble prices show the current trading price, albeit inflated, and therefore show the true value of the investment according to current prices.
When there is illiquidity in a market, fair value is called mark to model accounting. Ball (2006) explains that when this occurs, market prices are not accurate as firms try to find an approximate value for the assets. He continues by stating that this can let managers easily manipulate values according to their own preferences – affecting the reliability of financial statements. Betakova et al. (2014), argues that measurement procedures of fair value create loopholes and this means that prices can be written as vastly different from what they really are, which again allows manipulation.
The fair value of assets and liabilities is derived from the 3 level hierarchy of inputs. According to IFRS 13, the highest priority is given to level 1 inputs – the quoted price of assets and liabilities that are traded in the active market. Laux et al. (2010) state that assets or liabilities should be “marked to market”, which means that the quoted price has to be used to determine its fair value as it is the best approximation of how much an asset would be sold for (Magnan, 2009). IFRS also emphasises that the price to be used has to be those of an orderly transaction to ensure that it is not a forced transaction in order to maintain its representability. An example of level 1 valuation would be listed stocks or bonds. In cases where an asset does not have an active market, level 2 fair value measurement should be used. This is when the valuation inputs are directly or indirectly observable but do not fall under Level 1 (Magnan, 2009). Level 2 inputs, the net replacement cost, include quoted prices for similar assets or liabilities in active or non-active markets, and other relevant market data like the yield curves (Sundgren, 2013). For example, Petrobras issued a bond which is not traded. However, if there is an active market for a Valero Energy bond that is similar, the price of the Valero Energy bond can be used as level 2 input to value the Petrobras bond. Finally, the least priority is given to level 3 inputs, which are unobservable inputs. It is the least accurate as it is based on model assumptions. An example of level 3 measurement is when there is no observable input to value the Petrobras bond, then the value of the bond can be estimated by discounting its future cash flows. As a result, the reliability is reduced due to the subjectivity of the discount rate. Fair value is argued to be more appropriate, compared to historical cost, when level 1 valuation is used as it only allows minimal manipulation. However, during 2008, many companies overvalued their assets by using the level 3 measurement, contributing to the global financial crisis. Furthermore, there is an advantage in valuing certain assets using historical cost over fair value, like property, plant and equipment. This is because historical cost results in a more consistent calculation of depreciation. Moreover, under fair value, assets would need to be revalued frequently due to changing market conditions and this would impose additional costs to the organisation (Christensen and Nikolaev, 2013).
Fair value was a dominant force in the financial crisis and ‘exacerbated its severity’ (Cai-xia and Chi, 2010). Huizinga and Laeven (2009) note that fair value is ‘procyclical’ and therefore intensifies the phases in the economic cycle. They expressed that banks were materially impacted due to the contrast between ‘market and book values’. Lehman Brothers was an American investment bank, founded in 1850, and was the fourth-largest investment bank in the United States. Its bankruptcy in 2008 was a prominent event in magnifying the repercussion of the financial crisis (Acharya and Richardson, 2009). One of the pivotal reasons for this collapse was due to the high leveraging (Lehner, 2016). Lehman disguised this from stakeholders by utilising fair value accounting and creative accountancy. The incentive behind such manipulations would be the benefit pressurised managers derive by camouflaging vulnerabilities in the organisation. This is proved by the movement of the leveraging ratio from 23.7:1 in 2003 to 30.7:1 in 2007 (SEC Info, 2007) which signifies a high level of risk to investors. In addition, Azadinamin (2012) mentions that accounting standards, due to their defects, enable management to misrepresent financial information for momentary monetary rewards. He states further that Lehman window dressed the financial statements, using fair value, to present ‘healthy looking balance sheets’ which assisted in concealing a major complication – negative cash flows. Magnan (2009) states that ‘As of November 30, 2007, 75.1% of assets measured at fair value were measured according to level 2 or level 3 inputs’. This indicates that Lehman generally did not use the more reliable level 1 values. In addition, the proportion of assets valued using level 2 or 3 “increased to 81.7% the following year”. This shows the speed at which reliability in the accounting method was reduced. It is backed up by the empirical evidence provided by Magnan which shows that the movement from level 1 to levels 2 and 3 was done intentionally so that they were able to report assets too highly and hide losses. He goes on to explain that fair value provides beneficial information to investors when ‘assets trade in deep and efficient markets’ but are less useful when the markets are less liquid. One of the key reasons for the fall was the lack of liquidity caused by banks securing themselves, due to the financial crisis, by asking Lehman to pay off their debts. In addition, even though Lehman had a huge asset base, they lacked assets which could quickly be sold for cash (Brunnermeier, 2009). Apart from the ongoing financial crisis, another aspect that increased the speed of the collapse was the unrealised gains and losses brought about by the usage of fair value accounting (Magnan, 2009). For example, Hughes (2008) mentions that Lehman Brothers ‘showed a $400m gain from fair-valuing its own liabilities’. As no other firm wished to buy Lehman, in its state at the time, they declared bankruptcy on the 15th of September 2008 and this was quoted as the largest bankruptcy in the history of the United States (Mamudi, 2008). Therefore, fair value accounting ‘without adequate additional disclosure is neither fair nor a good reflection of the value that is at risk’ (Magnan, 2009).
To summarise, whilst relevance and reliability are the primary qualities of the usefulness of a financial report, there is a constant debate on the trade-off between these qualities when fair value measurement is adopted. Fair value is known to be relevant as it uses the current market price, however, it sacrifices its reliability as level 2 and level 3 inputs are used. The value of relevance and reliability is equally important because relevant information that has no reliability would mean nothing to the investors (Sing and Meng, 2005). In contrast, Hitz (2007) notes that fair value would be reliable if there was an actively traded market but the problem arises when there is not. He also remarks that usage of historical cost is falling whereas fair value accounting is on the rise. The reason for this is because fair value provides ‘more timely and comparable information than amounts that would be reported under other alternative accounting approaches’ (Laux and Leuz, 2009). Furthermore, they add to this by saying that fair value accounting recognises losses earlier than other methods of accounting and this makes it much more difficult to hide problems in the corporation which, if left to grow, would ‘make crises more severe’. However, we have seen that even through the use of fair value accounting, as in the case of Lehman Brothers, fair value accounting was a significant player behind the crisis of 2008. Wallison (2008) argues that fair value causes ‘instability among financial institutions’, although the title of the journal suggests that he would be taking a biased stance towards the topic. Moreover, the usage of fair value accounting causes volatility due to constantly changing prices. This concerned banks during the financial crisis due to the enormous write-downs caused by falling asset prices. However, Enria et al. (2004) argue that volatility provides information to investors regarding the risks of their investment. We believe that solely utilising fair value has pitfalls and therefore companies should adopt an integration between historical cost and fair value to eliminate the weaknesses of each. Nonetheless, we conclude that investors still prefer fair value accounting despite the disadvantages and the trade-off because it represents the true economic condition of assets and liabilities.
ACCA, 2016. A framework for determining fair value? [Online]. Available from: [Accessed 08/03/17]
Acharya, V.V. and Richardson, M., 2009. Causes of the financial crisis. Critical Review, 21(2-3), pp.195-210.
Azadinamin, A., 2012. The bankruptcy of Lehman Brothers: Causes of Failure

Financial Statement Analysis of Hilton Worldwide Holdings

Company Overview
HiltonWorldwide Holdings one of the largest and fastest growing hospitality companies in the world. The company is correctly positioned in the industry. We expect Hilton to grow at about 6.92% the same rate as its competitor and to maintain the median returns it currently generates. Hilton has relatively high profit margins while operating with median asset turns. Hilton’s year-to-year change in revenues and earnings are better than that of its competitor. Hilton’s revenue growth in recent years and current P/E ratio are both around their respective peer medians suggesting that historical performance and long-term growth expectations for the company are largely in sync.
Analytical Conclusion
Although the hospitality industry can get volatile Hilton Worldwide will continue to make strides as the company has a dedicated team coupled with an award winning portfolio and tailor made strategies for each hotel. Hence, the company will continue its operations for years to come. While Hilton has little control over external shocks, the company has the ability to adapt to its competitors, both old and new in all 104 countries and regions. Hilton worldwide is fairly valued. The company is currently valued at $19.07 billion with an anticipated value of $19.70-20B.
Summary Financials
Price (Sale):2.63(BV):3.21Float: 192.69M Debt to Equity: 184.85
52 Week Trading Range: 41.55 – 60.40Insider Holdings: N/A Current Ratio: 1.33 Cash: 1.42B Equity: 5.89 B P/E trailing: 54.77
Exchange: NYSEProfit Margin: 4.82% P/E forward: 27.65
Market Cap: 19.18BOperating Margin: 28.07%
Shares Outstanding: 329.73MROE: 6.17%
Selected Financials
FY 12/31 2018 2017 2016 2015 2014 2013 2012
Revenue 9.66B 8.88B 11. 66B 11. 27B 10.50B 9.74B 9.28B
Net Income 743M 571 M 348M 1.4B 673M 415M 352M
EPS (Basic) 2.06 1.74 1.06 4.26 2.04 1.35 1.14
EPS (Diluted) 2.06 1.74 1.05 4.26 2.04 1.35 1.14
P/E 28.22 33.25 21.59 30.65 34.40 33.82 35.98
Company Highlights
Net loss for the fourth quarter was $382 million, and net income for the full year was $364 million.
Diluted loss per share was $1.17 for the fourth quarter, largely driven by $513 million of non-cash corporate restructuring charges incurred prior to the spin-offs, and diluted EPS was $1.05 for the full year.
Added 354 hotels to its system in 2016, opening nearly one hotel per day in the year.
Completed spins-offs of Hilton Grand Vacations (HGV) and Park Hotels and Resorts (PK)
Hilton launched its newest brand the Tapestry Collection by Hilton.
Hilton is one of the largest and fastest growing hospitality companies in the world, with a portfolio of 14 world class brands comprising over 4,900 properties with more than 800,000 rooms in 104 countries and regions. Hilton is committed to fulfilling its mission to be the world’s most hospitable company by delivering exceptional experiences at every hotel, to every guest, every time. Hilton was founded in 1919 by Conrad Hilton when he purchased his first hotel in Texas, Hilton’s is the most recognized hotel brand in the world. Hilton’s operate its business across three segments: ownership; management and franchise; and timeshare. Hilton’s strategy focuses on providing service and cost models tailored to each hotel, reflecting size, business complexity, and market environment. Hilton provide appropriate levels of engagement depending on each hotel’s needs, by ensuring hotel owners are fully engaged in decision-making. This consolidated approach means Hilton maximize cost and scale efficiencies, by sharing best practice, market and trend intelligence and ensuring appropriate affordability to each hotel. For example: Hilton refine its luxury brands to deliver products and service standards that are relevant to each region. Hilton’s operations are mainly concentrated in the United States, however, it has its presence in the international markets such as in Europe, the Middle East and Africa, and in the Asia Pacific region.
Hilton operates its business across three segments namely; ownership, management and franchise, and timeshare.
Hilton is one of the largest hotel owners in the world based on the number of rooms at the company’s leased, owned and joint venture properties. Hilton’s diverse global portfolio of owned and leased properties includes a number of prominent hotels in major cities such as New York City, San Francisco, London, Chicago, São Paolo and Tokyo. Hilton’s portfolio includes renowned hotels with significant underlying real estate value, by the end of 2016, the ownership segment had 141 hotels with 57,716 rooms. In recent years Hilton has expanded its hotel system less through real estate investment and more by increasing the number of management and franchise agreements the company has with third-party hotel owners. Hilton focuses on maximizing profitability and cost efficiency of all its portfolios by, reducing fixed costs and implementing new labor management practices and systems. For instance, Hilton has developed and executed strategic plans for each of its hotels to enhance the market position of each property. At many of its hotels Hilton has renovated guest rooms and public spaces and added or enhanced meeting and retail space to improve profitability. At certain of its hotels, Hilton is evaluating options for the adaptive reuse of all or a portion of the property to residential, retail or timeshare uses.
Management and Franchise
Hilton’s management and franchise segment enables the company to manage timeshare properties and hotels and license its trademarks to franchisees. Hilton currently manages 4,734 hotels with 738,724 rooms. Therefore, this segment generates its revenue primarily from fees charged to homeowners’, hotel owners and associations at timeshare properties. Hilton grows its management and franchise business by attracting owners to become a part of its system and participate in its brands and commercial services to support their hotel. On Hilton’s part, these contracts require little or no capital investment to initiate and provide substantial return on investment for Hiltons. Hilton’s primary management services consist of operating hotels under management contracts for the benefit of third parties, who either own or lease the hotels. Hilton earns an incentive fee based on gross operating profits and a management fee based on a percentage of the hotel’s gross revenue.
For a fee Hilton franchise its trade, brand names, operating systems and service marks to hotel owners. Hilton does not directly participate in the daily operation or management of franchised hotels but its conducts periodic inspections to ensure that brand standards are maintained. Hilton approves certain aspects of development and the location for new construction of franchised hotels, in some cases, Hilton also provides the franchise with product improvement plans that must be completed in accordance with brand standards to remain in Hilton’s hotel system.
Hilton’s timeshare segment generates revenue from three primary sources: Resort Operations, Timeshare Sales, and Financing. Hilton market and sell timeshare interests owned by Hilton and third parties. The company sells timeshare intervals on behalf of third-party developers using the Hilton Grand Vacations brand. Through resort operations Hilton manages the Hilton Grand Vacations (HGV) Club, receiving annual dues, enrollment fees, and transaction fees from members. Hiltons also provides consumer financing, which includes interest income generated from the origination of consumer loans to customers to finance their purchase of timeshare intervals and revenue from servicing the loans.
Since Hilton Worldwide was founded, the company has been among the top hospitality companies in the industry. In fact, after almost 100 years it is considered one of the largest and fastest growing corporations with the goal to deliver outstanding customer experiences and excellent operating performance. Hilton’s business strategy is based on its service differentiation, the company distinguishes itself from its competitors by providing high quality service combining it with IT systems. According to Dudovki, (2016), Hilton has been focusing its strategy on digitalizing mobile services, booking channels, loyalty and data driven-personalization, and also improving guest experience and privacy.
Enhanced service offering is at the forefront of Hilton strategy. In order to allocate more of customers’ travel spending to Hilton hotels, and consequently to enhance customer loyalty for the entire system of hotels and timeshare properties, the team created Hilton Honors Loyalty Program. The program rewards guests with points for each stay at any of Hilton’s more than 4,900 hotels worldwide. Members can use the points earned for free hotel nights and other goods and services; moreover, it is possible to spend the points with 130 partners, among which car rental, rail, and airlines companies, credit card providers and others. The loyalty program contributed over $17 billion in terms of revenues as reported at the end of the year 2016.
Another strategy employed by Hilton is premium pricing. Hilton utilizes the premium pricing policies for its upscale services and hotels. The pricing strategy is established to emphasize, among customers, the sense of status and luxury rather than the sense of stay and dining. Through the analysis of previous performance and strategies they provide to manage future profitability. For instance, they engage with sales teams for hotels with significant group/corporate business, to ensure corporate pricing structure is maximized throughout the RFP process.
The management of Hilton believe every Hilton Worldwide property has its own unique strengths and challenges. As such they provide service and cost models tailored to each hotel, reflecting business complexity, size, and market environment. Hilton matches its service to the needs of the client’s hotel, Hilton management believes that one size fits all. This consolidated approach means that Hilton maximize cost and scale efficiencies, rapidly sharing best practice, market and trend intelligence and ensuring appropriate affordability to each hotel. Hilton have focused on optimizing hotels’ market share and delivering market-beating revenue per available room (RevPAR) results. Hilton’s team provides thorough analysis of previous performance and strategies to drive future profitability.
Hilton Executive Committee is characterized by key personnel with diverse backgrounds who were able to bring the company to the prominence it now enjoys in the hospitality industry. Among those executive are Hilton’s President and Chief Executive Officer, Christopher J. Nassetta. Nassetta has been one of the most important figure in the Hilton family since 2007. With a degree in finance, Nassetta has always been close to the hospitality industry and real estate market. In fact, he worked as President and Chief Executive Officer at Host Hotels