Evaluating the effect of fair value adjustments to investment property on profitability ratios

Abstract

South African investors buy and sell shares on the Johannesburg Stock Exchange (JSE) and attention is often directed towards the Top 40 JSE listed companies, that hold the highest market capitalisations (Sharenet, 2019). From an accountancy standpoint, JSE listed companies prepare financial statements on the basis of IFRS principles (PWC, 2011). Among these standards, IAS 40 is to be found. This standard regulates the accounting treatment of investment property, which permits that changes in value to such property may be recognised through the fair value model. The fair value model entails that fair value adjustments are posted to profit or loss accounts, despite the fact that these line items are intangible estimations (IASPlus, 2019). Researchers such as Al-Khadash and Khasawneh (2014:98), Andrews (2014) and Gjorgieva-Traijkovska, Temjanovski and Koleva (2016:7) theorise that profits are distorted by fair value accounting, as fair value adjustments are often dependent on market situations, which leaves accounting transactions subject to possible manipulation and they cannot be expressed as exact values. Yet, investors greatly rely on profitability information to make informed investment decisions (Dillalo, 2015). Profitability ratios are calculated in order to analyse profits. This study was undertaken to determine whether the recognition of fair value adjustments affect the profitability ratios of sampled companies. A Wilcoxon rank test and Cohen’s d-value were used as statistical measures to fulfil this objective. The Top 40 JSE listed entities were populated and judgment sampling was applied in order to calculate the sampling frame. This study was able to demonstrate that 50% to 75% of the sampled companies had profitability ratios, which were impacted by the recognition of fair value adjustments. The study, ultimately, recommends that the prospective investor should eliminate fair value adjustments when profitability ratios are calculated. Financial information cannot be studied in isolation and it is important to explore other avenues such as cash flow availability and qualitative financial factors.