Int. J. Accounting, Auditing and Performance Evaluation, Vol. 8, No.

4, 2012 373

The value relevance of fair value accounting of

investment properties in the Jordanian shareholding
companies

Husam Aldeen Al-Khadash

Accounting Department,
Faculty of Economics and Business Administration,
Hashemite University,
P.O. Box 802 AbuAlanda, Postcode 11592 Amman, Jordan
E-mail: [email protected]

Abstract: The study examines the effect of implementing fair value accounting
under IAS 40 on the financial performance of Jordanian shareholding
companies (JSC). It investigates how the inclusion of unrealised gains and
losses in income numbers affect the incremental explanatory power of earnings.
The study utilises Ohlson (1995) valuation model combined with a technique
developed by Theil (1971) and has been applied by several empirical studies.
The study covers the period of 2002–2009 and the data collected from the
Amman Stock Exchange database.
The results point out that unrealised gains and losses affect the net income
and the results of cross-sectional regression indicate that net income and book
values jointly and individually are positively and significantly related to stock
prices. The incremental information content of net income is greater than that
of book values and the inclusion of unrealised gain in income increases the
explanatory power of the model.

Keywords: fair value; investment property; IAS 40; Jordanian shareholding

companies; JSC; earnings; unrealised holding gains.

Reference to this paper should be made as follows: Al-Khadash, H.A. (2012)

‘The value relevance of fair value accounting of investment properties in the
Jordanian shareholding companies’, Int. J. Accounting, Auditing and
Performance Evaluation, Vol. 8, No. 4, pp.373–393.

Biographical notes: Husam Aldeen Al-Khadash is an Associate Professor of

Accounting. He graduated from Western Sydney University, Australia. He
specialised in accounting theory. His research interest is in accounting
education, accounting theory and auditing. He has over 20 published papers
and five text books. He has over 16 years of teaching experience in Jordan and
Australia.

1 Introduction

Currently under IFRS, fair value recognition, measurement and disclosure of transactions
and events are required under several accounting standards including: IAS 39 which deals
with financial instruments, IAS 40 Investment Property where entities can choose
between the cost or fair value model; IAS 38 and IFRS 3 Intangible Assets and goodwill

Copyright © 2012 Inderscience Enterprises Ltd.

374 H.A. Al-Khadash

where entities measure the fair value of intangible assets and goodwill acquired in a
business combination and IAS 16 Property, Plant and Equipment (PPE) where also an
entity can choose between the cost or fair value model.
Before applying fair value measurement, the accounting of non-financial assets was
concentrate to retain the original cost value of these assets on the balance sheet. It would
disclose as supplementary information (footnotes as example) about the current market
price(s) of the assets that the companies owned. By doing that companies avoid reporting
holding gains or losses from changes in the market price of non-financial assets unless,
they were actually sold. But a few academics and analysts complained that this approach
permitted companies to ‘cherry-pick’ gains and losses (King, 2009). By selling
non-financial assets especially investment properties with a built in profit, the company
would report an increase in income and earnings per share (EPS). Therefore, fair value
accounting asks now that those changes in market value must be reported directly (King,
2009).
Although fair value accounting has been defended on the grounds of being more
relevant for investment decisions, a cost to investors potentially arising from its use is
that many recognised assets might not be measured with sufficient precision to help them
assess adequately the firm’s financial position and earnings potential. This reliability cost
is compounded by the problem that in the absence of active markets for particular assets
such as investment properties, management must estimate its fair value, an issue that can
be subject to discretion or manipulation (PriceWaterhouseCoopers, 2008). The estimation
of fair value has an effect on the earnings or income through recognising unrealised gains
and losses. Under IAS 40, companies can choose to value their investment properties
using the ‘fair value model’ or the ‘cost model’. Under the cost model, investment
properties will be stated at cost less depreciation (less any impairment losses). Using the
fair value model leads to unrealised gains and losses and based on IAS40, these gains and
losses to be reported in the income statement.
The recognition of unrealised gains and losses has long been a contentious issue in
accounting. Holding gains from changing market prices have largely been deferred, or if
recognised, taken directly to equity, bypassing the income statement. Accounting
regulators are slowly extending the scope of application of market-to-market accounting
and, with it, have been subject to increasing criticism by preparers of financial
statements. However, it would seem, rightly or wrongly, that fair value accounting is
becoming more pervasive and its impact, beneficial or adverse, remains contentious
(Danbolt and Rees, 2008).
Consequently, in developed economies fair value accounting established status as a
measurement that is superior to historical cost accounting. There is still reason to
question whether fair value accounting is superior to historical cost accounting in
emerging economy environments with less-developed institutional environments, and
whether the IFRS fair value accounting requirements can and should be adopted and
implemented in these economies. As Sir David Tweedie, the IASB’s chairman, notes,
emerging economies “are some of the most fervent supporters of what we’re doing . . .
[due to their] desire for strong, stable, and liquid capital markets to fuel economic
growth. . . . Unfamiliar standards create a risk premium, which increases the cost of
capital. That, in turn, reduces investment” (Tweedie, 2006). While the adoption of IFRS
fair value accounting standards is highly desirable for emerging economies, the process
of adopting and implementing these requirements is expected to be especially challenging
for them because they lack many elements of a well-functioning capital market that are
 The value relevance of fair value accounting of investment properties 375

needed in order to adopt and implement fair value accounting successfully (Chen and
Chan, 2009).
Singleton-Green (2007) summarises the problems of fair value accounting as:
1 the lack of active markets for most assets and liabilities, which means that most fair
value measurements are estimates and are highly subjective and potentially
unreliable
2 costly information, especially for smaller companies
3 the recognition of profits based on fair values, which mean that unrealised profits or
losses from changes in fair value are recognised, and result in greater volatility and
unpredictability.
This study focuses on the third issue, the presentation of changes in fair value of
investment properties, in the income statement. There have been concerns that the
inclusion and presentation of such unrealised gains and losses in the income statements
might lead to undue increases in earnings volatility and investor confusion.
In Jordan the value of investment properties has shown a tremendous increase as a
result of high demand in 2005 until 2007 (Al-Khadash and Abdullatif, 2008). The prices
increased for some real estates over 300% during this period. Consequently using fair
value accounting to revalue the investment properties has significant impact on the
income of many Jordanian companies. In December 16th of 2007 the Board of
Commissioners of Jordan Securities Commission issued new regulations related to the
accounting standards of fair value accounting , which specify that “ …all the listed
companies should use the cost model when applying the IAS 40, Investment Property,
and should just disclose the fair value of investment property in the related illustration in
the financial statements” (Jordan Securities Commission, 2007); according to this
regulation all listed companies should use the cost model in valuing investment property.
These regulations in 2007 come as a result of comprising the income statements of many
Jordanian companies with significant numbers of unrealised holding gains and losses.
This study discusses and tests economic consequences of the application of fair value
accounting (in particular International Accounting Standard – IAS 40) in the context of
an emerging economy, Jordan. The empirical evidence provided in the current study
should be useful to the academics, practitioner and IASB as well as other local
accounting regulators, who are interested in knowing whether fair value numbers made
available by IAS No. 40 are value relevant to participants in the less-sophisticated capital
markets of developing countries. The problem of this study is to examine to what extent
noise may be added to income by incorporating the effects of fair value gains and losses
resulted from investment property measured at fair value after recognition. Hodder et al.
(2006) provide evidence that different measures of income can portray firm risk
differently for firms with significant exposure to changes in fair values of some assets.
The study also examines the role of unrealised gains and losses recognised under
IAS 40 in explaining stock prices for Jordanian shareholding companies (JSC) and how
the inclusion of unrealised gains and losses in income numbers affect the incremental
explanatory power of earnings. We decompose earnings for investment companies into
two components: earnings before unrealised gains and losses recognised under IAS 40
and the unrealised gains and losses. We compare the incremental explanatory power of
376 H.A. Al-Khadash

net income to that of net income before unrealised gains and losses to examine how
unrealised gains and losses affect the incremental explanatory power of earnings.
The study utilises (Ohlson, 1995) valuation model, which expresses stock prices as a
function of both book value of equity and earnings and uses statistical association
between stock prices and both earnings and book values as measured by R square as a
primary metric to measure value-relevance. The study uses a technique developed by
Theil (1971) and has been applied by several empirical studies to compare the
incremental explanatory power of earnings and book values (e.g., Collins et al., 1997;
Harris et al., 1994; Bao and Chow, 1999; El Shamy and Kayed, 2005). The technique
decomposes the combined explanatory power of earnings and book values into three
components:
1 the incremental explanatory power of book value of equity
2 the incremental explanatory power of earnings
3 the explanatory power common to book values and earnings.
The next section outlines the theoretical background. Section 3 covers some empirical
evidences on the application of fair value accounting. Section 4 discusses the IAS 40.
Section 5 discusses the research approach. Section 6 provides the results of the empirical
analysis while Section 7 concludes the study.

2 Theoretical background

Replacing traditional historical cost accounting measures with measures based on fair
values has been considered a controversial issue, or even a paradigm shift (Barlev and
Haddad, 2003). Several arguments have been put forward in support or against the
application of fair value accounting in practice.
This section begins by discussing the definition of fair value as used in accounting. It
then discusses arguments for and against the application of fair value accounting, and the
role of international adoption or convergence with IFRS in the international spread of
issues related to fair value accounting.

2.1 Definition of fair value as applied in accounting

According to IASB fair value is defined as: “the amount for which an asset could be
exchanged or a liability settled, between knowledgeable, willing parties in an arm’s
length transaction”. In the USA, the most recent SFAS 157 (paragraph 5) defined fair
value 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”. We can see
that both the IASB and the FASB definitions are basically equivalent, despite different
wording (Hitz, 2007; Turel, 2007). It is also clear that both definitions emphasise exit
prices as the chosen measure for fair value (Penman, 2007).
However, these definitions require a closer look when trying to apply them in
practice. For example, Barth and Landsman (1995) argue that the definitions can be
applied in a setting of perfect and complete markets, while in fact there are several
different alternative fair value constructs. Accounting theorists have argued in favour of
several different measures of fair value, including current cost accounting based on entry
 The value relevance of fair value accounting of investment properties 377

prices or exit prices, and current purchasing power accounting using price indexes
(Deegan and Unerman, 2006).
The application of fair value accounting follows a three-tier hierarchy, where first
market prices are applied as a best estimate of fair value. If market prices are not
available or do not exhibit sufficient quality, quoted market prices of comparable items
are considered. If this also does not work, fair value is applied by internal estimation
(Hitz, 2007). IAS 39 describes this in more detail (see Alfredson et al., 2007).

2.2 Arguments for the application of fair value accounting

Accounting theory literature is full of arguments by accounting scholars claiming that
historical cost accounting is obsolete and irrelevant for financial decision-making, and
therefore needs to be replaced by some form or another of fair value accounting.
According to its opponents, main deficiencies associated with historical cost accounting
include its irrelevance during inflation periods (Deegan and Unerman, 2006), its failure
to recognise unrealised increases in values of assets, and its lack of comparability
(Riahi-Belkaoui, 2004).
Given that, the use of fair values was proposed as an alternative to historical cost
measures. For some assets fair value has generally been considered as more relevant than
historical cost, as in case of financial instruments, and in many cases not much less
reliable, especially if current market prices are readily available. Fair value measures of
financial instruments have been seen as reflecting the market’s assessment of the effects
of current economic conditions on the financial instrument, not being affected by the past
history of the financial instrument or the specific enterprise that holds it (Carroll et al.,
2003), and allowing adequate financial statement reflection of asset liability management
activities (if fair value accounting is applied to all financial instruments) (Gebhardt et al.,
2004). Therefore, fair values can arguably be seen as reflecting value (rather than cost)
and true economic substance (Penman, 2007). It was also argued that fair value
accounting measures, as compared to historical cost accounting, provides better
international accounting harmonisation (Barlev and Haddad, 2007).
Barth (2006) concludes that the perceived usefulness of fair value accounting by
standard-setters has shifted the argument from whether they should be used in financial
statements to how they should be used in financial statements. However, the application
of fair value accounting has not been without criticism. The following subsection
illustrates this issue.

2.3 Arguments against the application of fair value accounting

Although the concept of fair value measurement in accounting has been seen as relevant
for investment decisions, it has been criticised on several grounds. These include the
arguments that fair value measurements may lead to distortion of net income through
recognition of unrealised holding gains and losses, and that fair value measurements are
not exact, costly to generate, subject to manipulation, and lead to breaking the historical
cost model which is seen as well working and well understood (Evans, 2003). Benston
(2005) argues that although the concept of using market values of assets and liabilities is
theoretically sound, its implementation has been seriously flawed, such as in the case of
treating investment properties by fair values that may in many cases be calculated with
378 H.A. Al-Khadash

substantial leeway by managers. Benston (2005) also argues that extending the use of fair
value accounting to the level of revaluation for all assets would allow managers to record
income in advance of reliable evidence that it has been earned. This carries the risk of
being misleading due to being based on expectations that may turn out to be false
(Rayman, 2007).
The emphasis of both the IASB and the FASB on exit prices for measuring fair value
has been criticised on several grounds. (Penman, 2007) argues that when a firm holds net
assets whose values come from executing a business plan rather than fluctuations in
market prices, a direct relationship between exit prices and fair value to shareholders does
not exist. Benston (2008) also criticises the use of exit values as fair value measurements
for assets like work-in-process inventories and special purpose machines, where exit
values may equal zero or even be negative, since exit prices offer little or even no value
to investors in ongoing firms. Finally, Ronen (2008) argues that fair value accounting
measures are not relevant, since they do not reflect the value-in-use of the asset, and thus
are not useful in predicting future cash flows generated for the firm from these assets. He
also argues that fair value accounting measures are not reliable, given the high level of
subjectivity involved in their estimation, and the possibility of moral hazard by managers
misusing them (Ronen, 2008).
A further problem was faced with the issue of international harmonisation of
accounting and promoting international accounting standards worldwide. The
introduction of IFRS into Europe (particularly IAS 39) caused strong objection from the
banking industry (Larson and Street, 2004; Zeff, 2006). This caused the European Union
to adopt IAS 39 after excluding certain sections from it, thus causing a major obstacle in
its convergence with IFRS and a problem for auditors in terms of what particular
financial reporting standards to refer to in the auditor’s report (Pacter, 2005).
The financial markets in many developing counties, and Jordan is no exception, are
inherently volatile because they are driven by expectations about the future. These are
markets for ‘credence’ goods, dependent on psychological factors, as opposed to search
goods or experience goods (Hodder et al., 2006). Financial markets deal with expected
valuation by diverse actors facing radical uncertainty and in some instance strategic
behaviour for some traders shift market faraway from the so-called fundamental value.
The competition among traders does not overcome the radical uncertainty that is typical
of a market economy. This is a major difference with respect to the functioning of
markets for standard goods. Consequently, fair value measurement might widen the
difference between market prices and the fundamental value, by comparison with
historical cost accounting.

3 Empirical evidence on the application of fair value accounting

Many empirical studies were undertaken on issues related to fair value accounting. These
issues include the value-relevance of fair value measures on earnings’ changes and
volatility resulting from the recognition of unrealised holding gains and losses under fair
value accounting, and the effect of adopting fair value accounting as part of IFRS on
capital markets, particularly outside North America. A discussion of some of these
studies and their results is presented below.
Studies covering the value-relevance of fair value accounting, measured by its
incremental effect over historical cost accounting, have generally found that fair value
 The value relevance of fair value accounting of investment properties 379

have significant explanatory power beyond that of historical cost measures (see for
example Barth, 1994; Bernard et al., 1995; Barth et al., 1996; Barth and Clinch, 1998).
As for earnings computed under fair value accounting, many studies have generally
found that fair value earnings, resulting from recognising unrealised holding gains and
losses, are more volatile than those computed under historical cost accounting (Barth
et al., 1995; Bernard et al., 1995). Hodder et al. (2006) argue that incremental earning
volatility under fair value accounting income is related to elements of risk not captured
by historical cost accounting net income or comprehensive income, and that these risks
relate more closely to capital market pricing.
Such value-relevance of fair value accounting measures has even been found under
less efficient circumstances. Carroll et al. (2003) argue that incremental value-relevance
of fair value accounting information is not eliminated when an estimation of fair value is
needed. They found this result for both fair values of securities and fair-value-based gains
and losses covered in their study of close-end mutual funds.
In his survey of many extant fair value accounting studies from the USA, UK and
Australia, Landsman (2007) concluded “that disclosed and recognised fair values are
informative to investors, but that the level of in formativeness is affected by the amount
of measurement error and source of the estimates – management or external appraisals”
[Landsman, (2007), p.19]. However, this view has been countered by some results of
studies where relatively different findings were reported. Eccher et al. (1996) found that
in some cases historical cost measures had incremental value-relevance higher than those
of fair value measures. Barth et al. (1995) found that although fair value earnings are
more volatile than historical cost earnings, incremental volatility is not reflected in stock
prices. In addition, Owusu-Ansah and Yeoh (2006) reported no significant difference
between recognition of unrealised gains from revaluation of investment property in
income and recognition of these gains in revaluation surplus. Nelson (1996) reported that
fair values of investment securities have more incremental power relative to book values,
but that this result holds only for investment securities, and not for loans, deposits, or
long-term debt.
A relatively similar result was reported by Khurana and Kim (2003), who found that
fair values of available-for-sale securities are more informative than those of their book
values. However, they found that for small bank holding companies and those with no
analyst following, fair value accounting measures for loans and deposits are less
informative than those of their historical cost accounting measures. They argue that this is
possibly because loans and deposits are not actively traded and may in many cases
include more subjectivity in estimating fair values. Khurana and Kim (2003) concluded
that fair value measures are more value-relevant when there exists available objective
market-determined fair values. Apart from that, they argued that simply requiring the use
of fair value accounting is not appropriate for all cases.
Some studies analysed the value-relevance of fair value measurements on the
financial performance of some companies. A study of Penman (2007) concludes that
book values change considerably when investments are accounted for at fair value, and
that the magnitude of this change varies between companies and types of assets.
However, only in few cases the difference in valuation leads to a relevant difference in
companies’ efficiency scores; that is, within the sample the overall rank order of the
companies with regard to efficiency and profitability remains largely the same under both
valuation bases. These findings seem to indicate that a change from historical cost to fair
380 H.A. Al-Khadash

value accounting for investments would alter analyst perceptions of a limited number of
companies but would not have any effect for the majority of them.
A note worth mentioning is that value-relevance of fair value measures and their
effect on stock prices has not always been reported to be a positive issue. Indeed, several
studies have found that fair value measures have caused negative stock price reactions.
This is generally in the case of banks, given their relatively large proportion of
investment securities to total assets, compared to other types of businesses. Cornett et al.
(1996) argue that new costs on banks resulting from fair value accounting announcements
exceed benefits from reducing alleged gains-trading practices. Beatty et al. (1996)
reported negative effects of stock price movements for banks as a result of fair value
accounting. This was found to be most in the cases of banks more frequently trading their
investments, having longer maturity investments, and being more fully hedged against
interest rate changes (Beatty et al., 1996).

3.1 Fair value model for investment property

The question of whether fair values are reliable is a primary concern to most financial
statement users, regulatory authorities, preparers and auditors. As stated by Wilson
(2001), “well established valuation models can produce significant variability in the
range of reasonable fair value estimates for an investment property and even minor
changes in the assumptions in the valuation models can significantly alter the results”. In
an ideal world with liquid and transparent markets this would not be a significant
problem. However the real estate market is characterised by inefficiency and
heterogeneity. Fair values of investment properties in many cases are based on valuations
and not observed prices. For assets traded in illiquid markets the volatility in reasonable
estimates of fair value can provide a vehicle for discretionary upward or downward
adjustments of balance sheet and income amounts. Even in the absence of an enterprise’s
intent to distort reported fair values, the variability of reasonable fair value estimates
from enterprise to enterprise may significantly reduce the comparability of financial
statements among enterprises (Wilson, 2001).
The inclusion of capital gains or losses arising from changes in the fair values in the
net profit or loss of the period will have wide effects on the net income or loss of the
company (Muyingo, 2003):
1 Solidity, which is the equity/assets ratio, will increase as the fair value of the
investment properties increases, if the fair value model is applied.
2 Total equity, (shareholder’s equity) which is the sum of restricted equity and the
retained earnings will increase tremendously as value changes will be included in the
profit.
3 Volatility in the net income will increase if the fair value model is applied.
The underlying idea behind the use of fair value as a measurement attribute is that fair
value represents a market price. Market prices capture the consensus view of all market
participants about an asset or liability’s economic characteristics, including assumptions
about cash flows, profit margins and risk (Muyingo, 2003).
With respect to the implications of fair value accounting on investment property and
real estate, Turel (2007) found that Turkish real estate investment trusts do not prefer
 The value relevance of fair value accounting of investment properties 381

valuing investment properties at fair value under IAS 40. He argues that this is because of
the effects of income volatility. On the other hand, Danbolt and Rees (2008) found that
the reliability of real estate values is contentious and potentially open to both error and
manipulation. The values are based on the work of individual experts who have to
estimate the marketability, or predict the cash flows and discount rates, for assets with
very different characteristics. Danbolt and Rees (2008) added, the experts are also
employed, directly or indirectly, by the real estate firms and are, at least potentially,
subject to the influence of the real estate firm’s management.
Danbolt and Rees (2008) conclude that as there is arguably more scope for
uncertainty surrounding fair values of property than financial securities, fair value
disclosures by real estate companies are expected to be less value relevant and more
biased than fair value disclosures by investment companies. According to them, while
fair values are generally straightforward and unequivocal for investment companies, the
valuation of investment properties for real estate firms is less clear-cut and more open to
manipulation. Compared to financial instruments, Mazza et al. (2009) argue that the
reliability of estimates for non-financial assets is of concern because, for the most part, no
market exists for these assets. According to SFAS No. 157 real estate valuation could be
either level 2 or 3 depending on the source of the input data.

4 What is IAS 40?

IAS 40 specifies that an investment property (land or a building or even part of a building
or both) is one which is held to earn rentals or for capital appreciation, or both by the
owner or by a lessee under a finance lease. Investment property excludes property
occupied by the parent or a subsidiary or fellow subsidiaries. However, investment
property includes property that is leased to an associate or joint venture, which occupies
the property, since associates and joint ventures are outside the consolidated group.
Assets (e.g., land) held by a lessee under an operating lease should be recorded according
to the requirement of IAS 17: Leases. Properties held for use in the production or supply
of goods or service, or for administrative purposes are accounted for under IAS 16: PPE.
Properties held for sale in the ordinary course of business are accounted for under IAS 2:
Inventory (Tohmatsu, 2007).
If the owner uses part of the property for its own use, and part to earn rentals or for
capital appreciation and the portions can be sold separately, they are accounted for
separately. If the enterprise provides ancillary services to the occupants of a property held
by the enterprise, the appropriateness of classification as investment property is
determined by the significance of the services provided.
Investment property must be recognised as an asset when it is probable that the future
economic benefit associated with the asset will flow to the enterprise and the cost of the
asset to the enterprise can be measured reliably.
The cost of a purchased investment property is its purchase price and any directly
attributable costs such as professional fees for legal services, property transfer taxes and
other transaction costs. The cost of a self-constructed investment property is its cost at the
date when construction or development is complete. Until that date cost is measured in
accordance with IAS 16 (Tohmatsu, 2007).
382 H.A. Al-Khadash

The subsequent measurement of investment property might be fair value model or

cost model. When an investment property is acquired or constructed, the enterprise
should be able to determine its fair value reliably on a continuing basis. If in exceptional
cases, there is clear evidence when an enterprise first acquires an investment property that
the fair value of the property will not be able to be reliably measured on a continuing
basis (because comparable market transactions are infrequent and alternative estimates of
fair value are not available), then that investment property is measured using the
depreciated cost model under IAS 16 until it is disposed of. However, if a property that
qualified as an investment property when acquired or constructed has previously been
measured at fair value, the property should continue to be accounted for under the fair
value model until disposal under IAS 40 even if comparable market transactions become
less frequent or market prices become less readily available.
Investment property is measured at fair value, which is the amount for which the
property could be exchanged between knowledgeable, willing parties in an arm’s length
transaction. Gains or losses arising from changes in the fair value of investment property
should be included in net profit or loss for the period in which it arises. This will make
the earnings of companies that hold investment properties more volatile, reflecting the
upturns and downturns of the property market, and blurs the assessment of operating
performance. The use of the fair value model is expected to introduce a degree of
volatility into the results of companies not seen before. Some companies may then be
tempted to hold investment properties at cost. However, these companies should not
celebrate too soon as the standard still requires management to determine and disclose the
fair value of an investment property when the cost model is adopted.
Fair value should reflect the actual market state and circumstances as of the balance
sheet date. The best evidence of fair value is normally given by current prices on an
active market for similar property in the same location and condition and subject to
similar lease and other contracts. In the absence of such information, the enterprise may
consider current prices for properties of a different nature or subject to different
conditions, recent prices on less active markets with adjustments to reflect changes in
economic conditions, and discounted cash flow projections based on reliable estimates of
future cash flows.
After initial recognition, investment property is accounted for in accordance with the
benchmark treatment under IAS 16, PPE (cost less accumulated depreciation less
accumulated impairment losses). No unrealised gains or losses to be reported in the
income statement, once the investment property is sold all gains and losses to be
recognised in the income statement.

5 The research approach

5.1 The Jordanian market, the big jump

Jordan witnessed an extraordinary boom in real estate sector during the period 2004–
2008, the total investment in this sector during this period was estimated at over JD 15
billion. Trading in the sector in 2007 reached JD 6 billion, compared to JD 4.6 billion and
JD 3.5 billion in 2006 and 2005 respectively (Central Bank of Jordan, 2006). The
Jordanian Real Estate market was affected significantly by the political turmoil and
 The value relevance of fair value accounting of investment properties 383

economic boom in recent years, instigated by the September 11th terrorist attack on the
USA which compelled Arabs to relocate their investments closer to home, followed by
the influx of thousands of Iraqis during the second Gulf war, alongside the rising oil
prices that produced an abundance of liquidity in the gulf states, inducing many capital
owners to invest in Jordan. The unrivalled activity in trading in real estate and property in
Jordan, in addition to the initiatives by the government to encourage investment, and the
relatively cheap Jordanian labour, drove local, Arab and foreign investors to divert their
investment attention to Jordan. While investment has been wide-spread across the
country, the lion’s share of investments has been claimed by the capital Amman, the
Dead Sea and Aqaba (Central Bank of Jordan, 2006).
Real estate has a direct impact in supporting the growth of other economic sectors,
particularly the construction sector, which has a spill-over effect to other areas of the
economy, creating job opportunities and generating demand for other supporting
industries, such as steel, cement, wood, glass, aluminium, etc…
It also has a bearing on the financial services sector, with opportunities arising for
banks to offer financing to real estate companies and contractors, in addition to providing
retail facilities in the form of mortgages for the purchase of land and property.

5.2 Methodology of the study

5.2.1 Data sources
The population of this study comprises all shareholding companies that are listed in the
first market at Amman Stock Exchange (ASE). The total number of these companies is
about 263. In this study 94 companies were selected, these companies were selected
because they all had investments in properties and they utilise IAS 40 for financial
reporting. The financial data of these companies were obtained from ASE database. The
data collected was about their operations in Jordan over the period of 2002–2009. Data
sources include financial statements: particularly, the balance sheet, and the income
statement.

5.2.2 Methodology
This study examines the effect of implementing fair value accounting under IAS 40 on
the income and the EPS of JSC and how the inclusion of unrealised gains and losses in
income numbers affect the incremental explanatory power of earnings. To test the effect
on EPS, a ratio is calculated. To compute this ratio the EPS is figured out twice, one EPS
is calculated where earnings include unrealised gains or losses of valuing investment
property at fair value (EPSiIP) and one more time, the EPS is calculated where earnings
exclude such unrealised gains or losses (EPSeIP). Consequently the final ratio is
calculated as follows:
EPS Ratio = EPSiIPit /EPSeIPit (1)
where

EPSiIPit is the earning per share when earnings include unrealised gains or losses of
valuing investment property at fair value for firm i during period t.
384 H.A. Al-Khadash

EPSeIPit is the earning per share when earnings exclude unrealised gains or losses of
valuing investment property at fair value for firm i during period t.
If the ratio result is 1 that means EPSiIP = EPSeIP, and more than 1 means that earnings
are include unrealised gains, finally less than 1 means earnings are include unrealised
losses.
Also the researcher used Ohlson (1995) model that has been used extensively in
previous studies. The model expresses the value of a firm’s equity as a function of its
earnings and book values as follows:
Pit = a 0 + a1EPSit + a 2 BVit + eit (2)

where

Pit firm i’s stock price at the end of year t

EPSit EPS for firm i during period t

BVit book value per share for firm i at the end of period t

eit other value-relevant information of firm i for period t.

To compare the explanatory power that earnings and book values have for prices, the
researcher follows Collins et al. (1997) methodology and decompose the combined
explanatory power of earnings and book value as measured by the coefficient of
determination of equation (2) into three components:
1 the incremental explanatory power of book values
2 the incremental explanatory power of earnings
3 the explanatory power common to both earnings and book values.
To calculate these components, the coefficients of determination for the following
additional two equations are estimated:
Pit = b 0 + b1EPSit + eit (3)

Pit = c0 + c1BVit + eit (4)

R2 from equations (2) to (4) are denoted R2(EPR, BV), R2(EPR) and R2(BV) respectively. The
incremental explanatory power provided by earnings (Incr. ER) can be measured by the
difference between R2(EPR, BV) and R2(BV). The incremental explanatory power provided by
book value (Incr. BV) can be represented as the difference between R2(EPR, BV) and R2(EPR).
The remaining R2(EPR, BV) – Incr. EPR – Incr. BV, represents the explanatory power
common to both earnings and book values and is donated as Incr. COM.
To examine the effect of unrealised gains included in the income number on the value
relevance of earnings, the above analysis has been repeated using a measure of earnings
that does not include the unrealised gain and losses and we compare the explanatory
power to that obtained earlier.
 The value relevance of fair value accounting of investment properties 385

6 Results

6.1 The effect of fair value measurement on the EPS

As shown in Table 1, the use of fair value accounting has a significant effect on the
firms’ reported financial performance and on the EPS. The EPS ratio is bigger than 1 for
2002–2008 years which means unrealised gains are included and earnings of these
companies are overstated by revaluation volatility. The fair value figures in this study
were calculated based on the disclosure statements shown in each annual report. It is
required by Jordanian regulatory authorities that when fair value alternative choice was
used fair value figures should be disclosed in the annual reports.
Table 1 EPS ratio for all companies during the period of 2002–2009

Year EPS ratio

2002 1.009
2003 1.163
2004 1.112
2005 2.025
2006 1.425
2007 1.356
2008 1.001
2009 0.879

Also, Table 1 indicates that the volatility of earnings is notable mainly in years 2005,
2006 and 2007. The increase in the EPS ratio comes as a result of revaluing investment
properties at fair values. The increase in the investment properties value was because of
the big growth in real estate market in Jordan and that affects the results of many
Jordanian companies especially the shareholding companies listed at ASE.
The data in Table 1 shows that fair value accounting has an impact on the firms’
reported financial performance and consequently on the EPS ratio. One criticism of fair
value is the potential impact of market price fluctuations on firms’ reported financial
performance. The use of fair value in developed countries is based on the assumption that
the capital market is efficient, such that prices incorporate new information relatively
quickly and accurately, without extreme fluctuations. If capital markets in developing
economies have large price fluctuations based on noise rather than relevant information,
use of fair values based on these market prices may create abnormal fluctuations in firms’
net income and owner’s equity. This raises concerns that the relevance and reliability of
financial information will both be reduced. Amman Stock Market showed considerable
fluctuations in 2005, 2006 and 2007.
The ASE general index reached its highest level in 2005 where the index closed at the
end of the year at 8,191.5 points. However, the same index closed at 5,518.1 points at the
end of 2006. Figure 1 shows the movements in ASE general index for the period of the
study. It is obvious from the figure that the movement in the index values in the years
2005 and 2007 caused a bubble in ASE in that period.
386 H.A. Al-Khadash

Figure 1 ASE general index (see online version for colours)

General Iindex

10000

9000

8000

7000

6000
Index

5000

4000

3000

2000

1000

0
02/01/2000 02/01/2001 02/01/2002 02/01/2003 02/01/2004 02/01/2005 02/01/2006 02/01/2007

Time

As discussed previously, the bubble years coincided with the influx of huge amounts of
capital from Arab and other non-Jordanian investors causing a very significantly larger
market capitalisation, figures are shown in Table 2. After 2007 the market capitalisation
and its percentage to the GDP is decreased significantly.
Table 2 The ASE market capitalisation during the period 2002–2009

2002 2003 2004 2005 2006 2007 2008 2009

Market capitalisation
5,029.0 7,772.8 13,033.8 26,667.1 21,078.2 29,214.2 25,406.3 22,526.9
(JD million)
Market capitalisation /
80.4 116.8 184.7 326.6 233.9 289.0 226.3 149.6
GDP (%)

To test the difference in the volatility of EPSiIP and the volatility of EPSeIP during the
period of the study, a paired t-test is used to allow the comparison between the means of
EPSiIP and EPSeIP. The results are shown in Table 3.
Table 3 Statistical tests (parametric and non-parametric) to compare measures of income
volatility

Paired-sample for means (T test)

EPSiP EPSeIP
EPS means .278 .2165
EPS variance 0.234 0.1967
Observations 658
Df 657
t Stat 2.5717
P(T <= t) two-tail 0.0146* (P < 0.05)
 The value relevance of fair value accounting of investment properties 387

Table 3 Statistical tests (parametric and non-parametric) to compare measures of income

volatility (continued)

Two-related-samples test (Wilcoxon)

z Stat 2.3516
P(T <= t) two-tail 0.0041*(P <0.05)
Note: *The results are significant (P < 0.05).
The mean of EPSeIP (.2165) is less than the mean of EPSiIP (.278) and the variance for
the EPSeIP is less than the EPSiP measure. These results indicate that using fair value
measurement leads to volatility of earnings and EPS. Such information may affect
investors, potential investors, debt covenants, credit ratings and others. Second, as shown
in Table 3 both parametric and non-parametric statistical tests are used to test the
volatility of earnings. The calculated t-statistic (t-stat) is 2.5717 and the P-value (two-tails
test) is 0.0146; which means that there is a significant difference in the volatility of
EPSiIP and the volatility of EPSeIP. Also when a two related samples test (Wilcoxon) is
used z-statistic (z-stat) was 0.0041, which is significantly less than 0.05. Consequently,
firm-specific t- and z-statistics (i.e., parametric and non-parametric statistical tests)
confirm the results that there is a significant difference in the volatility of EPSiIP and the
volatility of EPSeIP.

6.2 The cross-sectional regression results using net income as a measure of

earnings
Table 4 presents estimates of regressions 2, 3 and 4. Panel A shows the coefficients and
t-statistics. The results of equation (2) show strong association between stock prices and
operating income plus book values (operating income and book values are significant at
better than 1% level in every year and for all years combined).
Table 4 The results of cross-sectional regression of prices on income and book values for
2002–2009

Panel A: the models

Pit = a 0 + a1EPSit + a 2 BVit + eit (2)
Pit = b 0 + b1EPSit + eit (3)
Pit = c0 + c1BVi + eit (4)
Year N a1 a2 R2(N&BV) b1 R2 (NI) c1 R2(BV)
2002–2009 94 0.467 0.345 0.479 0.649 0.432 0.583 0.378
(2.940) (2.678) (5.211) (4.256)
Panel B: the decomposition of R2
Incr. NI = R2(NI&BV) – R2 (BV)
Incr. BV = R2(NI&BV) – R2 (NI)
Incr. COM = R2(NI &BV) – Incr. NI – Incr. BV
Year R2(N&BV) R2 (NI) R2(BV) Incr. NI Incr. BV Incr.COM
2002–2009 0.479 0.432 0.378 0.155 0.067 0.266
388 H.A. Al-Khadash

The results of equations (3) and (4) indicate that net income and book values individually
explains a significant portion of the variation of stock prices in every year and for all
years combined. The adjusted R2 indicates that net income alone, book value alone, and
net income and book value combined explain about 43%, 38% and 48%, respectively of
the cross-sectional variation in securities prices.
Panel B of Table 4 provides the results of the decomposition of adjusted R2’s. The
results reveal that net income adds more to the overall explanatory of the model than
book values. The incremental information content of net income, Incr. NI, is relatively
high at 15.5%. By contrast, the incremental information content of book values, Incr. BV,
is only 6.7%. The common explanatory power of earnings and book value, Incr. COM, is
26.6%.

6.3 The role of unrealised gains and losses on the explanatory power of
earnings

As mentioned earlier also this research examines the impact of including the unrealised
gains and losses recognised under IAS 40 in explaining stock prices for JSC and how the
inclusion of unrealised gains and losses in income affect the incremental explanatory
power of earnings, we exclude the unrealised gains and losses from net income and use
the resulting earnings number in the regression equations (2) and (3) and compare the
coefficients of determinations and incremental explanatory power of the new measure of
earnings.
Table 5 presents estimates of regressions 2, 3 and 4. Panel A shows strong association
between stock prices and net income before unrealised gains and losses plus book values.
The adjusted R2 for the regression indicates that net income before unrealised gains and
losses and book values jointly explain about 38.9% of the variation in securities prices.
The results of equation (3) indicate that excluding unrealised gains and losses from net
income reduces the explanatory power of new measure of earnings from 43.2% as shown
on Table 4 to 23.1% as presented on Table 5.
Panel B provides the results of the decomposition of adjusted R2’s. The results
reveal that excluding unrealised gains and losses from the measure of earnings
reduces its incremental information content, compared to the results shown in
Table 4. The incremental information content of net income before unrealised gains and
losses (Incr. NIBUG), is relatively low at 4.2% compared to 15.5% for net income as
indicated in Table 5. By contrast, the incremental information content of book values
(Incr. BV) is increased to 15.6% from 6.7%. The common explanatory power of earnings
and book value (Incr. COM), is 19.8%. Excluding unrealised gains and losses from net
income makes book values add more to the explanatory power of the model than
earnings.
The results show that unrealised gains and losses play a role in explaining stock
prices for investment companies and the inclusion of them in earnings increases the
incremental explanatory power of earnings.
 The value relevance of fair value accounting of investment properties 389

Table 5 The impact of excluding unrealised gain from net income on the explanatory power of
earnings

Panel A: regression of prices on net income before unrealised gains and book values
Earnings
N a1 a2 R2(NIBUG&BV) B1 R2(NIBUG) C1 R2(BV)
measure
NIBUG 94 0.258 0.463 0.389 0.497 0.231 0.596 0.365
(1.624) (2.913) (3.288) (4.267)
Panel B: the decomposition of R2
Earnings
R2(NIBUG&BV) R2(NIBUG) R2(BV) Incr. (NIBUG) Incr. BV Incr. COM
measure
Net 0.389 0.231 0.365 0.042 0.156 0.198
income

7 Conclusions

The investigation in this study is motivated by the shortage of empirical research in

emerging markets on the value relevance of the information content of fair value
information provided by IAS No. 40. IAS 40 requires the use cost model or of fair value
model in accounting. The fair value model is considered to have a number of qualities
that will help to present a better and fairer picture of the companies. However, the
uncertainty associated with the measurement of the fair values and the volatility in the
income and the EPS will affect the user of financial statement, specially the investors and
creditors.
The main issues that can be concluded from the previous results and discussion are
that changes in Jordanian reported financial performance are obvious as a result of
adopting fair value accounting and including unrealised holding gains and losses in the
calculation of reported income. Including such gains and losses in the reported income
significantly affects the income and the EPS, and this gains and losses are result of
accounting measures more than being result of economic activities. An effect of fair
value model increased focus on the management of some assets such as property
investments and the understanding of the strategies and economic factors which will
affect fair values and thus the company’s profit. Due to the changes in solidity and net
income caused by the use of the fair values, company management will have to focus a
lot more on informing investors and other users of the financial statements about the
management strategies undertaken to minimise the volatility in the fair values. And these
results consist with the result of Muyingo (2003) and Nordlund (2002).
The study also utilises Ohlson’s (1995) valuation model combined with a technique
developed by Theil (1971) and has been applied by several empirical studies to compares
the incremental explanatory power of earnings and book values. The study specifically
examines the role of unrealised gains and losses recognised under IAS 40 in affecting the
EPS and in explaining stock prices for investment companies in Jordan and how the
inclusion of unrealised gains and losses in income numbers affect the incremental
explanatory power of earnings. The study decomposes earnings for investment
companies into two components: earnings before unrealised gains and losses recognised
under IAS 40 and earnings after unrealised gains and losses.
390 H.A. Al-Khadash

The results of cross-sectional regression using only investment firms indicate that:
1 net income and book values jointly and individually are positively and significantly
related to stock prices
2 the incremental information content of net income is greater than that of book values
3 the inclusion of unrealised gain in income numbers increases the explanatory power
of the model
4 the incremental information content of net income before unrealised gains and losses
is lower than that of book value.
Thus, including unrealised gains and losses from investment in net income enhances its
incremental information content.
Our overall results show that unrealised gains and losses play a role in explaining
stock prices for Jordanian companies and the inclusion of them in earnings increases the
incremental explanatory power of earnings.
The empirical evidence provided in the current study on the value relevance of fair
value information should be useful to the IASC as well as other local accounting
regulators, who are interested in knowing whether fair value numbers made available by
IAS No. 40 are value relevant to participants in the less-sophisticated capital markets of
developing countries. Also, the situation reported in this study is hoped to be of value to
Jordanian regulators, scholars, and capital-markets participants (e.g., Jordan Securities
Commission) as they consider whether to adopt and impose more accounting standards in
Jordanian regulations to recognise changes in fair values for all financial instruments and
investment property in income. Further research is needed in the effect of using fair value
option on the reported owners’ equity and in different sectors in Jordan.

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