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Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
CHAPTER 18Accounting values and reporting
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Contents Accounting values Measurement focus Expanding the boundaries of the
accounting model Fair value measurement The IASB’s mixed-attribute model Comprehensive income Efficient market hypothesis
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounting values Different value perspectives
1) Entry value2) Exit value3) Value in use
Entry and exit values are market values Market buying price and market selling
price of an item Value in use is an entity-specific value
Specific to the company that uses the item Incorporates management intentions
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Value in use
Value in use is the incremental firm value from continuing use of the item Estimate the future net cash flows
expected to arise from the continuing use and ultimate disposal of the item and discount these to present value
More subjective and unique to the item
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Values in the accounting model
Entry values are basic to the historical cost model (initial measurement) Replacement cost as a (potential) revised
entry cost for subsequent measurement Exit values are used both as a control
and as a measurement base for subsequent measurement Net realizable value Fair value remeasurement
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Values in the accounting model (cont.)
Value in use is used as a control measure only Threshold value to arrive at an
estimate of the recoverable amount of an asset
IAS 36 Impairment of Assets
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Deprival value
Deprival value rests on a comparison of a current entry value (replacement cost) and the recoverable amount
Value to the business - what the loss to the business would be if it were obliged to forfeit the asset in question
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 18.1 Deprival value
= lower of
Replacement cost
Higher of Net realizable value or
Value in use
Deprival value
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Measurement focus
The income statement articulates with the balance sheet: the values in both statements are not derived independently of each other
Balance sheet focus: measure balance sheet values independently on different dates and the changes will determine profit or loss of the intervening period
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Measurement focus (cont.)
Income statement focus: measure income with the balance sheet representing unabsorbed costs (assets) and anticipated expenditure (current liabilities) and financing
The IASB’s view tends to a mixed focus
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Expanding the boundaries of the accounting model
Standard setters tend to give more emphasis on representing the current economic status of the company’s assets and liabilities in addition to its completed transactions
Drive towards earlier recognition of (changes in) assets and liabilities than takes place under the completed transaction approach
General issue of recognising changes in economic value
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Executory contracts Executory contracts are binding contracts
where the company has entered into an agreement but fulfilment of the terms has not been completed
Steps to bring executory contracts within the boundaries of the financial accounting model Treatment of onerous contracts (IAS 37) Recognising assets and liabilities from executory
contracts that are financial instruments (IAS 39)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fair value measurement
Fair value is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction
Fair value has been introduced in IFRS as A means of putting a value on an incomplete
transaction A measurement attribute for subsequent
measurement in a number of significant standards
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fair value measurement
Fair value is a market-based measurement and as such not affected by factors specific to a particular company
If available, an observable market price in an active market is the best evidence of fair value
But what if a) there is more than one market price, b) the market is illiquid, c) there are no recent prices, and d) there is no market for the specific item to be measured ?
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fair value measurement hierarchy
Need for a formal hierarchy which recognizes different market circumstances in how a fair value is derived
Bottom layer = fair value entirely derived using a model and company data with no market inputs
Reliability concerns
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
The IASB’s mixed-attribute model
In IFRS, fair value accounting has come to complement historical cost accounting in several domains
Main fair value requirements: IFRS 3 Business Combinations IAS 36 Impairment of Assets IAS 37 Provisions, Contingent Liabilities and
Contingent Assets IAS 39 Financial Instruments: Recognition and
Measurement IAS 40 Investment Property IAS 41 Agriculture
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Financial instruments
Financial instruments include cash, receivables, payables, equity and debt instruments as well as derivatives and some commodity contracts
IAS 39 Financial Instruments: Recognition and Measurement establishes principles for recognizing and measuring financial instruments
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Derivative financial instruments
Derivatives are defined as financial instruments exhibiting three characteristics:
1. Their value changes in response to a change in some market-related underlying variable
2. It requires no or relatively small initial investment
3. It is settled at a future date The potentially significant future cash flow
consequences of these risky contracts bring them within the scope of the definition of assets and liabilities with fair value as the most relevant measurement attribute
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Four categories of financial instrument (IAS 39)
A financial asset or liability at fair value through profit or loss (includes financial instruments held with a view to short-term profit taking and derivatives)
Held-to-maturity investments and liabilities
Loans and receivables Available-for-sale assets
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 39 measurement rules The four different categories of financial
instruments (financial assets and financial liabilities) are measured and reported (treatment of fair value changes) differently after initial recognition
Fair value option: a company has the option to designate a qualified financial instrument on initial recognition as one to be measured at fair value with fair value changes in profit or loss
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 18.2 IAS 39 – Measurement bases of financial assets
Measurementof
financial assets
General:Fair value
Specific:Amortised cost(historical cost)
Exception:Hedge Accounting
Held-to-maturity investments
Loans and receivables
If no reliable fair value estimate determinable
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 18.3 IAS 39 – Measurement bases of financial liabilities
Measurementof
financial liabilities
General:Amortised cost(historical cost)
Specific:Fair value
Exception:Hedge Accounting
Held for trading liabilities(including
derivatives)
Those designated using
the fair value option
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Hedge accounting
Hedge accounting rules apply if a financial instrument (usually a derivative) qualifys as an effective hedging instrument
Hedge accounting will try to match any gain or loss that arises due to movements in the hedged item (the result of the hedged risk) with corresponding (but opposite) movements in the hedging instrument
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 18.4 IAS 39 – Accounting for changes in fair value of financial
instrumentsRemeasurement gains or losses
on financial instruments
(Changes in fair value)
Held for trading (including
derivatives)Fair value option
Available-for-sale Special treatment
Hedge Accounting
Profit or loss of period in which fair value changes occur
Directly in equity(through Statement of
Changes in Equity)
Recycling of cumulative gain or loss to profit or loss on disposal or
impairment
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 40 Investment property
IAS 40 covers tangible fixed assets of property which are held as an investment for the purpose of earning rental or for capital appreciation
Choice between an historical cost model and a fair value model (with changes recognized in the income statement)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 41 Agriculture IAS 41 covers valuation of biological
assets and agricultural produce at the point of harvest
Required measurement at fair value less estimated point-of-sale costs from initial recognition up to the point of harvest, with changes in fair value to be include in profit or loss
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Comprehensive income
Comprehensive income encompasses all recognized changes in assets and liabilities from transactions or other events except those related to transactions with shareholders in their capacity as owners
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Comprehensive income (cont.)
It includes net income (as traditionally defined) and other comprehensive income
Other comprehensive income (OCI) is the result of remeasurements that are accounted for directly in equity Recycling of other comprehensive
income at transaction completion needed?
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 18.5 Comprehensive income
Changes in equity
• Share issue• Dividends• Retirement of shares…
Net profit or lossOther
comprehensive income
Retained profit Reserves
Share capitalShare premium
Accumulated OCI
Transactions with shareholders
Transactions with others than
shareholders
recycling
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Extended measurement of income income
Traditional transaction-based (historical cost realized)
profit
+ economic gains and losses (remeasurements)
= Comprehensive income
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Efficient market hypothesis
A strongly efficient financial market is one where the price of a security compounds all public information about the security
In such a context taking the market price without research would be an efficient way to invest
Challenges the benefits of financial statement analysis
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