Advanced Accounting Theory and Practice - Assignment Example

Advanced Accounting Theory and Practice: Assignment Contents Contents 2 A.Accounting for Preference Shares 3 A.1Preference share treatment as equity with no adjustments for time value of money 3 A.2Preference share treatment as financial liability with no adjustments for time value of money 3 A.3Preference share treatment under the Amortized Cost Method 3 A.4 Financial Liability treatment under the Fair Value through Profit and Loss 4 A.5 Different Accounting Treatments 4 B.Fair Value Accounting 6 Reliability 6 Marked to Market 7 Drawbacks for Fair Value System 7 Reference List 9 Bibliography 10 A. Accounting for Preference Shares A.1 Preference share treatment as equity with no adjustments for time value of money   2013 2012 2011 2010 £ £ £ £ Income Statement: Appreciation of Preference Shares 637627.52 612622.52 587617.52 0 Balance Sheet: 26837867.57 26200240.05 25587617.52 25000000 Non-current liabilities Equity A.2 Preference share treatment as financial liability with no adjustments for time value of money   2013 2012 2011 2010 £ £ £ £ Income Statement: Appreciation of Preference Shares 637627.52 612622.52 587617.52 0 Balance Sheet: 26837867.57 26200240.05 25587617.52 25000000 Non-current liabilities Financial liability A.3 Preference share treatment under the Amortized Cost Method   2013 2012 2011 2010 £ £ £ £ Income Statement: 2,683,787 2,620,024 2,558,762 2,500,000 Finance cost Balance Sheet: 37,362,573 34,178,786 31,058,762 28,000,000 Non-current liabilities Financial liability A.4 Financial Liability treatment under the Fair Value through Profit and Loss Income Statement for 2010 Loss on Financial Liability 587617.5 Balance Sheet for 2010 Financial Liability 25587618 Income Statement for 2011 Loss on Financial Liability 612622.5 Balance Sheet for 2011 Financial Liability 26200240 Income Statement for 2012 Loss on Financial Liability 637627.5 Balance Sheet for 2012 Financial Liability 26837868 Income Statement for 1st January 2013 Loss on Financial Liability 637627.5 Balance Sheet for 1st January 2013 Financial Liability 26837868 (Source: B. Elliott and J. Elliott, 2013; E. Stice and J. Stice, 2013) A.5 Different Accounting Treatments As per IAS 32, if an instrument has inherent terms whereby the company has an obligation to transfer the financial assets or redeem the instrument, then such an instrument is to be treated as a liability instrument regardless of the nature of the instrument. One such example could be preference shares. Preference shares are such instruments that are to be treated as a liability despite being equity in nature. Financial assets can be classified into 3 categories based on their accounting treatment apart from fair value treatment of financial assets and liabilities through profit and loss. 1. Instruments that are held to maturity: these are non-derivative financial instruments that have to pay a predetermined amount at the end of the maturity and are intended to be held until they become mature (Epstein and Jermakowickz, 2010). 2. Loans and Receivables: These are non-derivative financial assets that have a fixed maturity and are not quoted within the active markets. The holder of the instrument does not intend to hold the preference shares up for sale in the near future either. In such case, the preference shares can be easily classified as a debt instrument that satisfies the conditions of IAS 39. These become debt instruments at the hand of the issuer. 3. Available for sale: these are classified as non-derivative financial instruments or assets that are or cannot be classified within fair value through equity, loans and receivables or held to maturity. Among the ones discussed above, held to maturity is one of the alternative treatments that should be used by Yeats Plc in treatment of its preference share financial liability. This is because a held to maturity instrument is a non-derivative financial asset that has the obligation to pay a determinable payment and holds a fixed maturity. In case of preference shares, these financial instruments have to repay back a designated amount of maturity and until then, have no obligation of redemption (Ernst and Young, 2013). Yeats Plc has the power to classify preference share as held to maturity if it intends to hold the security until maturity. This would make the security either available for sale or be treated within the fair value accounting method. Such treatment allows for calculation of present value that is marked to market. The benefit of having a marked to market treatment leads to fair value justifications and facilitates analysts and investors. B. Fair Value Accounting The financial crisis of 2007–10 brought the debate regarding the importance and reliability of fair value accounting to the forefront (Véron, 2008). Such a heated discussion over the issue made it difficult for standard setters to allow the fair value accounting policy to go any further. The following discussion is aimed at addressing important areas of concern regarding fair value accounting, which clears what fair value accounting is and why it is so important. It moves on to discuss the concerns raised behind the marked to market system during the financial crisis. It also discusses the critic argument towards historical cost accounting as a better measure for budgeting and control. Lastly, it issues recommendations based on the discussion and analysis of pros and cons for fair vale accounting within the paper (Laux and Leuz, 2009). According to FAS 157, fair value is the price that is to be received on sale of an asset or paid for transfer of a liability in some orderly transaction among the market participants on a fixed date. This very definition has refrained from using transaction price to determine the fair value for any asset or liability. To state it differently, fair value is no longer determined as the exit price of the financial product. Again, the definition also lays stress on the fact that fair value is based on the market. This makes another important assumption that market participants might pay something that is not specific to the entity. Valuation of such instruments will be sceptical rather than positive. The common valuation techniques that are available as per FAS 157 are income approach, market approach and cost approach. These methods also require the assumptions that assets are viewed as liability by market participants. Reliability Reliability can be explained as the information quality that makes sure that such information is relatively free from bias and error and represents faithfully what it is assigned to represent. Fair value is nothing but an estimate of exit value provided that the market conditions are normal and are well defined in situations where a well established liquid market condition exists. In the event that there is unavailability of liquid markets, such fair value predictions will inevitably involve future cash flow predictions and a choice of appropriate rates of discounts. Such estimates also depend on measurement errors and assumptions made by the management, which in turn poses the threat of deliberate miscalculation and number manipulations that is highly undesirable (Landsman, 2007). According to a point of view presented by the FSB, certain significant measures need to be taken in seeking resolution to measurement issues, and the board is also said to be charting out a guide for estimation of fair value with the desired degree of controls. However, it is to be noted that for financial statement preparation the use of estimates is regarded as one of the most essential parts of fair value accounting. For example the inherent use of estimates forms the core of pension accounting. Additionally, in case the markets are liquid and clear for all kinds of assets and liabilities, fair value accounting is the most reliable information provider which is also useful for the process of decision making. Nevertheless, since most assets and liabilities are not all that active within the market, the methods and ways for estimating fair value becomes far more subjective and hence less reliable. Marked to Market Mark to market refers to accounting standards that have assigned a specific value to the position that is held by a financial instrument based on the fair and current prevailing market prices instead of the original cost or book value of such financial instrument or similar such instruments. Fair value is being treated within the US GAAP since the 1990s. It has been widely accepted by investors that there is a need for fair value estimations while valuing assets and liabilities. Such belief has come from the desire of investors and analysts to get a fair and better picture of realistic situations and appraisal of organizations and present financial situation of the company being apprised. The mark to market measure estimates the fair value of company accounts that is capable of changing over time. As an example, one can cite the case of future exchange transactions that are marked to the market prices per day. When such estimates are made, the first estimate is made towards the net realizable value of a complete portfolio of securities that are backed by assets. This also undertakes use of discounted ash flow method. Drawbacks for Fair Value System Critics to the fair value system of accounting argue that the measurement creates a false short run visibility which in turn diminishes the value of benefit schemes. The measurement also brings in huge unreliability for assets that are held for longer time periods. The findings of the positivity of fair value based accounting system also raises some doubts in terms of its utility to investors. It has been argued that fair value accounting should resort to historical cost basis mainly because such method of costing is based on actual costs incurred rather than assumed possible costs and such measurement allows investors to measure the amount or investment that has been spent in acquiring such investment. Critics also argue that the fair value system of accounting is imaginary and fictional in nature which makes it subjected to manipulation and biases of individual interpreters (Chea, 2011) According to Penman, 2007, such measurement debate is between the decision making usefulness and the stewardship function of valuation and must be reframed to encompass the broader issues. He suggests a dual reporting and measurement technique where the two aspects of providing the information from both historical cost and fair value method can be contained because both measurements serve different purposes. This also brings in some sort of drawback in preparation of budgets and forecasts that are used to manage the expectations of analysts (Hague, 2002) Reference List Chea, A. C., 2011. Fair Value Accounting: Its Impacts on Financial Reporting and How It Can Be Enhanced to Provide More Clarity and Reliability of Information for Users of Financial Statements. International Journal of business and Social Science, 2(20), pp. 12-19. Elliott, B. and Elliott, J. 2013. Financial Accounting and Reporting (16th Edition). New York: Pearson Publications. Epstein, B. J. and Jermakowickz, E. K., 2010. WILEY Interpretation and Application of International Financial Reporting Standards 2010. New York: John Wiley and Sons. Ernst and Young., 2013. International GAAP 2013: Generally Accepted Accounting Principles under International Financial Reporting Standards. New York: John Wiley & Sons. Hague, I., 2002. Fair value for financial instruments: Where to next? Balance Sheet, 10, pp. 8-12. Landsman, W., 2007. Is fair value accounting information relevant and reliable? Evidence from capital market research. Accounting and Business Research, 37(1), pp.19-30. Laux, C. and Leuz, C., 2009. The crisis of fair-value accounting: Making sense of the recent debate. Accounting, Organizations and Society, 34, pp. 826-834. Penman, S., 2007. Financial reporting quality: is fair value a plus or minus? Accounting and Business Research, 37(1), pp. 33-44. Stice, E. and Stice, J., 2013. Intermediate Accounting. Connecticut: Cengage Learning. Véron, N., 2008. Fair value accounting is the wrong scapegoat for the crisis. S Breugel Policy Contribution, May 2008. [online] Available at [Accessed 28 February 2014]. Bibliography Allatt, G., 2001. Fair value accounting: Examining the consequences. Balance Sheet, 9, pp. 22-26. Bath, M., 2006. Including estimates of the future in today’s financial statements. Accounting Horizon, 20, pp. 271-286. Bies, S. S., 2005. Fair value accounting. Federal Reserve Bulletin, 91, 26-30. Casabona, P. & Shoaf, V. (2010). Fair value accounting and the credit crisis. Review of Business, 30, pp. 19-31. Chambers, A., 2008). How do you mark to market? Euromoney, Fair value accounting: Breaking a butterfly upon a wheel? Balance Sheet, 9, p. 22-27. Elifoglu, I. H., Fitzsimons, A. P., and Lange, G. A., 2010. FASB proposal clarifies fair value measurement and disclosure. Commercial Lending Review, 75, pp. 42-48. Hague, I., 2001. Fair debate for fair value. CA Magazine, 134, pp. 47-49. Lempert, J. A. and Ward, K., 2011. Guide to accounting standards for private enterprises. Toronto: Canadian Institute of Chartered Accountants. Metzger, L. 2010. Mark to market governments. The Journal of Government Financial Management, 59, pp. 16-20. Poon, W. W., 2004. Using fair value accounting for financial instruments. American Business Review, 22, pp. 39-44. Power, M., 2010. Fair value accounting, financial economics and the transformation of reliability. Accounting and Business Research, 40, pp. 197-211. Read More