CHAPTER 18
Accounting values and reporting
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Contents
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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
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Different value perspectives
1)
2)
3)
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Entry and exit values are market values
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Entry value
Exit value
Value in use
Market buying price and market selling price of
an item
Value in use is an entity-specific value
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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
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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
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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
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Entry values are basic to the historical cost
model (initial measurement)
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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
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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.)
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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
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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
Replacement cost
Deprival value = lower of
Higher of Net realizable
value or Value in use
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Measurement focus
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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.)
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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
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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
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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
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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
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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
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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
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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
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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
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In IFRS, fair value accounting has come to
complement historical cost accounting in several
domains
Main fair value requirements:
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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
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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
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Derivatives are defined as financial
instruments exhibiting three characteristics:
1.
2.
3.
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Their value changes in response to a change in
some market-related underlying variable
It requires no or relatively small initial investment
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)
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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
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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
Measurement
of
financial assets
General:
Fair value
Specific:
Amortised cost
(historical cost)
Exception:
Hedge Accounting
Loans and receivables
Held-to-maturity
investments
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
Measurement
of
financial liabilities
General:
Amortised cost
(historical cost)
Held for trading
liabilities
(including derivatives)
Specific:
Fair value
Exception:
Hedge Accounting
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
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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 instruments
Remeasurement gains or losses
on financial instruments
(Changes in fair value)
Held for trading
(including derivatives)
Fair value option
Available-for-sale
Profit or loss of period
in which fair value
changes occur
Directly in equity
(through Statement of
Changes in Equity)
Special treatment
Hedge Accounting
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
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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
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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
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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.)
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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
Transactions with
shareholders
• Share issue
• Dividends
• Retirement of shares
…
Share capital
Share premium
Transactions with
others than
shareholders
Net profit or loss
Other
comprehensive income
recycling
Retained profit
Reserves
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Accumulated OCI
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
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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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts