Financial Accounting Theory Chapter 1 - Introduction

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References
Scott (2009) IASB Chapter 1 – Introduction Preface to IFRS (Jan 2010) Framework for the Preparation and Presentation of Financial Statements (Apr 2001) (ED May 2008) HKICPA Preface to HKFRS (Dec 2007) Framework for the Preparation and Presentation of Financial Statements (Dec 2007) CIMA FRC AICPA IAN Reading 1.1: Corporate Reporting, Financial Management, July/August 2009, pp 31 – 32 Reading 1.2: Louder than Words (in short), Retrieved August 2009, from http://www.frc.org.uk Reading 1.3: Shortridge, R. T., & Myring, M. (2004). Defining Principles-Based Accounting Standards, The CPA Journal Reading 1.4: Principles-Based Accounting Standards, 4th Global Public Policy Symposium (Jan 2008)
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Godfrey (2010) Chapter 1 – Introduction

Course objective
• To create an awareness and understanding of the financial reporting environment in a market economy – To describe and explore various theories that underlie financial accounting and reporting To explain and illustrate the relevance of these theories in order to understand the practice of financial accounting and reporting

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1970) – … the coherent set of hypothetical. 1970) – … logical reasoning in the form of a set of broad principles that: 1. conceptual and pragmatic principles forming the general framework of reference for a field of inquiry Accounting theory: (Hendriksen.Definition Definition of theory: (Hendriksen. guide the development of new practices and procedures 4 . provide a general framework of reference by which accounting practice can be evaluated and 2.

e. i. ad hoc fashion rather than systematically from a structured theory Accounting has frequently been described as a body of practices which have been developed in response to practical needs rather than by deliberate and systematic thinking (Chambers. 1963) • • 5 .Development of accounting theory • Accounting theory is primarily a modern concept when compared with. theories emanating from mathematics or physics Accounting has developed in an improvised. say.

Accounting theory timeline 6 .

1970: Normative period 1970s: Specific scientific theory/Positive era period 1980s: Behavioural accounting theory period 1990s: Conceptual framework period 2000s: Mixed development period (IASB Framework) 7 . 3. 5. 6. 2.1955: General scientific period 1956 . 1800 .Stages of major development 1. 4.

1800 . how firms already practised accounting • • • 8 . i.1955: General scientific period • Most theory developments were concerned with providing explanations of practice The emphasis was on providing an overall framework to explain and develop accounting practice Theories were developed largely on the basis of empirical analysis.e. which relies on real-world observations rather than solely on logic It involves developing a theory on the basis of what is observed.

e. The conceptual framework proponents 9 • • • . The critics of historical cost accounting 2. i.1956 . what should be vs what is Adopt an objective (ideal) stance and then specify the means of achieving the stated objective Two groups dominated the normative period: 1.1970: Normative period • Attempted to establish norms for best accounting practice Developed theories that prescribed what should happen.

Normative theories are based on value judgments A new form of empiricism which operates under the broad label of positive theory. the positive era The objective of positive accounting theory (PAT) is to explain and predict accounting practice • • 10 . Normative theories do not involve hypothesis testing 2.1970s: Specific scientific theory period • Two major criticisms of normative theories: 1.

even at the expense of shareholders If managers are remunerated partly with bonuses based on reported accounting profits.Example .Bonus plan hypothesis • This theory relies on managers being wealthmaximisers who would rather have more wealth than less. the managers have incentives to use accounting policies that maximize reported earnings in periods when they are likely to receive bonuses This theory leads to the prediction (hypothesis) that managers who are remunerated via bonus plans use profit-increasing accounting methods more than managers who are not remunerated via bonus plans 11 • • .

shareholders.1980s: Behavioural accounting theory period • The study of the behaviour of accountants or the behaviour of non-accountants as they are influenced by accounting functions and reports Primarily concerned with the broader sociological implications of accounting numbers and the associated actions of key players such as managers. creditors and the government as they react to accounting information Tends to focus on psychological and sociological influences on individuals in their use and/or preparation of accounting 12 • • .

Example Behavioural accounting theory • This theory predicts that loan managers cannot process all the financial information they receive. despite profitable activities. the manager would be predicted to place more reliance upon cash flow information than other information • 13 . so they assess firms’ credit risk using the information that is most relevant to the background of the loan manager If the loan manager had been involved with loans to firms that defaulted on their debt agreements because of poor cash flows.

Example Behavioural accounting theory • On the other hand. if the loan manager had been involved with loans to firms that defaulted because of unprofitable operations. the manager would be predicted to place more reliance upon the reported profit or loss and earnings prospects of prospective borrowers Behavioural accounting research (BAR) is concerned with improving the quality of decision making Has grown in acceptance but PAT still currently dominates the accounting research literature 14 • • .

recognition) and measurement of assets and liabilities Used in developing accounting standards and attempting to reduce the inconsistencies that arose from earlier ad hoc theory and practice developments 15 • • • . qualitative characteristics and rules for the definition (i.1990s: Conceptual framework period • An attempt to provide a definitive statement of the nature and purpose of financial reporting and To provide appropriate criteria for deciding between alternative accounting practices Outlined the objective.e.

Conceptual Framework of Accounting • Defined by the Financial Accounting Standards Board (FASB) in the United States as: – A constitution. function and limits of financial accounting and financial statements 16 . a coherent system of interrelated objectives and fundamentals that can lead to a consistent standards and that prescribes the nature.

2000s: Mixed development period • • Positive and behavioural theories Framework for the Preparation and Presentation of Financial Statements. adopted by IASB in April 2001 1. 3. 2. Defines the objective of financial statements Identifies the qualitative characteristics that make information in financial statements useful Defines the basic elements of financial statements and the concepts for recognising and measuring them in financial statements 17 .

Current structure of the IASB 18 .

the Trustees and the IASB. ‒ but the IASB has sole responsibility for setting accounting standards 19 . ‒ as well as a Standards Advisory Council (SAC) and the International Financial Reporting Interpretations Committee (IFRIC) • The IASC Foundation Trustees ‒ appoint the IASB members. exercise oversight and raise the funds needed.IASC Foundation • The IASC Foundation ‒ is an independent organisation having two main bodies.

IASB • Has sole responsibility for setting accounting standards – 15 board members as at January 2010. who come from different countries and have a variety of functional backgrounds (14 board members in 2009 and 16 in 2012) – members not dominated by any particular constituency or regional interest – foremost qualification for IASB membership is technical expertise 20 .

with a view to reaching consensus on the appropriate accounting treatment Address issues of reasonably widespread importance. not issues that are of concern to only a small minority of entities The findings are summarised and published in its IFRIC Interpretations 21 • • . accounting issues that are likely to receive divergent or unacceptable treatment in the absence of authoritative guidance.IFRIC • Review. on a timely basis within the context of current IFRS and the IASB Framework.

the International Accounting Standards Committee (IASC) ‒ After the establishment of the IASB. and – Interpretations (16 IFRIC and 11 SIC) – Standing Interpretations Committee (SIC) • The difference between IFRS and IAS: ‒ IASB has designated its accounting standards as IFRS ‒ IAS were issued by the IASB’s predecessor. as issued at 1 January 2010: – International Financial Reporting Standards (9 IFRS). – International Accounting Standards (29 IAS). IAS and Interpretations • IFRS are Standards and Interpretations issued by the IASB and comprise.IFRS. IFRS includes IAS 22 .

Accounting standards setting in Hong Kong HKSA (Hong Kong Society of Accountants): Jan 1973 – Sep 2004 becomes HKICPA (Hong Kong Institute of Certified Public Accountants) in Sep 2004 HKSSAP (Hong Kong Statements of Standard Accounting Practice): Jan 1973 – Dec 2003 becomes HKAS (Hong Kong Accounting Standards) in 2004 becomes HKFRS (Hong Kong Financial Reporting Standards) in 2004 23 .

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taking into account the diverse interests of both external users and management • • 25 .Textbook objective • The book is about accounting. not how to account. based on information economics Critically examines the broader implications of financial accounting for the fair and efficient operation of our market economy An understanding of the current financial accounting and reporting environment.

Organization of the textbook 26 .

1 .Organization of the book Users / Chapters External users => Chs 3-7 Chs 1-2 Current valuebased accounting Ideal conditions Information asymmetry User decision Accounting problem reaction Decision usefulness. full disclosure Mediation Adverse Rational selection investment (inside decision information) => Chs 12-13 Managers Chs 8-11 Standard setting Moral hazard (manager effort) Motivate and evaluate manager performance Precise and sensitive information => => 27 .Figure 1.

under both certainty and uncertainty • Under ideal conditions in an Arrow-Debreu economy. accounting is based on the present values of future cash flows • The present value model is highly relevant to financial statement users as it looks at the cash flows and profitability of the firm 28 .Ideal conditions • Chapter 2 reviews and analyzes the present value model.

Ideal conditions • Present value accounting (direct approach) is an example of the more general concept of fair value accounting • Another approach to fair value accounting is to value assets and liabilities at their market values (indirect approach) • Under ideal conditions. present value accounting is the more fundamental concept • When market values are not available. accountants usually fall back on present value to determine fair value 29 . present value and market value are the same (principle of arbitrage).

Determined using other valuation techniques • • 30 .The estimate of fair value shall be determined by reference to observable prices of market transactions for identical assets or liabilities at or near the measurement date whenever that information is available Level 2 .Determination of fair value Fair value hierarchy • Level 1 .Determined by adjusting observable prices of market transactions for similar assets or liabilities that occur at or near the measurement date Level 3 .

. also called exit value or opportunity cost. ED/2009/5) 31 1. 2. the amount that would be received or paid should the firm dispose of the asset or liability (“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”.Current value-based accounting • Two main current cost alternatives to historical cost for assets and liabilities Value-in-use such as discounted present value of future cash flows Fair value.

Information asymmetry • Information asymmetry .Some parties to business transactions may have an information advantage over others • Two main types of information asymmetry: – Adverse selection • Persons with an information advantage exploit this advantage .Insider trading – Moral hazard • Manager knows his/her actions in managing firm but shareholders do not .Manager shirking 32 .

Examples - Information asymmetry
• Example 1: Who would be first in line to purchase life insurance if there were no medical examination? – Is it Adverse selection or Moral hazard? Example 2: What quality of used cars are likely to be brought to market? – Is it Adverse selection or Moral hazard? Example 3: How hard would you work in this course if there were no exams? – Is it Adverse selection or Moral hazard?

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Adverse selection
• Definition: A type of information asymmetry whereby one or more parties to a business transaction, or potential transaction, have an information advantage over other parties (Chapter 1, page 13) • The tendency for the people who accept contracts to be those with private information that they plan to use to their own advantage and to the disadvantage of the less informed party

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Moral hazard
• Definition: A type of information asymmetry whereby one or more parties to a business transaction, or potential transaction, can observe their actions in fulfillment of the transaction but other parties cannot (Chapter 1, page 14) • When one of the parties to an agreement has an incentive, after the agreement is made, to act in a manner that benefits himself or herself at the expense of the other party

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User decision problem
• In presence of adverse selection problem – Rational investment decision • In presence of moral hazard problem – Motivate and evaluate manager performance

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Role of financial reporting
• To control adverse selection problem – Decision usefulness • Full and timely disclosure • To control moral hazard problem – Net income as a managerial performance measure • Sensitive and precise net income • Serve as an input into executive compensation contracts to motivate manager performance • Inform the managerial labour market, so that a manager who shirks will suffer a decline in income, reputation, and market value in long run
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and reduces the ability of insiders to take advantage of changes in fair values 38 . since it provides up-to-date information about assets and liabilities. hence of future firm performance.The fundamental problem of financial accounting theory • Investors’ interests are best served by information that enables better investment decisions and betteroperating capital markets • Providing it is reasonably reliable. fair value accounting fulfils this role.

such as one based on historical cost. a less volatile and more conservative income measure. may better fulfill a role of reporting on manager effort 39 . since this enables efficient compensation contracts and better operation of managerial labor markets • From a managerial perspective.The fundamental problem of financial accounting theory • Managers’ interests are best served by information that is highly informative about their effort in running the firm.

The fundamental problem of financial accounting theory • The best measure of net income to control adverse selection is not the same as the best measure to motivate manager performance – This implies that investor and manager interests conflict – Standard setting is viewed as mediating the conflicting interests of investors and managers in financial reporting 40 .

Enron Corp . electricity. natural gas. and weather futures To finance rapid expansion and support share price.Background • • A large US corporation with initial interests in natural gas distribution Successfully expanded its operations to become an intermediary between natural gas producers and users Subsequently extended this business model to a variety of other trading activities. including steel. Enron needed both large amounts of capital and steadily increasing earnings • • 41 .

Enron resorted to devious tactics One tactic was to create various special purpose entities (SPEs) . and effectively controlled by senior Enron officers • • 42 .limited partnerships formed for specific purposes. creating a temptation to disguise losses In the face of these challenges.Enron Corp .Background • Meeting these needs was complicated by the fact that its forays into new markets were not always profitable.

in return for notes receivable from the SPE The SPE could then borrow money using the Enron stock as security.Enron Corp . much of Enron’s debt did not appear on its balance sheet .Background • These SPEs were financed largely by Enron’s contributions of its own common stock.it appeared on the books of the SPEs instead • • 43 . and use the borrowed cash to repay its notes payable to Enron In this manner.

Enron Corp • On Enron’s books: Notes receivable $1.1 (billion) Capital stock $1. a shareholder? 44 .1 (billion) Capital stock issued to SPE owned by Enron officers • GAAP requires amounts due from shareholders be deducted from shareholders’ equity – Is a limited partnership. owned by Enron officers.

Enron Corp • Off-balance sheet financing – On SPE’s books: Cash xxx Debt xxx SPE borrowed money. using Enron stock as security Notes payable to Enron xxx Cash xxx Cash was paid to Enron to reduce its notes receivable from SPE – Enron had the cash but debt did not appear on its books 45 .

Background • In addition. Enron received fees for management and other services supplied to its SPEs. the SPE included increases in the value of this stock in its income As an owner of the SPE.Enron Corp .in effect. Enron included its share of the SPE’s income in its own earnings . Enron was able to include increases in the value of its own stock in its reported earnings 46 • • . and also investment income By applying fair value accounting to its holdings of Enron stock.

e. revenue would not have been recognized.Enron Corp • Enron rendered services to the SPE Accounts receivable $628 (millions) Net income $628 (millions) Services rendered to SPE 1997-2000 included If limited partnership had been consolidated. i. recognized only when earned outside the consolidated entity • 47 .

Enron Corp • Enron recorded its share of SPE profits Investment in SPE xxx Net income xxx Equity method of accounting for investment SPE profits included increases in fair value of its holdings of Enron shares Result: Enron included increases in the market value of its shares in its net income • • 48 .

Enron recognized that the SPE should have been consolidated: Shareholders’ equity $1.1 (billion) To deduct loan to SPE from shareholders’ equity • Also.1 (billion) Notes receivable $1.Enron Corp • In 3rd quarter of 2001. restated previous 4 years’ earnings to reduce by $628 millions 49 .

Department of Justice and Congress – Where were the auditors? The Board? 50 .Enron Corp • Impacts of the write-offs: – No effect on operating cash flow – Debt/equity ratio. debt covenants affected – Loss of investor confidence – Share price fell from $90 to 66¢ – Filed for bankruptcy protection on 2 December 2001 – Investigations by SEC.

Enron Corp .Special Purpose Entities (ED 10 Consolidated Financial Statements Dec 2008) Could comprehensive theory have prevented this? 51 • .Lessons • • • • • • Crucial role of investor confidence in financial information Role of auditor in adding credibility to financial information Off-balance sheet financing Earnings management Increased legislative reporting requirements Sarbanes-Oxley Act 2002 Standard setting: SIC-12 Consolidation .

Financial Accounting Theory Chapter 2 – Accounting under Ideal Conditions 52 .

IASB Project. Jan 2008 Reading 2. Exposure Draft.1: Revenue Recognition. Exposure Draft.3: Revenue from Contracts with Customers. Exposure Draft. Jun 2010 Reading 2. Jun 2010 Godfrey (2010) Chapter 6 – Accounting Measurement Systems 53 .2: Snapshot – Revenue from Contracts with Customers.4: Basis for Conclusions – Revenue from Contracts with Customers. Jun 2010 Reading 2.References Scott (2009) IASB Chapter 2 – Accounting under Ideal Conditions Reading 2.

Organization of Chapter 2 54 .

Ideal conditions of certainty • Assumptions – Known future cash receipts – Given interest rate • Basis of accounting – Present value • Income (true net income) recognition – As changes in present value occur 55 .

V.2 $150 $150 56 . Ltd.1 ---------.Example 2.1 Present value model under certainty • Consider P.0 ---------. a one-asset firm with no liabilities • The asset will generate end-of-year cash flows of $150 each for two years and then will have zero value • The risk-free interest rate in the economy is 10% • Time line: ---------.

10 + 150/(1.Example 2. the present value of the firm’s future cash flows is PA0 = $150/1.10)2 = $136.97 = $260.36 + 123.1 Present value model under certainty • At time 0 (the beginning of the first year of the asset’s life).36 57 . the present value of the remaining cash flows from the firm’s asset is PA1 = $150/1.33 • At the end of year 1.10 = $136.

36 58 BS 0 IS 1 ? BS 1 $150.1 .33 $260.97) $260.Present value model under certainty Financial statements Financial asset Cash Capital asset Opening value Amortization expense Accumulated amortization Total asset Shareholders’ equity Opening value Net income Total equity $260.33 26.33 ? (123.33 ? $260.03 $286.36 .33 $260.33 $286.Example 2.00 260.

at time 0. net income (NI) is simply interest on opening asset value = PA0 x 10% = $260.03 (accretion of discount) • It is also referred to as ex ante or expected net income since. the firm expects to earn $26. the expected net income will equal the ex post or realized net income 59 .1 Present value model under certainty • Since future net revenues are capitalized into asset value.03 • Since all conditions are known with certainty.Example 2.33 x 10% = $26.

Example 2.1 Present value model under certainty • The firm’s net income plays no role in firm valuation under ideal conditions of certainty • Future cash flows are known and hence can be discounted to provide balance sheet valuations • Net income is then perfectly predictable. being simply accretion of discount 60 .

e.Example 2. no information content • There is no information in the current net income that helps investors predict future economic prospects of the firm • These are already known to investors. the balance sheet contains all the relevant information and the income statement contain none.1 Present value model under certainty • In effect. and capitalized into asset valuation. i. under ideal conditions. by assumption 61 .

1 Present value model under certainty • Under ideal conditions. it is possible to prepare relevant financial statements that are also reliable • The process of arbitrage ensures that the market value of an asset equals the present value of its future cash flows • The market value of the firm is then the value of its net financial assets plus the value of its capital assets (less any liabilities) 62 .Example 2.

Ideal conditions of uncertainty • Assumptions – States of nature • Known set • Realization publicly observable – State probabilities • Objective • Publicly known – Given interest rate 63 .

Ideal conditions of uncertainty • Basis of accounting – Expected present value • Income (true net income) recognition – As changes in expected present value occur 64 .

Example Ideal conditions of uncertainty • You pay $100 to a bank to buy a 2-year investment which pays in each year $73.5 and $33.5 • The interest rate in the economy is 4% 65 .02 when the economy is bad with prob = 0.02 when the economy is good with prob = 0.

51 + 16.5(33.04 + (36.51)/1.Example Ideal conditions of uncertainty PA0 = [.98 + 49.0816 = $50.02)]/(1.02/1.04 + 53.51)/(1.02) + .51 + 16.02/1.00 NB: Risk-neutral valuation 66 .5(33.04)2 = $53.02 = $100.02) + .04 + [.04)2 = ($36.5(73.5(73.02)]/1.

the economy is good and so you receive $73.02) + .02 + [.02 + 50.98 = $124.04 = $73.02 PA1 = $73.Example Ideal conditions of uncertainty • Assume at end of year 1.5(33.5(73.00 67 .02)]/1.

02 + 0.50.100 = $24 68 . Change in balance sheet net assets – $124 .(100 .02 – (0.02)] = $4 + 20 = $24 3.02 .02 .02 = $24 2.Example Ideal conditions of uncertainty Net income for the year (good economy): 1.5 x 73.98) = $73. Sales less amortization format – $73.04 + [73.5 x 33. Alternative format of abnormal earnings – $100 x .49.

00 $100.02 100.00 $24.00 .00 24.02) (49.98) Accumulated amortization Total asset Shareholders’ equity Opening value Net income ($124 – 100) Total equity $100.Present value model under uncertainty Financial statements (Good economy) Financial asset Cash Capital asset Opening value Amortization expense ($100.00 – 50.00 $124.00 (49.00 69 BS 0 IS 1 $73.02) $100.00 $100.02 BS 1 $73.Example .00 $124.00 $100.

00 ? ? ? ? 70 BS 0 IS 1 ? BS 1 ? ? ? ? $100.00 $100.00 $100.Example .00 ? .Present value model under uncertainty Financial statements (Bad economy) Financial asset Cash Capital asset Opening value Amortization expense Accumulated amortization Total asset Shareholders’ equity Opening value Net loss Total equity $100.

Alternative format of abnormal earnings – $ =$ 3. Sales less amortization format – $ 2. Change in balance sheet net assets – $ 71 .Example Ideal conditions of uncertainty Net income for the year (bad economy): 1.

i.Lack of ideal conditions • Problems when conditions are not ideal – State probabilities are subjective.e.ready market value is not available – Information asymmetry 72 .market values do not exist for all firm assets and liabilities • Reasons for incompleteness – Thin markets . not objective – Incomplete markets • Definition of incompleteness .

Implications of lack of ideal conditions • Need for estimates (quantities. prices. timing) of states of nature • Need for estimates of state probabilities • Market value need not equal present value • True net income does not exist 73 .

Implications of lack of ideal conditions • Relevance and reliability must be traded off • Historical cost accounting a better tradeoff? – Relevance of historical cost accounting? – Reliability of historical cost accounting? 74 .

option pricing models => intrinsic value (IV) 75 .g. e.Fair value accounting • Implementing accounting under ideal conditions when ideal conditions do not exist • Meanings of fair value (FV) – Present value approach => present value (PV) – Market value approach => market value (MV) – Model-based approach.

Reserve recognition accounting (RRA) • Present value accounting applied to oil and gas reserves • An application of present value accounting when ideal conditions do not exist – Proved reserves – Discounted at mandated rate of 10% – Revenue recognized as reserves are proved – Major adjustments to previous estimates 76 .

Reserve recognition accounting • Relevance of RRA information? • Reliability of RRA information? • Management’s reaction to RRA – Concern about relevance and reliability – Concern about legal liability 77 .

Asset valuation is equivalent to income recognition • Proved reserves valued at present value ⇔ income recognized as reserves are proved • Proved reserves valued at cost ⇔ income recognized as reserves are sold • Recognition versus realization 78 .

67 = $6.02 .02 . Straight-line (SL) amortization: Net income = $73.50 = $23. Sum-of-years-digits (SOYD) amortization: Net income = $73.02 – 66.02 100/2 = $73.Relevance? Reliability? => Net income does not exist as a welldefined economic construct 79 .2/3 x 100 = $73.35 • Little theoretical basis to choose between different ways of accounting for the same thing .The challenge of historical cost accounting Amortization of capital assets (Good economy) 1.02 2.

Question 2-14 (page 48) Question 2-15 (page 49) 80 .Assignment questions 1. 2.

2008 • The asset will yield $500 cash at the end of each year from 2008 to 2010.Question 2-14 • Sure Corp operates under ideal conditions of certainty • It acquired its sole asset on January 1. inclusive. after which it will have no market value and no disposal costs • The interest rate in the economy is 6% • Purchase of the asset was financed by the issuance of common shares • Sure Corp will pay a dividend of $50 at the end of 2008 and 2009 81 .

Prepare a balance sheet for Sure Corp as at the end of 2008 and an income statement for the year ended December 31. Prepare a balance sheet for Sure Corp as at the end of 2009 and an income statement for the year ended December 31.Question 2-14 Required a. 2008 b. 2009 82 .

value-in-use) and market value (i. fair value)? Why? Under the real conditions in which accountants operate. to what extent do market values provide a way to implement fair value accounting? Explain d.Question 2-14 c. present value calculations tend to be of low reliability.e.. Why? Does this mean that present value-based accounting for assets and liabilities is not decision useful? Explain 83 . Under real conditions.e. Under ideal conditions.. what is the relationship between present value (i.

Question 2-15 • P Ltd operates under ideal conditions • It has just bought a capital asset for $3.210 cash flow at the end of one year and $2.100. which will generate $1.000 at the end of the second year • At that time. the asset will be useless in operations and P Ltd plans to go out of business • The asset will have a known salvage value of $420 at the end of the second year • The interest rate in the economy is constant at 10% per annum 84 .

Question 2-15 • P Ltd finances the asset by issuing $605 par value of 12% coupon bonds to yield 10% • Interest is payable at the end of the first and second years. at which time the bonds mature • The balance of the cost of the asset is financed by the issuance of common shares 85 .

Question 2-15 Required a. If ideal conditions do not hold. Prepare the present value-based balance sheet as at the end of the first year and an income statement for the year. Give two reasons why ideal conditions are unlikely to hold c. P Ltd plans to pay no dividends in this year b. but present valuebased financial statements are prepared anyway. is net income likely to be the same as calculated in part a? Explain why or why not 86 .

Irwin A classic textbook in accounting theory 87 Return .Reference 1 Hendriksen. Accounting Theory. Illinois: Richard D. E. (1970).

Hamilton. A. A. Tarca.. & Holmes.. (2010)... J. Hodgson.).Reference 2 Godfrey. J. S. Milton: John Wiley & Sons Australia A widely respected accounting theory textbook 88 Return . Accounting Theory (7th ed.

). Toronto: Pearson Prentice Hall Written in a friendly style with clear explanations. Financial Accounting Theory (5th ed.Reference 3 Scott. R. the textbook provides a thorough presentation of financial accounting theories Within this clear framework. (2009). W. it illustrates the theoretical concepts with plenty of examples to place them in context 89 Return .

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