Advanced Accounting Theory & Practice - Essay Example

Advanced Accounting Theory & Practice A Showing the preference shares as equity, with no adjustments for the time value of money (in £) Stockholder’s Equity 2010 2011 2012 2013 Balance Sheet: equity 25,000,000 25,500,000 26,010,000 27,500,000 1. A. 2. Showing the preference shares as a financial liability, with no adjustments for the time value of money (in £) 2010 2011 2012 2013 Balance Sheet: Non-current liabilities 25,000,000 25,500,000 26,010,000 27,500,000 1. A. 3. Showing the preference shares as a financial liability, using amortised cost (in £) 2010 2011 2012 2013 Balance Sheet: Non-current liabilities 27,000,000 29,200,000 31,620,000 34,282,000 1. A. 4. Showing the preference shares as a financial liability at fair value through Profit & Loss. Income statement for year ended 2010 (in £) Loss on Financial Liability 0 Balance sheet for year ended 2010 (in £) Financial Liability 25,000,000 Income statement for year ended 2011 (in £) Loss on Financial Liability 500,000 Balance sheet for year ended 2011 (in £) Financial Liability 25,500,000 Income statement for year ended 2012 (in £) Loss on Financial Liability 510,000 Balance sheet for year ended 2012 (in £) Financial Liability 26,010,000 Income statement for year ended 2013 (in £) Loss on Financial Liability 1,490,000 Balance sheet for year ended 2013 (in £) Financial Liability 27,500,000 (Stice and Stice, 2013; Antle and Garstka, 2004; Warren, Reeve and Duchac, 2011; Rajasekaran, 2011) 1. B. IFRS 9 outlines the ways in which an entity should categorize and measure financial assets and liabilities which include a number of hybrid contracts. According to the set standard, an entity is required to recognize a financial asset or liability in their financial statements only when the entity becomes a party of the contractual requirements of the reported instrument (IFRS, 2012a). An entity is obligated to classify all financial liabilities as measured at amortized cost implementing the effective interest method. However, this method is not applicable for financial liabilities which are recognized at fair value through profit or loss. Such liabilities, which have been recognized at fair value through profit or loss, shall be consequently computed at fair value. The type of liabilities that fall under this category includes any financial liabilities that are reported for trading, derivate instruments which are liabilities and any financial liabilities which are designated at initial recognition. The IFRS 9 accounting standard is also applicable for financial guarantee contracts as well as any commitments to provide loan at a below market interest rate. The subsequent measurement of these types of liabilities involves: Computation of the amount according to the standards set under the IAS 37 for Provisions, Contingent Liabilities and Contingent Assets. The amount that is initially recognized less cumulative amortization which is recognized according to the regulations specified under the IAS 18 for revenue. Following that, the treatment of such liabilities involves the recognition of that amount which is higher when calculated according to the steps mentioned above. Another form of liability that falls under the parameters of IFRS 9 includes financial liabilities that may arise from the transfer of any particular financial asset. However, these assets are only to be recognized if they do not qualify for de-recognition and in cases where there is a perpetuating involvement. According to IFRS 9, the accounting treatment of these types of liabilities involves the following two steps: Subsequent measurement: The net carrying amount of the asset that is transferred and the liability associated with it is measured as either: Amortized cost of the obligations and rights that are retained (this step is applicable only if the transferred asset is computed at amortized cost). The fair value of the obligations and rights that are retained by the entity when they are measured separately (this step is applicable only if the transferred asset is computed at fair value) (BDO International, 2014a). Yeats PLC should treat the preference shares as liability because according to IAS 32, preference shares paying a fixed rate of dividend that has a feature which allows mandatory redemption at a later data are contractual obligations to deliver cash and hence should be recognized as liability and should be measured at their value (Delloite, 2014; BDO international, 2014b; IFRS, 2012b). (Word count – 466) 2. Over the last few years, U.S markets began to experience significant illiquidity and instability. This led to the creation of circumstances that made the assessments made using fair value more controversial. The values of the modern day innovate yet complex financial instruments such as mortgage backed securities, derivatives as well as other structured financial products are subject to market instability and illiquidity. Even though many researchers and market leaders agree on the fact that fair value gives a more relevant representation of financial instruments compared to historical cost method, this approach is not perfect (Penman, 2007). The controversies that surrounds the implementation of fair value measurement approach includes the implementation of this accounting approach in illiquid markets and when and how modelling should be implemented as a method to determine the fair value of a particular financial instrument. The recent conditions in the credit market have led to large write-downs through the implementation of fair value accounting. Majority of the charges have been witnessed in case of broker-dealer and banking industries. Companies that provide credit protection through instruments such as credit default swaps on an underlying asset, contrary to insurance contracts, have been affected largely because of fair value accounting approach. Although the default that would drive the need for credit protection may not have happened, still companies are obliged to recognize losses on a particular contract which are unrealized when the underlying assets’ fair value has decreased by a huge margin (Ball, 2006). Even corporations, who made investments in auction rate securities, have been affected when the value of those securities fell. The requirement for applying the fair value measurement approach has been heavily criticized because of the fact that it produces erroneous results during abnormal market conditions that were lately experienced. Such outcomes as a result of fair value accounting is said to have had long term consequences on companies. This is precisely because, if a company reports losses in such an unusual environment then according to critics, it relays a bad news to investors which may ultimately mislead them. Thus, it is always preferable to report only recognised gains and losses. Considering the controversy, it is essential to understand the fact that fair value accounting principle is developed with the underlying objective to revel information that will best serve the interests of businesses, investors as well as policy makers in the long run. In response to market instability and illiquidity, it is widely suggested that fair value accounting should either be modified or suspended for certain financial instruments. In addition, it is also suggested that that businesses have the liberty to apply their accounting models in order to show a less instable scenario. The current market is regarded as an anomaly and taking this fact into consideration, these concerns must equalized against the interest of the investors to know the current value of the assets (Laux and Leuz, 2009). Comparing the factors, it can be said that fair value still is the most effective method that gives the best reflection of the economic actualities of the market situation. If fair value were to be modified, suspended or replaced with another based on historical cost, investors will have to implementing their own accounting model in order to evaluate the current value of their assets (Landsman, 2007). This would give rise to less reliable results and may delay the recovery of the market. Even though investors believe the fact that fair value is the most appropriate model for determining the value of financial instruments, they are still concerned regarding the use of fair value accounting in cases when determining market price of financial instruments is difficult. This is precisely because fair value measurement involves the application of market price even if the market behaves erratically or evaluating the prices of similar securities. When neither of the above mentioned steps can be executed, then companies implement their own models in order to measure the fair value. The consequence of fair value accounting measurement on long term value is obviously a concern. However, whether the implementation of fair value accounting reflects long term value accurately or not can only be assessed in the long term. Fair value accounting enables a company to report the way current market situations are affecting their financial instruments. The reveal the same through their financial statements. This results in an enhanced transparency to the market as well as the investors (Elliott and Elliott, 2013). Concluding remarks Although the implementation of the fair value approach has been largely debated, however, this approach continues to be the best available alternative accounting model which enables a company to measure and record the values of financial instruments within their financial system. Markets respond to financial and accounting information related provide by fair value accounting model naturally. The effects of such evaluations whether it is positive or negative on a particular company are the result of forces that work within the market and not accounting models. When the conditions that prevail in the market leads to insatiability in the values as well as earnings, investors more often than not benefit when companies transparently report in these situations and their resultant effect on the financial reporting. Fair value is currently the best possible model available to companies to evaluate and report their financial assets. The model is based on market measures and estimates. Researchers have concluded that the current market valuations of certain complex securities, done using the fair value approach do not reveal the long term reality. Inspire of that, it is understood that the composite issues of assessment are open to arguments on both sides and whether or not it truly reflects the long term reality is a question that has to be assessed in the long run. However, till date the fair value approach has given a reasonably fair representation of the financial position of a company (PWC, 2008). (Word count – 981) Reference List Antle, R. and Garstka, S. J., 2004. Financial Accounting. Connecticut: Thomson South-Western. Ball, R., 2006. International Financial Reporting Standards (IFRS): pros and cons for investors. Accounting and Business Research, 36(1), pp. 5-27. BDO International, 2014a. IFRS 9 Financial Instruments. [pdf] BDO International. Available at: [Accessed 10 March 2014]. BDO international, 2014b. IAS 32 Financial Instruments: Presentation. [pdf] BDO International. Available at: [Accessed 10 March 2014]. Delloite, 2014. IAS 32 — Financial Instruments: Presentation. [online] Available at: [Accessed 10 March 2014]. Elliott, B. and Elliott, J., 2013. Financial Accounting & Reporting. 16th edition. New Jersey: Pearson. IFRS, 2012. IFRS 9 Financial Instruments. [pdf] Available at: [Accessed 10 March 2014]. IFRS, 2012b. IAS 32 Financial Instruments: Presentation. Available at: [Accessed 10 March 2014]. 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. PWC, 2008. Fair value accounting: Is it an appropriate measure of value for today’s financial instruments? [pdf] PWC Available at: [Accessed 10 March 2014]. Rajasekaran, V., 2011. Financial Accounting. New Delhi: Pearson Education India. Stice, E. and Stice, J., 2013. Intermediate Accounting. Connecticut: Cengage Learning. Warren, C., Reeve, J. and Duchac, J., 2011. Financial Accounting. Connecticut: Cengage Learning. Read More