Accounting Theory and Standards - Assignment Example

Accounting Theory Name Institution Date Accounting Theory The published accounts used are balance sheets from the American International Group company for the year 2015 and year 2016. Question 1 There are several things that can be noted from the balance sheets for the 2015 and 2016. One of them is that there are various estimates in terms of value. It is notable that the entry on other assets, including restricted cash, on the two consequent balance sheets varies. Similarly, the entries on liabilities, on long term debt vary. The reason for selecting them as estimates or subjectively valued is due to the variance on the amount of money entered. The difference is not big but noticeable. The difference between the two estimates is reasonable reason being a difference in market value by virtue of appreciation or depreciation. Long term debts usually have interests attached to them. There is a difference in the closing and opening entries of the two balance sheets in regard to long term debts. This is due to an estimation of the interest accrued which is seen as earnings (Francis, 2011). It is also important to note that these balance sheets give an estimate in regard to the treasury stock. The amount in cash of the shares of the common stock is a subjective value due to the nature of the item. The nature of shares is that they cannot be held or touched hence given a fair value of their equivalent. The estimates are plausible due to the varying value of shares in that the stock market changes on daily basis. There may also be a risk that the obligation by other parties to get the value for all the shares of the company not being fulfilled (Francis, 2011). The other major balance sheet item that is subjectively valued is the future policy benefits for life, accident and health insurance contracts. The main reason as to why this can be classified as an estimate is because it depends on a future event happening. In case an accident or an illness does not befall there is an amount that the company will not part with in terms of claims (Christina 2016). The only sure thing to happen on this policy is death. But the mere fact that the other two are not bound to happen mean that part of what is contained in the balance sheet item on the policy is an estimate. The reason as to why the amount attached to the policy is an estimate is because medical costs may vary. Insurer competition and lack of transparency to make informed consumer decision are also reasons as to why these figures are estimates. Studies have indicated that majority of consumers leave the task of cost of various insurance policies to their employers. The consumers do not make informed decisions which means there is lack of cost transparency (Christina, 2016). These estimates are believable bearing in mind that they are a representation of the amount taken as insurance policies by different people. Similarly, it is likely that not all the policy holders will claim due to the reasons stated above. Question 2 An intangible asset is one that does not exist in a physical form, usually non-monetary, that is held for use in production or supply of various goods or services. It may also be for administrative or rental services. On the other hand, goodwill is a residual asset that is calculated after other tangible and intangible assets and liabilities have been recognized. Any change in recognition and measurement of intangible assets would consequently alter the amount of goodwill recognized in a company. This is what is referred to as goodwill impairment (Rusell, 2014). A company often uses resources, or incurs liabilities so as to maintain or develop its intangibles such as trademarks, licenses, or intellectual property. Goodwill is also another example of intangibles which can come up on acquirement or be generated internally. An intangible asset possesses characteristics such identifiability, control and future economic benefit (Rusell, 2014). The intangible asset should be identifiable, have control over a certain resource and have future economic benefits. Similarly, if an asset does not meet these standards, the expenditure to generate internally or acquire it is recognized as an expense if it is incurred. Some intangible assets may be in a physical material such as a film for videos, compact disk in case of software or legal documents for an asset such as a license (Thomas, 2014). A closer examination of the balance sheet indicates future economic benefits from intangibles such as policy benefits for life, accident and health insurance contracts. This future economic benefit from the intangible assets contained in the legal document is healthy for the company. The benefits of the current accounting for goodwill in AIG Company’s balance sheet justify the related costs. The financial statement indicates that the goodwill impairment test provides boundless decision. This information is useful because it indicates the goodwill and goodwill profits which is a healthy operating performance and financial condition of the company. The International Accounting Standards require that if there is no goodwill or if there is goodwill losses then a company’s financial condition is unhealthy. These are the applicable accounting standards in this case bearing in mind that it is located in the United States and Canada (James, 2014). Goodwill ought to be put into a test for impairment in case a prompting scenario which signals that the fair value of a company might be below its carrying amount. If such a scenario occurs, the company may first assess qualitative factors to determine whether the quantitative impairment is needed (James, 2014). If the assessment finds that goodwill might be impaired, then there is goodwill loss which is an indication that there are excesses of the carrying amount of the company over its fair value. Goodwill impairment loss should not exceed the company’s carrying amount of the goodwill. There ought to be disclosures under United States generally accepted accounting principles in this case, the GAAP. AIG Company has chosen to indicate the changes in goodwill in a tabular reconciliation since it is guided by these principles. This gives the investors and shareholders of AIG Company confidence that it in good condition since there is no goodwill impairment (James, 2014). Question 3 Equity is the least implemented element within the conceptual framework in the accounts. According to Keller et al (2011) equity refers to the residual interest in the assets of an organization after all liabilities are deducted. This means that equity is the balancing figure because it indicates the difference between the assets and liabilities. However, in the two balance sheets, some of the aspects of equity e were not integrated. Equity consists of the novel capital that the owner introduces (share capital/premium); the accrued retained profits of the organization (retained profits, unrealized asset increases in terms of revaluation reserves); as well as the equity interest from branch companies that the parent organization does not enjoy (the non-controlling interest). Equity can also encompass the equity component of convertible loan stock, variation between the increases and decreases in the non-controlling interests and contingently issuable shares. All these items are supposed to be included within equity component (Bauman, 2003). This is contrary to the analyzed balanced sheets where the balance sheet for year 2016 the items that are included are; AIG shareholders’ equity and Non-redeemable non-controlling interests. Similarly, the 2015 balance sheet also only included AIG shareholders’ equity and non-redeemable non-controlling interests. The most implemented element in the conceptual framework in the two balance sheets is the asset. Assets refer to as the resource that the entity controls due to past events and a resource that has constant economic benefits to the entity. Assets can be current, noncurrent or intangible. Whereas s the entity owns most of the assets, the ownership is not a requirement for recognition in the financial statement, but control is the main issue (Bontis, 2001). For instance, leases when it comes to a lessee with a finance lease fit the definition of an asset. This is because the economic actuality of a finance lease is a loan used to purchase an asset, and hence the accounting is an authentic presentation. In the two balance sheets, all items such as inventory, financial assets and even properties have been presented. Specifically, all investment such as fixed maturity securities, bonds available, equity securities and even Mortgage and other loans receivable have been presented in the balance sheets. In addition, cash component that consists of: accrued investment income, deferred income taxes, and deferred policy acquisition costs etc have been included. Generally, as asset is acknowledged in the balance sheet when it is likely that the asset will have economic benefits to the organization and that the asset has a measurable value (Bontis, 2001). In the both balance sheets, all assets that have economic benefits to the entity and whose value is measurable have been presented in the balance sheet. Question 4 According to the International Accounting Standards, fair value is defined as the amount for which a liability may be settled or an asset changed, between knowledgeable willing parties of sound minds, in an arm’s length transaction. However, it is important to note that the risk of non-performance or the risk that the obligation will not be fulfilled should be integrated into the fair value measurement (Bulls, 2007). Derivative financial instruments are normally recorded at fair value on the balance sheet either as liabilities or assets. The accounting for changes in the fair value of a varying instrument is usually determined by whether it has been selected and qualifies as an equivalent. Fair value equivalence is reflected on what the original instrument gains or losses on the derivative instrument to the extent that they are attributable to the accounting standards (Bulls, 2007). These changes are in value are clearly visible on the balance sheet of this company. A change in fair value before it is incepted is normally dependant on changes in the fair value of loans that are similar to it and changes in probability that the loan fund them as per the obligations that is normally affected by both change in interest rates and time that elapses. The probability of getting back loans in time and with the interest attached increases if the purpose of the loan creases. A good example is that of mortgage. The original value in the loan commitment is recognized through sale of loans when the original one is sold (Bulls, 2007). This has been the case in this company where long term debts and treasury stock, which is the amount in cash of the shares of common stock, rose. This brought about the changes in the entries on the two balance sheets. It was as a result of earnings from the interests which are seen as income. Derivatives that do not meet the standards of the GAAP or the International Accounting Standards are first recognized at fair value, with transaction costs expensed as incurred. The derivatives are measured again at fair value consequently with the changes in fair value recognized in earnings. Fair value is estimated using valuation techniques integrating estimates and suppositions that are in line with the prevailing market conditions. In case the fair value turns out to be positive, the derivative is recognized as a financial asset. When the fair value is negative the derivative is recognized as a financial liability (Chris, 2007). The figures that do not match in the two balance sheets are derivatives. This is because the figures at the closing dates of the year are higher than the figures on the opening dates of the year. They are the ones on “long term debt” entry while the other one is “other assets including restricted cash” entry. The question should be whether these derivatives meet the GAAP standards. The fair value is positive which means the derivatives are financial assets. This therefore means that the accounting standards have been adhered to by the AIG Company. References Bauman, M. P. (2003). The impact and valuation of off-balance-sheet activities concealed by equity method accounting. Accounting Horizons, 17(4), 303-314. Bontis, N. (2001). Assessing knowledge assets: a review of the models used to measure intellectual capital. International journal of management reviews, 3(1), 41-60. Chris P. (2007). Managing Your Investment. Chester: 76 Minn. Christina E. (2016). Costs of Insurance Policies. Exploring Variability. Geneva: Open University Press Francis J. (2014). Accounting for Derivative Financial Instruments. Cambridge Mass.: Harvard University Press James L.K. (2014). Accounting Standard (AS) 26.Washington: World Bank Keller, K. L., Parameswaran, M. G., & Jacob, I. (2011). Strategic brand management: Building, measuring, and managing brand equity. Sydney: Pearson Education. Russell G.G. (2014). Financial Accounting Series. Accounting Standards. Washington: Small Business Administration. Thomas B. (2004). State-Mandated Benefits and Employer-Provided Health Insurance," Journal of Public Economics, 55(2). Read More