Chapter 1 ACC 301 Accounting Theory & Contemporary Issues Recap Slides – Week 6 COMMONWEALTH OF AUSTRALIA Copyright Regulations 1969 WARNING This material has been reproduced and communicated to you...

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Chapter 1 ACC 301 Accounting Theory & Contemporary Issues Recap Slides – Week 6 COMMONWEALTH OF AUSTRALIA Copyright Regulations 1969 WARNING This material has been reproduced and communicated to you by or on behalf of Kaplan Business School pursuant to Part VB of the Copyright Act 1968 (the Act). The material in this communication may be subject to copyright under the Act. Any further reproduction or communication of this material by you may be the subject of copyright protection under the Act. Do not remove this notice. Introduction • Historical factors in the development of accounting including: • The separate legal liability of companies • The establishment of limited liability • The separation of ownership from control • The difference between normative (prescriptive) and positive (descriptive) accounting theories Conceptual framework • Understand the role of a framework and know the key elements of one including the fundamental and enhancing qualitative characteristics of useful financial information given in the current IASB framework: • Fundamental: • Relevance (incl. materiality) • Faithful representation (substance over form, complete, neutral, free from error) • Enhancing: • Comparability • Verifiability • Timeliness • Understandability Conceptual framework • Understand the limitations of the current IASB framework • Is it consistent with accounting standards in all cases? • When there is an apparent inconsistency, which prevails – standards or framework? • What is the difference between rules based and principles based standards? Which do you prefer? The Benefits Of A Conceptual Framework • Technical Benefits • Improve the practice of accounting and to provide a basis for answers to specific accounting questions and problems. • It is stated that the Conceptual Framework does this in two ways: • By providing a basis and guidance for those who set the specific accounting rules. • By helping individuals involved in preparing or auditing or using financial statements. The Benefits Of A Conceptual Framework • Political Benefits • Prevent political interference in setting accounting standards. • Accounting information has significant real-world affects • Professional Benefits • Protect the professional status of accounting and accountants. Problems & Criticisms Of The Conceptual Framework • It is ambiguous • The principles are too vague • Too much room for alternative interpretations. • It is descriptive not prescriptive • The Conceptual Framework simply describes current accounting practise. • Should be prescriptive (normative) and try to improve practice. Problems & Criticisms Of The Conceptual Framework • The concept of faithful representation implicitly assumes that there is one best or ‘most correct’ method of accounting preparation and presentation – this reflects the realist view that: Financial statements . . . are representationally faithful to the extent that they provide an objective picture of an entity’s resources and obligations • However, the materialist view suggests that there are multiple versions of the ‘truth’ rather than one being the ‘most correct’: Although the underlying events and transactions do exist the accounting measures that are reported are created by accountants and do not exist independently of them. 2 7 Problems & Criticisms Of The Conceptual Framework What do you see in the picture below? A picture or a series of transactions may have more than one ‘correct’ interpretation – again this is the materialist view. See the example on page 46. Theories in Accounting You should understand: • Agency theory (incl. information asymmetry) • Contracting theory • Legitimacy theory • Stakeholder theory: • Normative (ethical) – consider all stakeholders • Positive (managerial) – most powerful considered first • Institutional theory • Contingency theory Regulation Understand arguments for and against regulation of the accounting profession and associated theories, including: • Signalling theory • Legitimacy theory (again) • Public interest theory • Capture theory • Bushfire theory • The role of lobbying Advantages of Regulation 1 • Increased efficiency in allocating capital. 2 • Cheaper production. 3 • Check on perquisites 4 • Public confidence. 5 • Standardisation. 6 • Public good. Disadvantages of Regulation 1 • Difficult to achieve efficiency and equity. 2 • Determining the optimal quantity of information is problematic. 3 • Regulation is difficult to reverse. 4 • Communication is restricted to that specified by the regulations. 5 • Reporting entities are different – “one size fits all” doesn’t work 6 • There is lobbying. 7 • Monopolisation of accounting standards. Measurement • Understand the different bases which can be used for measurement, including: • Historical cost (modified) • Fair value (broadly exit price) • Current cost (entry price) • Present value (value in use) • Deprival value • Understand what a ‘mixed measurement’ model is • Understand the arguments for and against the increasing use of fair value accounting Fair Value Defined • Fair value is 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. (IFRS 13/AASB 13, Para. 9) Fair Value Hierarchy • Level 1 Inputs • Quoted prices (unadjusted) in active markets for identical assets or liabilities. • Level 2 Inputs • Inputs other than quoted prices included within Level 1 that are observable. These include prices for similar (but not identical) items, such as a similar building in a similar location. • Level 3 Inputs • Inputs that are not based on observable market data (unobservable inputs). These could include estimates of future cashflows. The Importance of the Concept of a Market An inactive market would be characterised by: a) Few recent transactions. b) Price quotations are not developed using current information. c) Price quotations vary substantially. d) Indices that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated. e) The market has gone toxic. f) There is a wide bid-ask spread. g) There is a significant decline in the activity. h) Little information is publicly available. Financial reporting process & Earnings management • Understand what earnings management is • Understand why it is undertaken • Earnings quality • Describe and explain specific methods of earnings management • Argue whether earnings management is a good or bad thing • Do accountants only have big baths when they are dirty?