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Regulation
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The market does not work efficiently and the regulation is costless
The information is public good, so it may under-produced without the
existence of regulation
Regulation is supplied in response to the demands of the public for the
correction of these inefficient or inequitable market practices.
Concludes we need regulation to get companies to report appropriately to
users
regulation 0
Lobby
definition Lobbying relates to the political process by which standards are set and
there should be some discussion of the nature of the standard setting
process where views can be expressed and considered, through such
mechanisms as providing feedback on exposure drafts, writing submission to
standard steers directly or indirectly.
Why to lobby Those affected by accounting standards have an incentive to lobby standard
setters to achieve a favourable outcome
Lobbying target Accounting standard setters, such as IASB, AASB, IASC
Lobbying players Large companies, large banks, government, auditors, causal users,
academics
Week2
Normative Positive
definition Recommend what should Describes, explains or predicts
happen; what ought to be activities
Prescribe action to achieve Help us understand what
specific objectives happens in the world
Examples Conceptual framework Agency theory
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Variety kinds of theories
Agency theory
Used to understand relationships whereby a principal employs the services of, and delegates
the decision making authority to, an agent.
Agency cost
Types of cost description Who bear the cost
Monitoring The cost of shareholder to monitor the shareholder
manager
Bonding Cost incurred by the managers to assure manager
that they act for the interest of
shareholders
Residual loss The cost suffered by the shareholders due shareholder
to the suboptimal behaviour of
management that cannot be eliminated by
monitoring and bonding
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Risk Shareholders prefer risk but managers do Under- Managers have incentives
aversion not investment not to invest in positive NPV
Solution: Profit based measurement projects that can increase
funds available to lenders
Share based compensation
Dividend Shareholders prefer receive dividend but Asset Managers choose riskier
retention managers prefer retain profit substitution investment to maximize
Solution: Link bonuses to dividend shareholder returns
payout ratio Lenders bear the risk, but
do not share any benefits
Link bonuses to profits
Claim Increase borrowing from
dilution higher priority debt can
reduce security to lenders
Debt covenant
definition A kind of Restrictions placed on borrowing by a lender
example limit borrowing and spending power
meet certain ratio (e.g. interest coverage ratio, gearing ratio, debt/asset
ratio)
keep certain level of cash
If default, immediate repayment
examples of liquidate / forced to sell assets
action work out a new agreement (renegotiation is costly)
Stakeholder theory
defeinition Considers the relationships that exist between the organisation and its
various stakeholders
Normative branch Managerial branch
Argues that organisations should treat The extent to which an organisation
all their stakeholders fairly. will consider its stakeholders is related
An organisation should be managed for to the power or influence of those
the benefit of all its stakeholders stakeholders.
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Question 2: Theories in accounting (week 2) and corporate governance (week 3) (14
marks)
Week3
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Question 3: Measurement and fair value (week 4) (8 marks)
Benefits and limitations of measurement
Historical Assets are recorded at the amount of cash paid or the fair value of consideration
Cost given to acquire. Liabilities are recorded at the amount of proceeds received in
exchange for the obligation
Fair value 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
Present Assets are carried at the present discounted value of the future net cash inflows
value that the item is expected to generate in the normal course of business. Liabilities
are carried at the present discounted value of the future net cash out flows that
are expected to be required to settle liabilities in the normal course of business.
Current Cost Item is valued and recorded at the amount that would be paid at the current time
to provide or replace the future economic benefits expected to be derived from
the current item
Market approach identify a market for an identical or comparable asset or liability (most
common used in active market)
Income approach Converting future cash flows or income and expense into a single present
value
Cost approach An estimate of the cost of replacing the service capacity of the asset
under consideration (current replacement cost)
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Comparison among different measurement
Potential users of the financial statements (What will provide the most decision
useful information)
Practical considerations
Is it possible to calculate
Impact on incentives
Reputational impact
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Question 4: Accounting for intangibles (week 5) (13 marks)
Week 5
Intangible asses
Unidentifiable intangibles:
Cannot be recognized as assets; The cost of developing these items cannot be separately
distinguished from the business as a whole.
Impairment or amortization
1. Active market should be The items traded in the market are homogenous;
2. Willing buyers and sellers can normally be found at any time; and
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Research and development
1. the technical feasibility of completing the intangible asset so that it will be available for use
or sale;
2. its intention to complete the intangible asset and use or sell it;
4. how the intangible asset will generate probable future economic benefits. Among other
things, the entity can demonstrate the existence of a market for the output of the intangible
asset or the intangible asset itself or, if it is to be used internally, the usefulness of the
intangible asset;
5. the availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset; and
6. its ability to measure reliably the expenditure attributable for the intangible asset during its
development
Major indicator:
a) The lessor transfers ownership of the asset to the lessee by the end of the lease
term;
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b) The lessee has the option to purchase the asset at a price that is expected to be
sufficiently lower than the fair value at the date the option becomes exercisable for
it to be reasonably certain at the inception of the lease that the option will be
exercised; fair value
c) The lease term is for the major part of the economic life of the asset even if title is
not transferred.
d) The leased assets are of such a specialised nature that only the lessee can use them
without major modification. At the inception of the lease the present value of the
Minimum lease payments amounts to at least substantially all of the fair value of the
leased assets.
e) At the inception of the lease the present value of the Minimum lease payments
amounts to at least substantially (90%) all of the fair value of the leased assets.
Other indicator:
1. If the lessee can cancel the lease, the lessors losses associated with the cancellation are
borne by the lessee.
2. The lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent.
Types of lease
Direct-financing lease The lessor provides the finance to acquire the asset and enters into a
lease agreement to lease the asset to the lessee. No sale is recorded, but
the lessor derives income through periodic interest revenue.
Sales type lease This lease involves manufacturers /dealers. It is where the fair value of
the property being leased differs from the cost of the leased asset to the
lessor. This is because the lessor has directly made the asset instead of
purchasing it.
Sale and leaseback A sale and leaseback transaction is one which first involves the sale of
transaction property, with all or part of that property being leased back to the seller
(lessee) by the purchaser (lessor). Depending upon the circumstances,
the leaseback may be classified as a finance or operating lease.
What advantages would a company gain from entering into a sale and leaseback agreement
It is a fast way for the company to obtain funds if the company has a liquidity problem; maybe the
interest rate in a lease is more attractive than business borrowing via a loan.
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Question 6: financial instruments and foreign currency transactions (week 7-9)
Week 7-9 (Calculation- in class exercises)
Foreign currency
The difference between functional currency and presentation currency
Functional currency is the currency of the primary economic environment in which the entity
operates
Presentation currency is the currency in which the financial statements are presented
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its
intended use or sale
It is required that the exchange difference related to qualifying assets should be included in the cost
of acquisition of the asset, to the extent that they arise before the assets cease to be qualifying
assets.
Only those differences occurring before an asset ceases to be a qualifying asset should be included.
Once the asset is no longer qualifying asset, the exchange rate difference shall be credited or
debited in the income statement.
However, the amount capitalised as the cost of the asset shall not exceed its recoverable amount. If
the cogs exceeds the recoverable amount, the excess shall be written-off to the income statement.
Financial instrument
Financial instrument: A financial instrument is any contract that gives rise to both a financial asset of
one entity and a financial liability or equity instrument of another entity
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Equity instrument: Any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities
Investments
Dividend payables
Borrowings
Preference shares: if there is an option to redeem the shares for cash, it should be debt rather than
equity. When distributions to shareholders are at the issuers discretion, shares are equity.
Initial recognition: Generally at initial recognition financial instruments are measured at fair value
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Some financial instruments
Forward contracts are OTC-traded derivatives with customized terms and Note: OTC stands for
over- the-counter features. Forward contract
International accounting
Week 10
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2. Uniformity versus flexibility:
Harmonisation : reconciling different points of view and reducing diversity, while allowing
countries to have different sets of accounting standards.
Convergence : A process that takes place over time, implies the adoption of one set of
standards across the globe.
benefit limitation
Providing a cost-effective way to institute a The adoption of IFRS may have limitations
comprehensive system of accounting primarily concerning differences in business,
standards. financial and accounting culture from one
country to another. IFRS
Especially for developing countries.
Enhanced the operation and globalisation of Certain standards and requirements may not
capital markets. reflect local situations
Reduced costs for financial report preparation.
Transportable accounting skills
Weak form: prices reflect information about past prices and trading volumes
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Semi-strong form: all publicly available information is rapidly and fully impounded into share
prices in an unbiased manner when released
Strong form: security prices reflect all information (public and private)
Market model
Why there is a greater share price reaction to earning s announcements released by small firms
than large firms?
Large firms have larger information available. So the new announcement is not surprise for large
companies and their share prices because such information is already impounded in share price.
Market value and book value are both measures of firm value
Share prices are considered as benchmark measures of firm value, which can be used to compare
usefulness of alternative accounting and disclosure. The share price includes intangible values from
human capital, and internally generated assets that are not permitted to be included in book value.
book value,
share value
Information transfer
Earnings announcements by one firm also results in abnormal returns to other firms in the same
industry
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Definition of sustainable development
Sustainable Development is development that meets the needs of the present without
compromising the ability of future generations to meet their own needs, including issues:
Intergenerational Equity
Intragenerational Equity
Eco-Justice
Eco-Efficiency
Sustainability reporting
A sustainability report refers to a report that not only presents information about the economic
value of an entity, but provides information upon which stakeholders can also judge the
environmental and social value of an entity.
It is not only for reporting purpose, but also for accounting, auditing and reporting.
Embedding sound corporate governance and ethics systems throughout all levels of an
organisation.
Formalising and enhancing communication with key stakeholders such as the finance sector,
suppliers, community and customers.
Integrated reporting
Creating a globally accepted integrated reporting framework which brings together financial,
environmental, social and governance information in a clear, concise, consistent and comparable
format
Advantages Disadvantages
Sets up systems and structures Additional compliance costs
for understanding impacts and Companies adopting a
risks compliance mentality
Provides investors with access whereby companies change
to non-financial risks. their practices in accordance
with the regulations rather in
the best interest of the
company
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Research Article summary
Research Article: Chief Executive Officer Departures and market uncertainty.
What is the article about?
Investigates whether the level of market uncertainty (provided by a firms stock return volatility)
differs between voluntary and forced CEO departures.
What do we already know about this topic and what is left to discover?
When new and price-sensitive information is released to the market, assuming the market is efficient,
investors revise expectations of firm value through stock trading, which affects stock return volatility.
CEO departure announcements release new and price sensitive information that triggers investors
reactions.
Empirical research
400 CEO departures (uni-variate analyses) or 259 CEO departures (multi-variate analyses) in
Australia between 1998 and 2009.
Data source: ASX announce cents from DatAnalysis, the time of the announcement was manually
collected using Factiva and SiRCA Australian Equities ASX announcement search functions.
Event window: [-7,+7], where day 0 is the date of the ASX announcement.
Use both company announcements and media reports to classify the type of CEO departure.
Previous studies rely on information contained in the official departure announcement, where
firms may deliberately misclassify.
Use shot-term stock return volatility as a more accurate estimator to isolate the effect of a single
disclosure.
Previous studies use one-run volatility which primarily reflects the underlying economics of the
firm, and limits its ability to capture the uncertainty surrounding a particular event.
What did the author(s) find and how did they find it?
The level of stock return volatility increases following announcements of CEO departures.
The increase in stock return volatility is more pronounced for forced CEO departures compared
to voluntary CEO departures, thereby supporting the signaling effect.
Signed cumulative abnormal returns are more negative for a forced CEO departure.
The magnitude of cumulative abnormal returns is smaller when a CEO successor is
simultaneously announced, as investors resolve uncertainties about the future direction of the
firm.
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Research Article: Corporate commitment to sustainability - is it all hot air?
What is it about?
Considers how social and environmental performance indicators are used within management
remuneration plans (MRPs).
Specifically, considers whether a sample of 10 carbon intensive Australian firms have included
social and environmental indicators as components of executive remuneration plans.
Why is it important?
Theoretical framework
Reviewed components used with MRPs in annual reports for key management personnel in 10
companies in 2010.
Compared disclosures from 1992 to 2010 for these firms.
Classified MRP components as financial or non-financial.
Despite increased talk about sustainability, remuneration of senior personnel has not changed
to take this into account in rewarding performance.
Statements in annual reports are symbolic - the sustainability image is not aligned with
measures used in remuneration.
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Research Article: The effect of National Culture, Acculturation, and Education on
Accounting Judgments: A Comparative Study of Australian and Chinese Culture.
What is the aim or objective of the study?
The study seeks to examine the influence of national culture on the judgments of Australian and
Chinese tertiary accounting students when they are interpreting selected IFRS that contain uncertainty
expressions. The study also examines whether cultural values of individuals can change because of
acculturation and accounting education.
Provides support for the notion that Chinese accounting students are more conservative than
Australian accounting students in assigning probabilities to in-context uncertainty expressions
contained in IFRS. However there is no difference in the judgments between Anglo-Celtic accounting
students and Chinese Australian accounting students. The level of tertiary education (first year and
third year) and national culture have a significant effect on judgments.
What are the implications for accounting practice, regulation and/or education?
The findings suggest that national culture has an influence on tertiary accounting students
interpretation of uncertainty expressions. Therefore presumed benefits of high levels of global
comparability of financial reports through convergence may not be realized due to cultural differences.
This has implications for policy makers, standard setters and regulatory bodies because results show
that it takes more than a single set of accounting standards to achieve high cross-national
comparability.
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Research Article: Derivatives use and financial instrument disclosure in the extractive
industries.
Explain why companies might enter into a forward hedge contract.
Companies enter forward hedge contracts as a means of managing financial risk against adverse
movements in exchange rates. It is a means of hedging against losses that might arise in the future in
relation to other assets or liabilities.
Explain the difference between a primary financial instrument and a derivative financial instrument.
Provide an example of each to support you answer.
Primary financial instrument generates rights and obligations between the parties directly involved in
the underlying transaction. Examples include: receivables, payables and equity securities
Derivative financial instruments are those which create rights and obligations that have the effect of
transferring one or more of the financial risks inherent in an underlying primary financial instrument,
and the value of the contract normally reflects changes in the value of the underlying financial
instrument. Examples include: forward contracts, interest rate swaps, foreign currency swaps,
options
Objective: to document the use and disclosure of derivatives in the extractive industries.
Sample firms are drawn from the Australian extractives industry over the 2008 calendar year resulting
in a final sample of 341 firms. Study examines the financial statements and note disclosures - therefore
referring to the firms annual report for evidence of derivative use.
Also develop a disclosure index and use regression analysis to examine the relation between firm
characteristics and the extent of financial instrument disclosure.
Findings:
Derivatives are used by 23% in the sample, with mitigation of commodity risk and foreign
exchange risk being the most common purposes for which derivatives are used.
The most common types of derivatives used are forward rate agreements and options.
Results indicate that derivative use is positively associated with financial risk and firm size. Empirical
results reveal that large firms with higher leverage, which use derivatives, and are audited by a Big 4
auditor provide more extensive disclosure of financial instruments.
Implications:
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Research Article: The Structure and Level of Remuneration Across the Top Executive
Team
What is it about?
Examines the level and structure of executive remuneration across the executive team
Why is it important?
CEO pay varies across industries - finance firms paying higher levels of salary. Reason?
Cash payments to CEOs are higher in 2009 than for other years. Reason?
No discernable difference in level of structure of executive pay between 2007-2008. Reason?
Finance sector is more likely to rely on bonuses than other sectors. Reason?
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