AFM401 Chapter Notes - Chapter 7: Ias 39, Cash Flow Hedge, Financial Instrument

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Scott, Financial Accounting Theory, 6th Edition Instructor’s Manual Chapter 7
Copyright © 2012 Pearson Canada Inc
213
CHAPTER 7
MEASUREMENT APPLICATIONS
7.1 Overview
7.2 Current Value Accounting
7.3 Longstanding Measurement Examples
7.3.1 Accounts Receivable and Payable
7.3.2 Cash Flows Fixed by Contract
7.3.3 The Lower-of-Cost-or-Market Rule
7.3.4 Revaluation Option for Property, Plant, and Equipment
7.3.5 Ceiling Test for Property, Plant, and Equipment
7.3.6 Pensions and Other Post-Employment Benefits
7.3.7 Summary
7.4 Financial Instruments
7.4.1 Introduction
7.4.2 Valuation of Debt and Equity Securities
7.4.3 Fair Value versus Historical Cost
7.5 The 2007-2008 Market Meltdown Again
7.5.1 Standard Setters Back Down Somewhat on Fair Value Accounting
7.5.2 Derecognition and Consolidation
7.6 Derivative Instruments
7.6.1 Characteristics of Derivatives
7.6.2 Hedge Accounting
7.7 Conclusions On Accounting for Financial Instruments
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Scott, Financial Accounting Theory, 6th Edition Instructor’s Manual Chapter 7
Copyright © 2012 Pearson Canada Inc
214
7.8 Accounting for Intangibles
7.8.1 Introduction
7.8.2 Accounting for Purchased Goodwill
7.8.3 Self-Developed Goodwill
7.8.4 The Clean Surplus Model Revisited
7.8.5 Summary
7.9 Reporting on Risk
7.9.1 Beta Risk
7.9.2 Why Do Firms Manage Firm-Specific Risk?
7.9.3 Stock Market Reaction to Other Risks
7.9.4 A Measurement Approach to Risk Reporting
7.9.5 Summary
7.10 Conclusions on Measurement Applications
LEARNING OBJECTIVES AND SUGGESTED TEACHING APPROACHES
1. The Distinction Between Fair Value and Value-In-Use
This distinction is important since recent IASB accounting standards, such as IFRS 9,
exhibit some backing off from fair value towards amortized cost, a historical cost-based
version of value-in-use.
Points to bring out include:
The fair value hierarchy, including tradeoffs between relevance and reliability.
The concept of business model. This is a clever way to operationalize value-in-
use accounting. It controls the possibility that management may change its
intended use of an asset so as to influence the accounting valuation.
The concept of amortized cost.
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Scott, Financial Accounting Theory, 6th Edition Instructor’s Manual Chapter 7
Copyright © 2012 Pearson Canada Inc
215
The opportunity cost interpretation of fair value. This moves the income
statement in a stewardship direction since we can interpret measuring assets at
fair value as charging management with the opening opportunity cost of the
assets entrusted to it. The income statement can then be interpreted as a report
on the ability of management to earn more than cost of capital on assets used in
the business. If not, the firm would be better off to sell the assets (or dismiss the
manager).
2. To Review Long-Standing Examples of Current Cost Accounting
Section 7.3 is a mainly descriptive section designed to review common examples of
measurement. The concept of ceiling tests is important since they pervade fair value
accounting, particularly for financial instruments.
3. To Introduce the Accounting for Financial Assets and Liabilities
This is an extremely complex topic, and one which is undergoing considerable change.
The IASB is currently reviewing IAS 39 with a view to simplifying the accounting for
financial instruments. IFRS 9 is the first result of this process, with Financial
Instruments: Amortized Cost and Impairment (2009), currently at the exposure draft
stage, the second.
I feel it is important not to get bogged down in this topic. Suggestions for points that
can be usefully discussed are:
The financial instrument categories of IAS 39, and the intuition behind their
differing valuation bases. Theory in Practice 7.2 provides a vehicle to illustrate
some of the complexities here.
The concept of mismatch, leading to the fair value option. Theory in Practice 7.1
could be used as a basis for discussion. Theory in Practice 7.4 illustrates
another implementation of the fair value option, in a derivatives context.
The proposed new standards on derecognition can be used as a basis for
discussion of the standard setters response to some of the accounting problems
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