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Lecture 5 + summary PHP/A&W
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PHP: 4 A&W: 14 (chapters not included are already summarized in other lecture notes)
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Advanced Financial AccountingPHP: CH 2/4
Chapter 2: Strategy analysis
Industry analysis:
There are three potential sources of competition in an industry (degree to which there is
competition among suppliers of the same/similar products. Competitive forces:
1) Rivalry between existing firms
2) Threat of entry new firms
3) Threat of substitute products/services
4) Bargaining power of buyers
5) Bargaining power of suppliers
Potential limitation: Assumption that industries have clear boundaries.
Competitive strategy analysis:
Profitability depends also on the strategic choices it makes to cope with the competitive
forces. Two generic competitive strategies: 1) Cost leadership 2) Differentiation.
Corporate strategy analysis:
Not only industries and strategies of individual business units but also the economic
consequences of managing all the different businesses under one corporate umbrella.
A&W: CH 14
Chapter 14: Issues in financial reporting by multinationals
Values in accounting
Market values (less information, more reliable):
Entry value: Acquiring something (how much can you buy it for)
Exit value: Selling or liquidating something
Entity-specific value (more information, less reliable):
Value in use: Incremental firm value from continuing use of item. Differs from
company to company and is calculated by estimating and discounting net cash flows.
Only used as control measure in financial accounting.
Entry value measurement (historical cost model): Gross value of an asset is what it cost to
acquire it (market value at time acquired = historical cost)
Current value measurement: Remeasure the value of assets at reporting date (prescribe
value principle – decide on what basis a new value was to be derived)
Revised entry cost – what would it cost to acquire now an asset in the same age and
condition as existing asset (current cost).
,Inventories must be held at the lower of cost (normal convention) or net realizable value
(exit value of inventories). Exit value provides a ceiling for the carrying value of the
inventory.
The income statements articulate the balance sheet (statement of financial position) – an
explanation of changes in balance sheet.
General belief that currents accrual-based earnings measures are better predictor of future
cash flows than current cash flows – in making accrual adjustments, management build in
their view of the long-term likely outcomes.
Expanding measurement attributes
There are many changes in circumstances (like much use of derivatives, future unknown)
and there are boundaries of what is reported in financial statements.
Executory contracts (binding contracts where performance is not complete) are not
included in the traditional accounting model.
1) Onerous contract (the unavoidable cost of meeting obligations under the contract
exceeds the economic benefits expected from it) is a first step
2) Revenue from Contracts with Customers – with performance obligation (delivery
goods/services to satisfy contract), net effect on FS is nil.
Not only change in what should be measured, also how one might measure (better models,
established techniques) Fair value (price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at measurement
date)
A means of putting value on an incomplete transaction
Measurement attribute for subsequent measurement
Fair value measurement hierarchy:
1) Market with exactly same transactions in active market
2) Similar but not exactly the same transactions
3) No market transactions, use financial model to estimate market values
Identify the principal market; in absence use the most advantageous market (highest and
best use)
When determining the most relevant measurement basis:
a) What are the characteristics of asset or liability?
b) How will it contribute to future cash flows?
Mixed-attribute model: When considerations all factors, there will be different
measurement bases for different assets, liabilities, income and expenses (IFRS9 Financial
instruments)
Financial instruments
Derivatives have three characteristics:
, Value changes in response to market-related underlying variable (interest rate,
commodity price, foreign exchange rate)
They require no/relatively small initial investment
They are settled at a future date
Risky contracts
IFRS contains a basic model with three classifications of financial instruments and three
measurement approaches
Default measurement basis is fair value with changes flowing through profit or loss
(other two exceptions)
Measured at amortized cost (historical cost)
Instrument held to collect contractual cash flows, but which may also be sold (fair
value with changes through OCI)
Hedge accounting rules will apply if the financial instrument qualifies as an effective hedging
instrument – these rules will try to match gain or loss due to movements in hedged item
with corresponding movements in hedging instrument
Investment property and agriculture
IAS 40 – Investment property – Tangible non-current assets of property that are held as an
investment for the purpose of earning rental or for capital appreciation.
IAS 41 – Agriculture – Industry-specific standard and covers valuation of biological assets
and agriculture produce at the point of harvest.
Pension obligations
1) Defined contribution plan: The company pays fixed contributions to the fund and
has no obligation to pay further contributions if the fund does not hold sufficient
plan assets to pay the pension benefits
2) Defined benefit plans: Pension scheme guarantees to provide a pension to the
retired employees that is a proportion of their final salary or some average of their
later years working at the company.
The central problem with the defined benefit obligation is that the estimation is based on a
set of actuarial assumptions the company has to forecast how long employees will work,
what their final salary will be and how long they will live after retirement.
Changes in actuarial assumptions and unexpected changes in the fair value of the plan
assets, result in actuarial gains and losses.
Provisions imply a present obligation where an outflow of resources if probable
A contingent liability reflects a possible obligation or a present obligation where the outflow
of resources is not probable or cannot be measured with sufficient reliability.
Executory contract = a contract where the company has entered into an agreement, but
fulfilment of the terms has not been completed.
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