‘Deprival value’ vs. ‘fair value’ measurement for contract liabilities: how to resolve the ‘revenue recognition’ conundrum?

Revenue recognition and measurement principles can conflict with liability recognition and measurement principles. We explore here under different market conditions when the two measurement approaches coincide and when they conflict. We show that where entities expect to earn ‘super profits’ (residual income) the conceptual conflict is exacerbated by the adoption of ‘fair value’ (FV) as the measurement basis for assets and liabilities rather than the more theoretically grounded approach of ‘deprival value/relief value’ (DV/RV) which better reflects the impact of, and rational management response to, varying market conditions. However, while the problems of balance sheet liability and revenue recognition, and the related problems of income statement presentation, can be resolved by the application of DV/RV reasoning, this is not sufficient fully to resolve issues of the appropriate timing of profit recognition. Performance measurement issues still need to be addressed directly. The standard setters' current projects on ‘revenue recognition’, ‘insurance contracts’ and ‘measurement’ therefore need broadening to consider the pervasive issue of accounting for internally generated intangibles.     

Fair value accounting and the present value fallacy: The need for an alternative conceptual framework

The major functions of company accounting identified by the IASB and the FASB are (1) reporting on ‘the custody and safekeeping’ of the company's resources and (2) reporting on ‘their efficient and profitable use’. The joint IASB/FASB project for improving the conceptual framework for financial reporting is directed towards better performance of both functions within the conventional ‘accrual’ system of accounting through the use of ‘fair value’. Although the disclosure of fair values is a development to be welcomed, the requirement that changes in fair value should be reported as ‘gains’ or ‘losses’ appears to rely on the ‘Hicksian’ concept of income as a theoretical ideal.The object of the present paper is to establish that this concept is fundamentally flawed by what may be called the ‘present value fallacy’. Even in an economic utopia of perfectly competitive markets (with no discrepancies between objective market values and subjective present values), the concept of income or profit as value growth can be seriously misleading.If the prevailing Hicksian conceptual framework is discarded in favour of an alternative based on Fisher's theory of income, the two major, but incompatible, functions of financial reporting can be carried out independently and without compromise. The conventional ‘hybrid’ system of accrual accounting, in which backward-looking measures of volume and forward-looking measures of value are mixed together, would be replaced by a ‘segregated’ system in which they are kept strictly apart. A logical extension of Fisher's theory suggests the disclosure by agent/managers of the return on investment that they are planning to deliver to their principal/owners. This type of ‘decision-useful information’ is vital for the efficient operation of capital markets and for removing the accounting incentive to short-termism.     

LESSORS' DEPRECIATION AND PROFIT-AN APPROACH VIA DEPRIVAL VALUE

Lessor accounting raises intriguing problems. Its accepted methods spread depreciation, and thus profit, in yearly doses whose size jumps capriciously and with scant regard to any principle. Yet the economic qualities of an (asset do not change just because it is leased; the only new factor is the odd way in which tax and interest re-shape its cash flows. If the rules of deprival value are sound for familiar assets, they should be sound too for leased assets. But its arithmetic must expand to cover flows (tax and interest) that are not usually coupled with depreciation. Two results then follow: after-tax profit tends to be constant throughout the lease, and the full size of tax bounty becomes clear.     

Bivariate normal mixture spread option valuation

We discuss the pricing and hedging of European spread options on correlated assets when the marginal distribution of each asset return is assumed to be a mixture of normal distributions. Being a straightforward two-dimensional generalization of a normal mixture diffusion model, the prices and hedge ratios have a firm behavioural and theoretical foundation. In this ‘bivariate normal mixture’ (BNM) model no-arbitrage option values are just weighted sums of different ‘2GBM’ option values that are based on the assumption of two correlated lognormal diffusions, and likewise for their sensitivities. The main advantage of this approach is that BNM option values are consistent with both volatility smiles and with the implied correlation ‘frown’. No other ‘frown consistent’ spread option valuation model has such straightforward implementation. We apply analytic approximations to compare BNM valuations of European spread options with those based on the 2GBM assumption and explain the differences between the two as a weighted sum of six second-order 2GBM sensitivities. We also examine BNM option sensitivities, finding that these, like the option values, can sometimes differ substantially from those obtained under the 2GBM model. Finally, we show how the correlation frown that is implied by the BNM model is affected as we change (a) the correlation structure and (b) the tail probabilities in the joint density of the asset returns.     

Use of CCA in the Public Sector: Lessons From Australia's Experience With Public Utilities

The background to the widespread adoption by Australian public trading enterprises of a deprival value variant of current cost accounting reflects successive efforts to establish demanding rate of return targets, or to legitimise price increases, or to monitor the financial performance of PTEs on a national basis. The experience of three public utilities in implementing CCA is reviewed. This experience suggests that CCA valuation of infrastructure (using deprival or optimized deprival values) is unable to deliver financial data to permit valid cross-sectional and longitudinal comparisons of performance. Issues raised during the 1970s and 1980s debates about CCA were either ignored or overlooked.     

Equity Financial Assets: A Tool for Earnings Management—A Case Study of a Chinese Corporation

With China’s adoption of principles-based international accounting standards and its convergence with International Accounting Standard 39 (IAS 39), Chinese companies have discretion under the original Accounting Standards for Enterprises 22 (CAS 22) as to how they account for the initial measurement, sale, and subsequent reclassification of financial assets. We use a Chinese company (‘Company A’) as a case study to illustrate how earnings are managed to exploit this discretion. We document that the company re-classifies its available for sale equity investments as long-term equity investments to decrease the volatility of the company’s apparent profits. We also make some predictions regarding how the company will handle its financial assets under the new standard, which is the same as IFRS 9. Our research contributes to the continuous improvement of China’s accounting standards and has implications for regulators of the capital market.     

Small fish in big ponds: Connections of green finance assets to commodity and sectoral stock markets

We analyze return and volatility connectedness of the rising green asset and the well-established US industry stock and commodity markets from September 2010 to July 2021. We find that the time-varying return and volatility connectedness have exhibited serious crisis jumps. Some individual assets of both the green and commodity markets are in connection to the US sectoral stock market returns, and the volatility connections are even more common than the return connections. Furthermore, some financial and economic uncertainty indicators manifest positive impacts from the volatility of some ‘big pond’ markets for e.g. commodities, whereas some others affect the connectedness negatively. Additional analysis of financial and economic uncertainty indicators manifests positive impacts from the volatility of some ‘big pond’ markets, e.g., commodities, while others negatively affect the connectedness.     

Concentration and profits: A test of the accounting bias hypothesis

An extensive research tradition in economics considers the degree to which leading firms of dominant proportions use the advantages of large relative firm size to earn above normal or monopoly profits. To date, the findings of this research remain inconclusive and controversial. This study considers the hypothesis that accounting method selection bias may be responsible, at least in part, for confounding the results of empirical research on the issue. Using a general framework featuring alternate accounting and nonaccounting market value-based measures of profitability, we find consistent and robust evidence rejecting a monopoly-based explanation of leading firm profits. The consistency of results across profit measures is important from an accounting and public policy perspective because, at least in terms of the monopoly profits issue, accounting method selection bias does not emerge as an important factor limiting the usefulness of accounting data.     

Leveraged Lévy processes as models for stock prices

Adopting a constant elasticity of variance formulation in the context of a general Lévy process as the driving uncertainty we show that the presence of the leverage effect? ?One explanation of the documented negative relation between market volatilities and the level of asset prices (the ‘smile’ or ‘skew’), we term the ‘leverage effect’, argues that this negative relation reflects greater risk taking by the management, induced by a fall in the asset price, with a view of maximizing the option value of equity shareholders. in this form has the implication that asset price processes satisfy a scaling hypothesis. We develop forward partial integro-differential equations under a general Markovian setup, and show in two examples (both continuous and pure-jump Lévy) how to use them for option pricing when stock prices follow our leveraged Lévy processes. Using calibrated models we then show an example of simulation-based pricing and report on the adequacy of using leveraged Lévy models to value equity structured products.     

Legitimating the standard-setter of public sector accounting reforms

ABSTRACT

This paper shows how the Brazilian Treasury has developed strategies to build legitimacy in a civil law context where the legislature left a vacuum regarding the accrual accounting standard-setting mandate. While the accounting ‘rule-enforcers’ neglected to require compliance with the rules, the ‘rule-makers’ co-operated with each other to build normativity for accounting rules and eventually attempted to develop new forms of enforcement, which the ‘rule-appliers’ lobbied against.     

Pro-producer regulation and accounting for assets: The case of electric utilities

This paper's thesis is that rate-of-return regulation of the electric utility industry was a pro-producer regulatory policy, and that supra-competitive returns were earned by regulated utilities even while their accounting rate-of-returns met the ‘fair’ return constraint established by law. It is argued that this was accomplished by using the accounting system to revalue upward the asset bases of regulated utilities. The empirical results support this hypothesis in that utilities regulated by state commissions had abnormally high book values for their assets compared with unregulated utilities in 1917 and 1922.     

Good-Deal Option Price Bounds for a Non-Traded Event with Stochastic Return: A Note

Cochrane and Sa'a-Requejo (2000, Journal of Political Economy) proposed the good-deal price bounds for the European call option on an event that is not a traded asset, but is correlated with a traded asset that can be used as an approximate hedge. One remarkable feature of their model is that the return on an event process explicitly appears in the option price bounds formula, which offered a contrast with the standard option pricing model. We show that the good-deal option price bounds on a non-traded event are obtained as a closed-form formula, when the return on an event is governed by a mean reverting process.     

Rechnungslegung und Aufsicht von Versicherungsunternehmen — Zur Vereinbarkeit von IFRS und Solvency II

Current discussions of Insurance Accounting and supervisory regulation present some major challenges for insurance companies. The International Accounting Standards Board (IASB) started a project on Insurance Accounting to apply the principles of fair value to insurance liabilities. At the same time ‘Solvency II’ contains a fundamental and wide-ranging review of the insurance solvency regime in the light of adequate risk consideration. The paper discusses the aims and problems of both projects. The separate illustration presents the basis to identify the essential interdependences of ‘Insurance IFRS’ and ‘Solvency II’.The main problem is to create a unique valuation basis for Insurance Liabilities which makes allowance for relevant and reliable accounting rules as well as for solvency margins. On the basis of an actuarial approach an adequate model is shown. The construction of Fair Value contains the deviation of a Market Value Margin (MVM), which reflects the premium that a marketplace participant would demand for bearing the uncertainty inherent in the cash flows. For the purpose of solvency additional risk components must be integrated due to the fact that the Market Value Margin basically does not allow for all parts of volatility and uncertainty risk in insurance liabilities.     

会计准则改革、会计利润信息与银行债务契约

本文考察了新、旧准则下合并报表净利润对银行信贷决策有用性的变化,以及新、旧准则下合并—母公司净利润差异对银行信贷决策有用性的变化。研究发现,合并报表净利润是银行信贷决策的重要依据,新准则下合并报表净利润与债务契约的相关性减弱,且公允价值变动损益高的公司更明显。论文还发现,新准则实施后,合并—母公司净利润差异与企业获得银行借款的相关性减弱,说明新准则下的合并母公司净利润差异为银行信贷决策提供了新的信息含量。     

When Does Extra Risk Strictly Increase an Option's Value?

It is well known that risk increases the value of options. Thisarticle makes that precise in a new way. The conventional theoremsays that the value of an option does not fall if the underlyingasset becomes riskier in the conventional sense of the mean-preservingspread. This article uses two new definitions of "riskier" toshow that the value of an option strictly increases (i) if theunderlying asset becomes "pointwise riskier," and (ii) onlyif the underlying asset becomes "extremum riskier."     

A theoretical analysis connecting conservative accounting to the cost of capital

We connect conservative accounting to the cost of capital by developing an accounting model within an asset pricing framework. The model has three distinctive features: (1) transaction-cycle-conformity, where the book value equals the value of cash at the beginning and the end of a cash-to-cash transaction cycle; (2) a revenue recognition principle, where uncertainty affects the amount of revenues recognized; (3) a matching principle, where expenses are matched with revenue with a conservative bias due to uncertainty. We demonstrate how the growth rate of expected earnings, the accruals-to-cash ratio, and the expected earnings yield relate to the expected stock return.     

The development of fixed asset accounting in South African gold mining companies: confronting the issues of prudence,matching, periodicity and capital maintenance

The ‘Appropriation Method’ of accounting applied by South African gold mining companies is fundamentally different from mine accounting elsewhere and results in reported earnings and asset values that are not comparable with those of mining companies in other countries. This paper traces the development of the Method, in an historical context, in an attempt to understand why, and how, it emerged and became established. Particular attention is paid to 19th century writings of local accountants, ‘transactions’ of professional bodies, and to the special characteristics of the South African gold mining industry. Transitional processes are illustrated by reference to the published accounts of the Crown Reef Gold Mining Company. The persistence of the Appropriation Method is a reminder that while assumptions of uniform accounting periods, matching, business continuity and the need for capital maintenance underpin most conventional accounting, nevertheless useful accountings can exist without these assumptions.     

Leverage effect breakdowns and flight from risky assets

Though part of ‘market lore’, in 1976 Black first reported the inverse relationship between price and volatility, calling it the ‘leverage effect’. Without providing evidence, in 1988 Black claimed that in the months leading up to the October 1987 crash the relationship changed: price and volatility both rose. Using daily data for the Old VIX, derived from S&P 100 Index option market prices, to estimate intra-quarterly regressions of implied volatility against price from Q2 1986 to Q1 2012, the author verifies Black’s claim for the October 1987 crash, and interestingly, for subsequent periods of crisis. He then analyses several constant-elasticity-of-variance optimal portfolio rules, which include the leverage effect, to show the elasticity sign switch implies that investors reduce their risky asset holdings to zero.     

A closed-form solution for options with ambiguity about stochastic volatility

We derive a closed-form solution for the price of a European call option in the presence of ambiguity about the stochastic process that determines the variance of the underlying asset’s return. The option pricing formula of Heston (Rev Financ Stud 6(2):327–343, 1993) is a particular case of ours, corresponding to the case in which there is no ambiguity (uncertainty is exclusively risk). In the presence of ambiguity, the variance uncertainty price becomes either a convex or a concave function of the instantaneous variance, depending on whether the variance ambiguity price is negative or positive. We find that if the variance ambiguity price is positive, the option price is decreasing in the level of ambiguity (across all moneyness levels). The opposite happens if the variance ambiguity price is negative. This option pricing model can be used to address various empirical research topics in the future.     

Intra–day Behavior of Treasury Sector Index Option Implied Volatilities around Macroeconomic Announcements

If option implied volatility is an unbiased, efficient forecast of future return volatility in the underlying asset, then we should be able to predict its path around macroeconomic announcements from responses in cash markets. Regressions show that volatilities rise the afternoon before announcements that move cash markets, and that post–announcement volatilities return to normal as rapidly as cash prices do. Although implied volatilities are predictable, the Treasury options market is efficient since informed traders do not earn arbitrage profits once we account for trading costs.