The impact of IAS 39 on the risk-relevance of earnings volatility: Evidence from foreign banks cross-listed in the USA

We examine the impact of adopting International Accounting Standard 39 – Financial Instruments: Recognition and Measurement (IAS 39) by non-US commercial banks cross-listed in the US on earnings volatility and its risk relevance. As IAS 39 requires the recognition of unrealized fair-value gains and losses for a larger set of financial and derivative-financial instruments, and the impairment charges for loans and receivables, we expect and find that IAS 39 adoption increased earnings volatility in IFRS-adopting firms from 2005 onwards. Furthermore, both hedge accounting and the fair value option under IAS 39 are designed to reduce mixed-measurement volatility and to improve the sensitivity of firm risk measures to earnings volatility. We also find that the relationship between credit ratings (proxy for risk) and earnings volatility increases for IFRS-adopting firms after 2005. The evidence is consistent with the argument that IAS 39 increases the credit relevance of earnings volatility.     

Assessing Conformity with Generally Accepted Accounting Principles Using Expert Accounting Witness Evidence and the Conceptual Framework

To enhance understanding of the status of the Financial Accounting Standards Board's Conceptual Framework for Financial Reporting, we analyse important rules of evidence in United States (US) courts regarding the presentation of expert accounting witness testimony. We draw on this analysis to recommend the relocation of the Conceptual Framework in the US Generally Accepted Accounting Principles (GAAP) hierarchy. For empirical support, we explore how rules of evidence in the criminal trial in 2006 of Enron's two most senior executives affected assessment of whether Enron's financial reports conformed with the FASB's GAAP. We recommend that the FASB's Conceptual Framework should be included in authoritative literature as the uppermost authority, and that it be grounded closely in user needs and the ethical principles associated with meeting those needs. Further, we recommend that accounting expert witnesses adopt an overriding concern for objectivity and impartiality in assisting courts to understand complex accounting matters within the Conceptual Framework.     

Comparative analysis of accounting treatments for derivatives

This paper provides educators with a classroom example or a self-study tutorial to teach Statement of Financial Accounting Standards No. 133 (FAS 133), Accounting for Derivative Instruments and Hedging Activities. The example can be used in courses such as intermediate or advanced accounting that discuss derivative instruments or investments topics or in a training program that focuses on implementing FAS 133. This teaching material can help students gain technical knowledge of FAS 133. It can also help develop critical thinking skills in analyzing the impact of an accounting standard on a firm's operation. A scenario based on a futures contract used by a natural gas company to hedge price fluctuations of its gas inventory is applied across four cases to show the impact of derivative designation on the accounting treatment and to provide a comparative analysis of the economic results from using different accounting treatments for the derivative. Case 1 and Case 2 demonstrate hedge accounting under FAS 133 by designating the derivative as a fair value hedge and a cash flow hedge, respectively. Case 3 illustrates accounting for a derivative that is not designated as a hedge. Case 4 demonstrates the impact of not entering or using a derivative to mitigate market risk. A downloadable spreadsheet on the author's website can be customized for use in the classroom.     

The mixed attribute model in SFAS 133 cash flow hedge accounting: implications for market pricing

In this study, we examine the pricing of cash flow hedge adjustments reported in other comprehensive income (OCICF), under the mixed attribute model in SFAS 133 Accounting for Derivative Instruments and Hedging Activities. Our OCICF pricing investigation integrates empirical research on the derivatives use that gives rise to such mark-to-market adjustments with the accounting information pricing literature. Based on this integration, we generalize mispricing theory for the SFAS 133 mixed attribute model and predict both the direction and magnitude of OCICF pricing. Screening on U.S. multinationals with ex ante exposure to currency risk, we provide evidence of OCICF mispricing in the expected direction, consistent with the notion that SFAS 133 cash flow hedge accounting results in a mixed attribute problem (Gigler et al. in J Account Res 45:257–287, 2007). Moreover, we find that both OCICF gains and losses are inversely related to future cash flows and of the expected magnitude, consistent with our predictions based on valuation theory (for example, Ohlson in Rev Account Stud 4:145–162, 1999). Our results support the Financial Accounting Standards Board’s concern that the SFAS 133 mixed attribute model does not provide the information necessary for investors to understand the net economic effects of derivatives use (FASB in Accounting for financial instruments and revisions to the accounting for derivative instruments and hedging activities. FASB, Norwalk, 2010).     

MEASURING HEDGE EFFECTIVENESS FOR FAS 133 COMPLIANCE

Financial Accounting Standard (FAS) 133 requires business entities to document their anticipation of hedge effectiveness in order to qualify for hedge accounting treatment of gains and losses from financial derivatives. In the absence of specific guidelines, the accounting industry has espoused the "80–125" rule for determining hedge effectiveness. But the authors observe that meaningful assessment of anticipated hedge effectiveness must consider two distinct aspects of a firm's hedging strategy: (1) the strength of the hedging relationship, which is determined by the choice of the hedging instrument; and (2) the position taken in the hedging instrument relative to the holdings of the hedged item. They take both aspects of hedging into consideration in developing alternative measures of hedge effectiveness and distinguishing between the potential and attained effectiveness of a particular hedge. This approach enables the user to evaluate the relative merits of alternative hedging strategies to support risk management decisions, and also to document a selected hedging strategy's anticipated effectiveness for purposes of compliance with FAS 133. While the authors endorse a fairly broad interpretation of hedge effectiveness, their approach can also be used in the narrower context of an "80–125" rule.     

Sorting and comparing: Standard-setting and “ethical” categories

The Financial Accounting Standards Board (FASB) describes its public interest function as “…developing standards that result in accounting for similar transactions and circumstances in a like manner and different transactions and circumstances…in a different manner (Facts about FASB).” This statement implies that rule-makers possess an expertise that makes analogizing transactions or circumstances to other transactions or circumstances unproblematic. In this paper we utilize two instances of standard-setting, SFAS 123R and SFAS 143, to demonstrate from FASB's analogic reasoning in these cases that similarity and dissimilarity are not so easily ascertained. A judgment about similarity invariably involves ignoring some perspectives of similarity that would lead to substantially different conclusions about the appropriate accounting. We also illustrate via the two examples the inherent value judgments that underlie the conclusions reached by FASB and how these value judgments raise questions about the ethics of the current standard-setting process.     

STANDARD SETTING FOR OIL AND GAS ACCOUNTING: AN ANALYSIS USING ALLISON'S APPROACH

The three models advanced by G. T. Allison in Essence of Decision are applied to FASB's Statement of Financial Accounting Standards No. 19 to explain the adoption of the “successful-efforts” method. In the first model, the decision is explained as the action that reflects a consistent, value maximizing choice within specific constraints. In the second, it is interpreted as the “output” of the FASB regulated by standard procedures, namely in recognizing an asset. In the third, it is viewed as a political resultant in a struggle involving interest groups. The analysis revealed the usefulness and some weaknesses of the Allison Approach to an understanding of the standard setting decision by the FASB. The approach is applicable world-wide to other standard setting scenarios.     

Statement 133: Not Perfect, but a Step in the Right Direction

Statement 133 represents progress toward achieving the goals of GAAP. To the extent it requires companies to mark their derivatives to market, balance sheets will give investors a clearer, more complete picture of a company's assets and liabilities.
But if the fair value accounting prescribed by Statement 133 has provided clarity for investors about corporate derivatives positions, it has also forced some companies—those unable or unwilling to qualify for hedge accounting—to report more volatile earnings, causing the accounting rule to come under heavy criticism. As the author argues, however, such criticism is based on the misperception that the objective of GAAP income statements is to provide a "normalized" measure of financial performance—a single number that can be discounted or capitalized by analysts to arrive at a company's value. In fact, it is mainly the job of the analysts themselves, not accountants, to determine which elements of a company's income statement are recurring and central to the business.
What's more, the author argues that the FASB went too far when it allowed hedge accounting for forecasted transactions. Rather than expanding the use of hedge accounting, the FASB should promulgate a comprehensive fair value standard, one that aims to mark all corporate assets and liabilities to market—which would eliminate the need for hedge accounting or any of its associated complexity, and compensate for 133's dearth of disclosures.     

THE FASB'S CONCEPTUAL FRAMEWORK SURVIVES A MARXIST CRITIQUE: A COMMENTARY ON BRYER

Rob Bryer has thrown down a fascinating challenge to practitioners of accounting standard setting and to accounting theorists by his bold conclusion that whereas the FASB's framework, founded in the marginalist concept of economic value, is subjective and vague, the Marxist theory provides accounting with a `scientific' foundation. The present author has intellectual capital both in the type of accounting theory which gave rise to the FASB's framework and in the work of the UK's Accounting Standards Board (ASB), which has adopted principles similar to those of the FASB. Not surprisingly, he was sceptical about Rob Bryer's paper, both before and after reading it. However, it is not necessary to accept the conclusions to find the argument illuminating and challenging to the accepted wisdom. What follows is a sceptic's attempt to interpret the Bryer argument and to explain the sources of doubt. The subsequent commentary follows the paper's argument chronologically and uses the same headings. A final summing up section attempts to identify the key issues identified in the commentary.     

Practice versus Prescription in the Disclosure and Recognition of Derivatives

The contentious issue of the recognition and measurement of derivative instruments is again high on the Australian standard-setting agenda, following pronouncements by the International Accounting Standards Committee (USC) and Financial Accounting Standards Board (FASB). This study investigates firms' disclosure of derivative accounting policies and measurement practices pursuant to the introduction of AASB 1033. A lack of clarity and completeness in the disclosures suggests that supplementary requirements are necessary. A preference for using hedge accounting is also apparent. Should an Australian standard disallow or impose conditions on hedge accounting, fims will need to alter their current accounting practices and risk management strategies and they will probably reassess their use of derivatives.     

Fair value accounting: Simulacra and simulation

The paper examines the application of simulacra and simulation in fair value accounting for financial instruments in the U.S. As copies of copies, simulacra problematize the notion of an original and with it an imaginary of a single authentic reality. We examine simulacra as they have been applied in two interconnected fair value accounting arenas. Firstly, simulacra employed as a measurement basis for certain financial instruments. In this regard, we challenge the FASB's insistence that fair value accounting is an originary market based measurement system. Secondly, we examine the process of simulation as employed by the FASB in copying and amending FAS 157 in its subsequent modifications to the guidance provided to the preparers of financial statements. Our purpose here is to both reinforce the absence of a market reality and also to illustrate how the FASB's subsequent modifications to FAS 157 were shaped by political forces. We conclude with some suggestions as to how simulacra and a politicization process might be productively embraced in future fair value accounting endeavors.     

Issues in the Drive to Measure Liabilities at Fair Value

This paper compares the discussion on liability measurement in Accounting The0y Monograph 10 with the liability measurement requirements in recent international proposals on accounting for financial instruments. Rather than conducting a detailed review of the Monograph, the paper examines three major issues which wawant amplifjing, extending or criticising: What is “fair value”? Why fair value liabilities? Should fair value include an entity's own credit risk? The focus is on financial liabilities such as “plain vanilla” debt; other financial liabilities, such as insurance obligations, pensions, wawanties and environmental damage restoration involve additional considerations and are therefore not considered.     

Pirate Wireless: Revenue Recognition in the Telecommunications Industry

Pirate Wireless is a telecommunications company with stores and offices all over the globe. Jim Bayley is an extremely busy professional who enters into a contract with Pirate Wireless for the ultimate purchase of a smartphone with one‐year warranty, voice and data services, Cryptonite encryption software, and an extended warranty. The case requires students to act as Assistant Controller of Pirate Wireless Corporate and determine the appropriate revenue recognition for Pirate Wireless's contract with Jim Bayley. This mandates a thorough review of the five steps of revenue recognition set forth in Revenue from Contracts with Customers, the jointly converged standard issued by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) in May 2014. The FASB's Accounting Standards Codification 606 is effective for all U.S. public entities for fiscal years ending after December 15, 2017. The IASB's International Financial Reporting Standards (IFRS) 15 applies to an entity's first annual IFRS financial statements for a period beginning on or after January 1, 2018. This case is appropriate for an undergraduate or graduate level Intermediate Accounting course.     

The Usefulness of Derivative-related Accounting Disclosures

The Financial Accounting Standards Board attempts to improve reporting and disclosure of derivative transactions through SFAS Nos. 105, 107, and 119. These statements require recognition of gains or losses on trading purpose derivatives, and disclosure of notional principal amounts, credit exposures, and fair values of trading and nontrading derivatives. Using a multiple regression model, this study investigates the relevance of these disclosures to stock returns for a sample of large banks. All derivatives-related disclosures, except for notional principal amounts, are found to contain new information not incorporated in market beta and earnings. These results support the Board's derivative disclosure requirements.     

How Do Investors Regard ESOs?

All top‐50 and more than 80% of the top‐500 Australian listed companies now reward their executives with stock options (ESOs) of one kind or another.₁ We address the question: “Which method of accounting for ESOs — current practice, the US FASB's recommended practice or the AASB's preferred position — most closely reflects investors' pricing decisions?” We answer the question using models that relate a company's stock price to its earnings and book value of equity calculated according to these three choices of accounting treatment.     

Der Exposure Draft „Insurance Contracts“ – Eine kritische Analyse aus theoretischer Sicht

The Exposure Draft “Insurance Contracts”, issued by the International Accounting Standards Board (IASB) in July 2010, contains the IASB’s latest proposals regarding accounting on insurance contracts by insurance enterprises and is the basis for the planned International Financial Reporting Standard “Insurance Contracts” which shall be finished in 2011. The paper follows a presentation with the same title at the Annual Congress of the German Insurance Science Association in Berlin on March 17th, 2011 and mainly aims at a comparison of the IASB’s proposals with the solutions derived from different accounting theories for the most important accounting problems concerning insurance contracts, namely the treatment of premiums, losses, and acquisition costs. The IASB’s proposals do not follow one of these theories homogeneously and contain several additional inconsistencies. Irrespective of their pros and cons in the light of other criteria they, therefore, have to be criticized as highly problematic.     

Tratamiento contable de las transacciones separadas en las combinaciones de negocios Proceso armonizador de la normativa contable internacional (IFRS) y americana (FAS)

Amendments made to 2007 Financial Accounting Standards ¾FAS 141 (R)¾ and 2008 International Financial Reporting Standards ¾IFRS 3 (R)¾ in order to harmonize the accounting aspects of operations concerning a business combination, have shown the existence of certain transactions that are not part of the combination itself, which are called “separate transactions”. The definition and delimitation of business combinations “separate transactions” is dispersed in both standards, at times with a little clarifying result. Therefore, this paper aims to facilitate the reader’s understanding of their accounting treatment to address the problem of identifying those transactions that occur, or not, as a result of a business combination, the accounting treatment for this dilemma and its effect on the recognition and valuation of goodwill.     

HOW TO FIX ACCOUNTING—MEASURE AND REPORT ECONOMIC PROFIT

Bending accounting rules has become so ingrained in our corporate culture that even ethical business leaders succumb to the temptation to “manage” their earnings in order to meet analysts' demands for smoothly rising results. The author of this article argues that such behavior reflects not a general decline in ethical standards so much as executives' growing sense that accounting itself has become “unhinged from value.” For example, clearly valuable expenditures on R&D, customer acquisition, and employee training are generally expensed immediately against earnings. And reported corporate income is often further reduced by provisions for losses that most companies never expect to incur, by “book” taxes they never expect to pay, and by depreciation charges on assets that are actually increasing in value. At the same time, the opportunity costs associated with employee stock options and the corporate use of equity capital are not reflected in the accountant's measure of profit. To improve the quality of corporate governance and revitalize the public's faith in reported earnings, the author proposes a complete overhaul of GAAP accounting to measure and report economic profit, or EVA. Stated in brief, the author's concept of economic profit begins with an older, but now seldom used, definition of accounting income known as “residual income,” and then proposes a series of additional adjustments to GAAP accounting that are designed to produce a reliable measure of a company's annual, sustainable cash‐generating capacity. Besides expensing the cost of equity capital as well as stock options, the author recommends bringing off‐balance‐sheet items such as pension assets and liabilities back onto the balance sheet, eliminating reserve accounting, capitalizing R&D and other expenditures on intangible assets, and recording economic rather than accounting depreciation. Such changes, by replacing the accountants' current flawed definition of earnings with a comprehensive new statement of value added, could restore investor confidence in financial statements. Even more important, managers would be less likely to pursue their now common practice of boosting earnings by making value‐reducing operating and investment decisions and more likely to use financial reporting not to mislead the market but as an opportunity to communicate relevant, forward‐looking information.     

Insights from Accounting Practitioners on China's Convergence with IFRS

This study provides insights from accounting practitioners on China's convergence with International Financial Reporting Standards (IFRS). Through a survey of 33 senior financial executives of Chinese listed companies in 2014, the study reports their perceptions on the following issues: first, the degree of convergence between IFRS and Chinese Accounting Standards (CAS); second, the choice between fair value and historical cost accounting, and the usefulness of fair value accounting for Chinese companies’ financial reporting; third, challenges in the process of China's harmonisation with IFRS; and finally, essential capabilities of Chinese accounting professionals in the process of China's harmonisation with IFRS. Multivariate regression was used for further analysis. The survey findings reveal that in general CAS have converged with IFRS, with a few exceptions that reflect the unique Chinese context. Historical cost accounting is the preferred measurement base to fair value accounting. Exercising professional judgement was identified as a challenge for China's full convergence with IFRS. Ownership structure and the expertise of accounting practitioners were found to affect respondents’ judgements on China's convergence with IFRS. This study has policy implications for international accounting standard setters and accounting educators to consider the contextual issues of implementing IFRS in an emerging economy.     

SAC 4: A Source Of Accounting Change

Despite its long gestation, the latest release in the Australian Accounting Research Foundation's conceptual framework, Statement of Accounting Concepts 4 Definition and Recognition of the Elements of Financial Statements (SAC 4), is poorly understood by many accountants. The statement specifies definitions for the elements which form the basis of the information in financial reports and sets out the criteria to be used in deciding when these elements should be recognised (reported) in the reports. Statements of accounting concepts do not attract the same direct legal force as AASB accounting standards. Nevertheless, this statement promises significant reforms to financial reporting. Because of its potential to create far-reaching changes, it is essential that accounting professionals are familiar with its contents and application. This paper describes the structure of SAC 4, comments upon some of its important components and illustrates its operation and key features in the context of one element, “assets”.