Title: Welcome to ACC3116: Financial Accounting Theory
1Welcome to ACC3116 Financial Accounting Theory
- Unit Leader - Julie Cotter
- Room - L106
- Phone - 4631 2916
- Email - cotter_at_usq.edu.au
- Home page - www.usq.edu.au/users/cotter
2Tutorials
- Tutorial times are
- Tuesday 11 1 K303
- Wednesday 2 4 K308
- Consultation times are
- Monday 1 3
- Wednesday 1 2 4 - 5
- Friday 3 5
3Assessment
- Assignment 1 10 Due 20 August
- Assignment 2 10 Due 20 September
- Exam 80
- Restricted - Translation dictionary only
4Module 1
- Introduction to Financial Reporting Decisions
5Lecture Overview
- Definition of financial reporting (1.1)
- Financial reporting decisions (1.2)
- The fundamental problem of financial reporting
(1.3 1.4) - Overview remainder of unit
6Definition of Financial Reporting
7Forms of Accounting
- In your degree you have studied
- bookkeeping
- management accounting
- financial reporting (fin acct, comp acct, law of
assoc) - Accounting adapts to the size and form of
organisation
8SummaryForms of Accounting
- Form of Accounting is a function of
- separation of ownership and control (linked to
size) - diffusion of ownership
- Small business (centralised), owner-managers
bookkeeping - Decentralised firm with tight ownership mgmt
acct bookkeeping - Decentralised firm with diffuse ownership
financial reporting mgmt acct bookkeeping
9Scope of Financial Reporting
- Financial reporting covers more than just
financial/company accounting (preparation of 3
financial statements). Although this is an
important part of it. - Financial reporting also includes disclosures
that are not contained in the financial
statements - Examples of disclosures
- Environmental disclosures, notes to the accounts
regarding the valuation of assets, press releases
10Financial Reporting Financial Accounting
Disclosures
11Financial Accounting
- Profit Cash from Operations (CFO) accruals
- Accountants and managers apply the accrual system
to convert cash flows into profits/losses
(earnings) - Examples of accruals
- recognition of sales prior to receipt of cash
- depreciation and amortisation of non-current
assets - Reported profit depends on financial accounting
decisions - There is less discretion to manage CFO than
accruals (earnings management)
12Financial Reporting Decisions
13Financial Reporting Decisions
- Financial reporting decisions relate to
application of the accruals system (financial
accounting) as well as disclosure related choices - Five types of financial reporting decisions
- Expensing versus Capitalisation of Costs
- Accounting Methods
- Accounting Estimates
- Disclosure versus Recognition
- Disclosure Policy
14Expensing versus Capitalisation
- The treatment of an outlay as an expense or as an
asset affects profit, equity, and assets - eg. a large repair / overhaul of a motor vehicle
- Dr Expense - it goes to net income, or
- Dr Asset - it goes to net income over many years
as depreciation - Long term total profit over time is unaffected
but the timing of profit recognition is affected,
which affects ability to pay dividends,
impression of mgmt performance and other
decisions made by stakeholders
15Accounting Methods / Principles
- There are many accounting standards which must be
adhered to, however choices are often allowed - Eg. Depreciation involves acct policy choice
- straight line, reducing balance, units of
production
16Accounting Estimates
- There are many acct estimates
- Bad debts, provisions for warranties, recoverable
amount test for AASB 1010, depreciation - Eg. Depreciation involves
- estimate of useful life, estimate of residual
value - Abuse of estimates can be controlled by auditors,
regulatory authorities - eg. Reserve bank has published concerns over
current levels of banks bad debt allowances - not as visible as changes to accounting methods
17Disclosure versus Recognition
- Recognition involves booking an item to the
accounts, whereas disclosure does not affect the
accounts - Example an asset revaluation
- The firm can have land and buildings valued by an
independent valuer - Its choices are
- Record a full or partial revaluation in the
accounts - Disclose the asset values in the notes
- Do not disclose the information at all
18Disclosure Policy
- Disclosure can include
- Good news - new investment projects, discoveries
- Bad news - losses
- They can be made
- in the notes to the financial statements
- in the front end of the annual report
- via press release or letters to shareholders
- made to financial analysts in various forums
- Certain disclosures are required (eg. ASX),
Others are voluntary
19SummaryFinancial Reporting Decisions
- Financial reporting involves decision making
about application of the accruals process and
disclosures - Financial reporting decisions impact the
information provided to users of financial
reports - this may impact on users decisions - Important to understand determinants of
financial reporting decisions and expected
impacts on decisions of stakeholders
20The Fundamental Problem of Financial Reporting
21Information Asymmetry
- Occurs when some parties to a business
transaction have an information advantage - Adverse selection
- one party has knowledge not possessed by the
other - Moral hazard
- arises when some parties cannot observe all the
actions of the other parties to the transaction
22Adverse Selection
- Key Issue managers have considerable inside
information - about past performance of the firm its future
prospects - Solution financial accounting and reporting to
make inside information available to stakeholders
23Moral Hazard
- Key Issue motivating manager effort
- difficult for owners to observe mgmt behaviour
- manager can shirk on effort or over consume perks
of the job - Solution net income can be determined and
utilised as an indicator of management performance
24SummaryInformation Asymmetry
Adverse selection (Financial reporting to
convert inside info to outside info.)
Moral hazard (Accounting to monitor the behaviour
of managers)
25What is the Fundamental Problem of Financial
Accounting?
- There are conflicting roles for accounting
information to solve the problems of adverse
selection and moral hazard - ie. the best measure of net income to inform
investors (to control adverse selection) need not
be the same as the best measure to motivate
managers (to control the problem of moral hazard)
26The Fundamental Problem of Financial Accounting
Theory
Provision of relevant info. to aid
investor Decision making
Provision of reliable info. to control management
behaviour
27The Fundamental Problem of Financial Accounting
Theory
- How to reconcile the different roles for
accounting information - impacts on
- asset valuation
- income measurement
- disclosure decisions
28What is the Solution?
- How do we reconcile these different roles for
accounting information - solution 1 rely on market forces
- supply (managers) and demand (stakeholders)
- can market forces control the adverse selection
and moral hazard problems so that - investors are protected and
- markets work fairly and efficiently
- Solution 2 Regulation
- to protect investors - reliance on market forces
has been rejected by our society (and in US,
UK...)
29Historical Cost vs Present Values
- Present values involve estimation and compromise
- these estimates make the information subject to
wide degree of error and therefore unreliable - Historical cost is also a compromise between
relevance and reliability - HC asset values lack relevance, but make up for
it through increased reliability
30Historical Cost Revisited
- HC model is not completely reliable
- It involves matching revenue and expense to
determine a net income figure - Accruals are subject to estimation problems
(earnings management)
31Improving on Historical Cost
- Likely that HC will be with us for the
foreseeable future - use of PVs is not always practical
- we can observe
- greater use of market values in some areas
- greater amounts of disclosures in annul reports
32Overview of Remainder of Unit
33Framework of the unit
- Some areas of financial reporting are regulated
- Mod 2 current reg. environment / theories of
regulation - Much of financial reporting is unregulated, so we
look at making financial reporting decisions - Mod 3 contracting determinants of financial
reporting - Mod 4 social determinants of financial reporting
- Mod 5 critique of theories
34Framework of the unit (cont.)
- We also look at the impact of financial reporting
decisions - Mod 6 impacts on share price
- Mod 7 impacts on individual financial statement
users - We finish by looking at two financial reporting
issues - Mod 8 Asset measurement
- Mod 9 Environmental Performance Reporting
35Purpose of the Unit
- ACC3116 is about theories which relate to
financial accounting practice - accountants do bookkeeping
- apply technical skills (apply acct standards)
- exercise judgement / make decisions
- Theoretical frameworks help us to make decisions
- The unit is designed to
- Enhance your decision making skills
- Improve your written communication skills and
your critical thinking skills
36For Tutorials
- Required reading
- Selected readings 1.1, 1.3, 1.4 1.5
- (pages indicated in your study book)
- Self assessment questions
- Questions 1 6 from module 1
- Answers in tutorials
- Important - YOU ARE REQUIRED TO READ FOR THIS
SUBJECT!