Welcome to ACC3116: Financial Accounting Theory - PowerPoint PPT Presentation

Title: Welcome to ACC3116: Financial Accounting Theory


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Welcome 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

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Tutorials

• 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

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Assessment

• Assignment 1 10 Due 20 August
• Assignment 2 10 Due 20 September
• Exam 80
• Restricted - Translation dictionary only

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Module 1

• Introduction to Financial Reporting Decisions

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Lecture 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

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Definition of Financial Reporting
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Forms 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

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SummaryForms 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

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Scope 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

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Financial Reporting Financial Accounting
Disclosures
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Financial 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)

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Financial Reporting Decisions
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Financial 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

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Expensing 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

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Accounting 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

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Accounting 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

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Disclosure 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

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Disclosure 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

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SummaryFinancial 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

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The Fundamental Problem of Financial Reporting
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Information 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

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Adverse 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

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Moral 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

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SummaryInformation Asymmetry
Adverse selection (Financial reporting to
convert inside info to outside info.)
Moral hazard (Accounting to monitor the behaviour
of managers)
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What 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)

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The Fundamental Problem of Financial Accounting
Theory
Provision of relevant info. to aid
investor Decision making
Provision of reliable info. to control management
behaviour
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The Fundamental Problem of Financial Accounting
Theory

• How to reconcile the different roles for
  accounting information
• impacts on
• asset valuation
• income measurement
• disclosure decisions

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What 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...)

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Historical 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

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Historical 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)

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Improving 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

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Overview of Remainder of Unit
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Framework 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

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Framework 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

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Purpose 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

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For 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!