Accounting for Financial Instruments Set 1

• Principle of creditor protection is fulfiled by providing information instead of the following principle of prudence in recognition and measurement
• Equal formal principles but different priorities
  • framework
    • attaches main importance to fair presentation
    • subjects principle of prudence to period-based accounting
    • declines hidden reserves
    • allows fair value accounting in exceptional cases (it is more and more allowed in new standards)
    • refuses provision for expense
    • defines criteria for the realisation of profits in a different way

• Historical Cost
• Current Cost
• Reliasable Value
• Present Value

other valuation concepts without an assignment to the main categories

• Fair Value
• Recoverable Amount

No hierachy in valuation concepts

• Tendency to focus on assets instead of prodit/loss
• No hierarchy of valuation concepts
  • framework: measurement basis most commonly adopted is historical cost
  • more recent standards: increase in fair value accouning
• Recognition of changes in assets
  • income statement: not later than point of realisation
  • balance sheet: fair value changes frequently "parked" in revaluation reserve (in equity)

• Fair value in sense of replacement cost
  • Organic Accounting
  • Replacement Cost Accounting
• Fair value in sense of market prices
  • Static Theory
  • Dynamic Thoery
  • International Financial Reporting Standards

• Effective assets as enterpirse value
  • total measurement - subject based
• Approximation by individual measurement
  • value addition principle
  • fair values of assets less fair values of liabilities
  • no consideration of economies of scope and synergy effects
  • no inclusion of internally generated goodwill
  • need to decide between relevance for decisions and objective consideration (reliability)

• No clear definition of profit
• Focus on fair value accounting (only as a hidden agenda, but not fixed in the framework)
• Principle based accounting doesn't work in practice
• Revision of the framework is urgently demanded
• Rule based accounting in sense of an "isolated" view of a single standrd is required

• Principle of historical cost accounting
  • recogniztion and measurement of financial instruments follow specific business purpose
  • accounting for financial instruments has always to be reported at historical cost
  • fully hedged portfolio can be included in that accounting system by accpting economic hedge relationship
• Principle of full fair value accounting
  • Standardised accounting of financial instruments (regardless of their business purpose) avoids earnings management
  • no special hedge accounting rules necessary

• Long-term objectives
  • Full fair value accounting
  • Strongly opposed by banks (and other companies)
• Short-term objectives
  • All derivatives to be recognised in balance sheet
  • All derivatives to be measured at fair value
  • All changes in fair values to be recognised immediately in profit or loss account (cash flow hedge is technical exception=
• -> Consistent alignment neither in full fair value concept nor in principle of historical cost

• Financial instruments are any contracts that (IAS 32.11)
  • give rise to financial asset of one equity and
  • a financial liability or equity instrument of another entity

• Financial assets are any assets that are (IAS 32.11)
  • cash
  • contractual rights to receive cash or another financial asset under conditions that are potentially favourable
  • contractual rights to exchange financial assets
  • equity instruments of another entity

• Financial liabilities are any liabilities thar are (IAS 32.11)
  • contractual obligations, to deliver cash or another financial assets
  • contractual obligations, to exchange financial liabilities under conditions that are potentially unfavourable
• Equity instrument is any contract that evidences a residual interest in the assets of an entiry after deducting all of its liabilites

• Amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction (IAS 39.9)
• Normally the fair value corresponds to the market price, in absence of a market price, than
  • deriving of financial transactions in comparable markets
  • using valuation techniques
    • DCF method
    • Option pricing model

• Amortised cost of a financial asset or liability is (IAS 39.9)
  • the amount at which the financial asset or financial liability is measured at initial recognition
  • minus principal repayments
  • plus or minus the cumulatie amortisation using the effective interest method of any difference between that initial amount and the maturity amount
  • minus any reduction for impairment (directly or throught the use of an allowance account)

• Interests in subsidiaries, associates and joint ventures
• Employers' right and obligations under employee benefit plans
• Own equity instruments, including options and subscription rights, in term of IAS 32
• Rights and obligations under leases
• Rights and obligations arising under and insurance contract
• Contracts for contingent consideration in a business combination
• Share-based payment transactions
• (Most of the) loan committments