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Accounting for Financial Instruments Set 1

Accounting for Financial Instruments

Accounting for Financial Instruments

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Flashcards 15
Language English
Category Micro-Economics
Level University
Created / Updated 18.02.2013 / 04.10.2018
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IASB Framework - Supports the IASB by

  • developing of further and amendment of exisiting international financial reporting standards
  • encouraging of harmonisation of regulations, accounting standards and methods in relation of setting and presenting of financial reprts
  • limiting of the number of alternatives by the permitted accounting methods of the standard

Comparison to HGB accounting

  • 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

Conglomerate of value concepts in the framework

  • 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

IFRS - providing information that is useful for making decisions

  • 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)

Theoretical background of the fair value accounting

  • 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

Fair value as approximation of value of the company

  • 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)

Problems of IFRS accounting

  • 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

Divergent theoretical accounting principles

  • 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

IAS 39 objecitves

  • 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

Definition - Financial instrument

  • 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

Definition - Financial asset

  • 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

Definition - Financial liability

  • 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

Definition - Fair value

  • 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

Definition - Amortised cost

  • 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)

The following financial instruments are out of scope of IAS 32.4 and IAS 39.2 (intuition)

 

  • 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

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