1
Q
Relevance vs reliability
A
Holtshausen and Watts (2001):
- value relevance literature offers little insight
- other important aspects: contracting, litigation, stewardship
Barth, Beaver, Landsman (2001):
- primary focus is on equity investment
Both sides have merit
Ball and Brown (1968): evidence that the timeliness of info and the impact it has on stock market values
2
Q
Analysis if interested in growth
A
Share price (NPV future cash flow)
Balance growth
Income statement growth
Asset base growth
3
Q
Conceptual framework aspects
A
Timeliness relevance reliability - verifiable representational fairness Presentation neutrality (no bias) Conservatism (bias downwards)
4
Q
Example relevance vs reliability
A
Physical assets: historical cost + depreciation - have receipts, economically meaningless
Financial assets: track value most days - reflective of underlying firm?
Intangible assets - no deep and liquid market.
5
Q
Single setter
A
Different jurisdictions: luxembourg -banking, Japan- automotive.
Market will turn to alternatives if not timely / appropriate e.g. integrated reporting
6
Q
Loss in relevance of income statement.
A
Hail (2013):
- alternative ways to disseminate information
- more pronounced in countries with strong institutional background
- relevance in terms of ability to summarise firm value
7
Q
Influence of pre-dominant national culture
A
Hossfeld (2011):
- even if only IFRS used
- for PRESENTATION
8
Q
Legitimacy of accounting profession
A
Kirk (1984): additional services shouldn’t impinge independence
Zeff (2003): reward systems - salesmanship over technical efficiency
FT (2019): commercial cultures
Is it a profession or a service? Increased commercialisation
9
Q
Hail et al (2010)
A
- confer monopoly status
- 2002 Norwalk agreement: funding dependent on lobbyists.
- convergence involve compromise amongst very diverse set of constituents
- one size doesn’t fit all
10
Q
Examples of issues with convergence
A
Karthik (2013):
- China MoF lobby expedient exceptions
- India Tata Steel - vol net income 64% - deferred convergence twice
- Canada fully embrace
Armstrong et al (2010):
- domiciled code-law countries -ve reaction when adopt IFRS in EU - investors harbouring concerns over weaker enforcement
11
Q
Critic conceptual framework
A
Benston et al (2007):
- fails to distill into a coherent whole. Many disparate issues.
- neutrality & conservatism both prioritised
- not applicable to specific standards
- neglects stewardship role
- relies on fair value
12
Q
Empiric study on switch to principles from rules (leases)
A
Henderson and Brian (2014): looks at UK and AUS
- omit bright lines doesn’t curb transaction structuring, didn’t inc use of capital leases
- Nobes (2011): deep-stead and resistant
- Ball (2006): not overcome incentives of those who prepare and audit -> law bigger influence for change
- cultural or regulatory setting not the accounting standard that drives the outcome
Cohen et al (2013): experiment 97 auditors
- find constrain reporting under principle-based, under weak & strong regulatory regime
13
Q
Rules vs principles theory
A
Benston et al (2007): FASB more rules
- Enron, rules under fire - not intent but tech requirement
Schipper (2005): exposure draft to solicit public comment - prov answers, erode extent..
Quinn (2003): if dishonest what’s true & fair to scoundrel?
ICAS (2006): ethics debate
Dunn et al (2003): less moral reasoning
Influence of predominant national culture: difference not from nature of standards but
14
Q
Earnings management examples
A
Sherman and Young (2016):
- Kraft bought Cadbury 14% IFRS, 9% GAAP
- RBS wrote-down greek bonds 51% - CNP and BNP 21%
- traceable securities vs intangibles
Bank investments: traceable sec (every period) vs AFS
Lufthansa (12 years, 15% salvage) vs KLM (20 years, 0)
Software/phone inc future upgrades - then future cost not known so don’t record rev - carve out price upgrades - stop using more attractive bundling strategy
Nelson et al (2003): expenses most common
Subscriptions paid in advanced: quality of deferred revenue
15
Q
Earnings mgmt definiton
A
Management using reporting discretion to produce financial statements that place mgmt in a particular light.
- decisions opportunistically favourable
16
Q
Earnings management author / point
A
Sherman and Young (2016):
- influence way business done - become more than just a messenger.
- Serving interest of short-term reporting that undermines long-term performance
17
Q
Fair value examples
A
Chang et al (2010):
- Levels: 0.98, 0.97, 0.68
- concern over reliability
Wells Fargo: 9% inc net income but negative if not Level 3
18
Q
Fair value opinions
A
Penman (2007):
- passage of time historical cost becomes irrelevant - investors want value not cost
- unbiased market measure - not firm specific
- conceptual level should read equity value with no further analysis needed - vs implementation (if no observable prices then opp to manipulate to meet own objectives)
- relies on EMH but some not traded
Barth (2010): prove more prone to measurement error
- no better alternative
Magnan et al (2015): forecast error higher -> prone to manipulation -> lack decision usefulness
Based on past costs and present data, not hypothetical expectations of future
19
Q
Revenue rec standard
A
2014:
- identify contract
- identify p.o
- determine t p
- allocate t p to p o
- rec when satisfy p o
20
Q
Revenue recognition problems
A
Colson et al (2010):
- SSP when have multiple p o.
- early recognition
- e.g. warranties
- notion of control
KPMG (2015):
- e.g. rebates (contractual vs relationship)
- e.g. credit card fees & other services (receivables or revenue standard)
- e.g. software and integration services
21
Q
GAAP vs non-GAAP
A
McLannahan (2017):
- average difference is 31%
- 96% report them
FT (2019):
- 50% 2 decades ago
- favourable spin or GAAP no good
- accountants shouldn’t try value but establish verifiable lower bound
22
Q
R and treatment
A
R&D:
- GAAP D not capitalised except software
- IFRS D capitalised: non-bright line requirements.
- Probable benefit?
- When to amortise?
ASB in 1970s: 2% R ideas become commercially viable. D - 15%
23
Q
Intangible asset definition and what to mention
A
An identifiable non-monetary asset without physical substance
- probable future benefit, control, separable, more info in disclosures
- seperable or arising from a contractual or legal right
24
Q
Intangible assets list
A
RandD
Copyright - 20 years
Customer list - control?
Patents - indefinite renewals US office of 10 years each
Goodwill - indefinite life?
Brands - legal contract or external evidence
25
Brand contradiction
Sinclair and Keller (2014):
- not separable: distinguished from general business cost
- suggests asset accretion rank in importance with impairment
- not representational fairness? but conservatism?
26
Facebook / WhatsApp
FB paid $19bn - loss of $138m
| - accounts communicating eco information / value?
27
OCI components
- Revaluation surplus
- Actuarial gains / losses on benefits
- FX translations
- AFS
- Hedging instruments
28
OCI authors
Probonis and Zulch (2011):
- presentation irrelevant - empirics: influences decisions
- no evidence CI has superior predictive income
Nishikawa et al (2016):
- financial position (CI) vs performance (NI)
- net income: irreversible outcomes
- difference is one of timing
- want predictor of earnings
Chasan et al (2014):
- OCI distort P/E
- employee benefits through OCI: dis-incentivise deal large liabilities head-on. BHS.
29
Capital lease old requirements
- transfer ownership
- contains bargain purchase
- PV payments >90% fair value
- non-cancellable lease term: 75% useful life.
30
Lease statistics
Enron : $1.25tn
| IFRS (2016): listed companies using IFRS or GAAP have $3.3trn lease commitments. >85% not on BS
31
Lease changes impact
Singh (2011): if capitalised
Negative: interest coverage and capital ratios
Positive cash flow measures: EBIT / EBITDA
- as interest / amortisation not operating expense
32
Lease authors
Spencer and Webb (2015):
- lenders, rating agencies, analysts under OBS leases
FT (2016):
- analysts already capitalise leases -> minimal impact
Bratton et al (2013):
- depends if disclosures are reliable if so then not processed differently
- recognised vs as-if recognised & proxies for costs of debt and equity
- they overcome info asymmetries
33
Lease pressures
US lawmakers:
| - destroy jobs as inc cost of capital as makes BS look riskier
34
Ratios
```
Profitability:
- margins, ROE
- EPS: net income / no. shares
Solvency:
- leverage
- dividend cover: EPS / D
- interest coverage
- volatility
Liquidity
- quick ratio, current, stable cash flow
Management of resources:
- working capital cycle: inventory days + sales days - payable days
```
35
Ratio criticism
Johnson (1994):
| - no accounting system said if in control or customer satisfied
36
Absorption costing table
- Sales
- COGS (inc fixed)
- Gross profit
- S&A
- Operating income
- PVV
- Net profit
37
Absorption costing issues
- PVV shown in net profit but doesn't account for how many sitting in storage
- increasing production by unethical managers
- incentive to spread cost among more products
- 'FASB' allow for normal excess capacity, expense abnormal
- Segarra (2012) e.g. Ford, Crysler, GM using to keep up with ST incentives
- Long term: advertising and inventory holding costs (e.g. replacing tyres) increase. Sell at discount -> impacts brand image.
38
Variable costing table
- Sales
- Variable cost
- CM
- Fixed
- S&A
- Operating income
39
Variable costing
Horngren amd Sorter (1961):
- fixed related to capacity than specific units vs both necessary
- expenses as incurred vs becoming assets
- VC conceptually and pragmatically superior as changes in production levels don't impact profit calculations
- usefulness enhanced by exp stating total fixed incurred and released from/ added to inventory
- more closely aligned with cash flows
40
Solution to absorption costing
Baldenius & Reichelstein (2005):
- residual income performance metric
- subtracts an interest charge for the value of all operating assets including inventory
- measurement reflects value created by sales AND production
41
Traditional costing criticisms
- arbitrary overhead allocation
- if use greater proportion then under-costed
- impact on business decisions
- Overcosting: use relatively few resources but reported to have high cost
- product cross subsidisation: have efficient processes subsidising less efficient
42
ABC in services
Gordon & Loeb (2001):
- customer as primary cost objective
- software identify internet ad that routes customer
- trace specific software-related costs
43
Issues with ABC
- if target costing (market dictates price)
Kaplan and Anderson (2004):
- timely, costly --> abandoned
Norren and Soderstrom (1997):
- hospitals: 30% variable of overhead
- if assume proportional then grossly overstate
- 'learning organisation': don't repeat mistakes
Distorting incentives: do activities differently
Intrusive culture
44
Benefits of ABC
- cost accuracy, better control, decision making
- inc accuracy, more decision support, continuous improvement
- software and big data creating huge possibilities
MacAurther et al (2008):
- harder to perpetuate fraud
45
ABC empirics
Max (2008): ABC in a bank
- leadership and improved tech supporting new successful ABC initiatives
Provost (2013): DHL case study
- INSIGHT: every shipment
- Whether accurate to how act
Stratton et al (2009):
- 348 manufacturing and services
- greater decision support
- concerns are less
Kutcha and Troska (2007): case study. 400/1400 profitable
- small orders
46
Relevant costing things to remember
- say incremental
- check if fits in relevant capacity
- ignore fixed costs (special order)/ allocated costs (continue segment)
- use CM approach
47
CVP assumptions
- costs separated into F and V
- no significant changes in inventory levels
- linear revenue
- constant VC per unit
- Therefore constant CM
48
What's missing in CVP
Guidry et al (1998):
- wealth of firms (only cover full costs if profit exceeds COC), asset structures, risk levels
Banker et al (2016):
- sticky costs: asymmetric retention of slack resources e.g. dismissed workers and disposal (curvilinear nature of rev and cost schedules)
- including would be radical departure from the point - its simplicity
49
i) Breakeven point
ii) Breakeven no. units
iii) Breakeven no. sales
iiii) CM ratio
Breakeven point with mixed products
i) Total CM = Total fixed costs
ii) fixed costs / unit CM
iii) fixed / CM ratio (units*p)
iiii) Total CM / sales revenue
= Total fixed / weighted average CM per unit
50
Operating leverage equation
Definition
What is means
factor = CM / net income
how % change in sales will impact profit
(high = high fixed/ variable = high risk of loss if fall but quick inc profits if rise)
51
Margin of Safety
- usefulness
Ratio (%)
- interpret
actual no. of sales - breakeven units
- likelihood of making a loss in the near future, a measure of risk
Margin of safety / actual no. sales units
- sales volume can drop 25% before make a loss
- if more capital intensive the often find this declines
52
Tax relationship with NPAT
NPBT = NPAT / ( 1-t)
53
ZBB points
Cichocki (2012)
- how activities performed vs what performed
- justify expenses from scratch - bottom-up reconsidered not last year +- 3%
- start with clean state (ignore past)
- very volatile industry
- q long-standing assumption, allocate resources partially on a need and benefit approach
- expensive
Mahler (2016):
- focus on SandA rather than core processes e.g supply chain, procurement or cost drivers e.g. complexity
- most outcomes are burdensome policies that fail to address underlying fundamentals (e.g. travel)
- need scale make it worth while
- look at costs at interfaces not in organisational silos
54
Beyond budgeting issues and alternatives
Hope and Fraser (2003):
- time consuming, distorts behaviour, impedes flexibility , disconnected from strategy
- command and control culture predominant to IT, BSC, process reengineering, moving to devolved networks
- disempowers front-line, slow responses
Alternatives:
- world-class benchmarks (market feedback - eco conditions that prevail at the time) (relative performance contract - not fixed)
- rolling forecasts (don't manipulate) - 5/8 quarters - few key variables
55
Examples of costly budgeting
WorldComm CEO: rigid demands 2% under and nothing else acceptable
- breakdown in ethics - $3.3bn in acc errors
Ford Motor: $1.2bn process
1999 study: only 21% time spent analysing numbers, rest of 'lower-value-added' - gathering and processing
- 30% of management's time
56
Budget and compensation
Jensen (2001):
- traditional system has a kink
- suggests a linear compensation plan
- if reward for falsifying numbers then threaten integrity
- extra $ rev, same bonus this year as next: PfP independent of budget target
- paid for luck?
57
Critics of Beyond budgeting
Libby and Lindsey (2010):
- perceived as value-added - < 20% report little value
- not fundamentally flawed, just adjust use
- fixed performance contract less prevalent: 5% Canada, 9% US
- revised frequently, allowance for uncontrollable events
- time not excessive
- not everyone in unpredictable so budgets not quickly outdated
58
Examples of good budgeting
Frow et al (2010): Astronia
- continuous budgeting
- allows discretion when unexpected events but imposes strict accountabilities
- solve tension with meeting targets (accountability) and being flexible (empowerment)
- contributed effectively to both the flexibility and the financial discipline required for effective strategy implementation.
Simons (1987): Johnson nd Johnson
- decentralised mgmt, culture info sharing, multiple revision, long-term
59
Price variance
(AP - SP) * (AQ)
| - to get standard price can either do historical data or task analysis (costs should vs what they were last year)
60
Usage variance
(AQ - SQ) * (SP)
61
Direct materials if different
Price: (AQpurchased) * (AP - SP)
Quantity: (SP) * (AQused - SQ)
62
Fixed overhead usage variance
PVV: BOH * (AQ - SQ)
63
Reconcile absorption and marginal
= fixed cost per uni * change in inventory
64
Variable overhead variance analysis
VO absorption rate = cost / hours
Price: (actual hours * VOAH) - (actual cost)
Usage: (SH - AH) * VOAR
65
Interpret price variance
- rush orders (low quantity)
- quality - lower = more defects
- negotiation
- discounts
66
Interpret usage variance
- worker efficiency
- machine maintenance
- PVV: inventory build up?
67
General usefulness of variance analysis
- assists in management by exception: action when diverge significantly but don't blindly follow
- less useful in rapid change
- focus on cost not performance
- distort behaviour (quality or bulk buying - build inventory)
- needs to be timely
Cheatham (1996):
- overemphasis on price and efficiency to the exclusion of quality
- PVV measure capacity utilisation while ignoring overproduction and unnecessary build up of inventory
68
Full cost accounting
Bebbington et al (2001):
- make costs more visible so decisions more compatible with sustainability agenda
- top-down vs bottom-up
- top: evaluate at global-level then divided by total units
Antheaume (2007):
- 'non-market' monetary value: morality?
- no appropriate market mechanism
Ittner and Larker (2003):
- factory: crime rate, water pollution
International Energy Agency
69
Environmental regulation
Burke and Clarke (2016)
- 3% qualify as IIRC. SA.
Megash (2012):
- IFRS >100 countries
- legal backing, credibility
- public good, voluntary
- 3 mining: fluff, non-disclosure, non-recognition
IFRIC 3: Emissions rights 04-05.
- 15 variations on EU ETS
International Integrated Reporting Council: principle-based framework. Auditors to check?
Global Reporting Initiative: 93% report on sustainability.
Market based vs regulatory intervention.
70
Benefits of integrated reporting
Eccles (2012):
- 90 H v L: policies guiding impact
- H> L acc and stock
- B2C: compete on brand
- why don't: agency (lower vol), inertia, don't know how
Burke and Clarke (2016):
- not just ethical story: corporate relations and understanding valuation creation
71
Balance score card
Kaplan and Norton (1992):
- inno, internal, customer, financial
- lag vs leading
- how achieved - maximise the collective - tension
Simon:
- how results achieved
- managers held accountable
- translate strategy to measures - at centre rather than control
- 90% vs 100% satisfaction
72
Empirics on BSC
Bain (2015): 38% use and inc
Ittner (2003): large bank
- subjectivity, reduce the balance, weight on financial for bonuses
- implementation issues
Campbell et al (2008):
- Store24
- reveal problems faster than quarterly review.
- hypothesised links are valid
73
BSC causal links
Ittner and Larker (2003):
- 60 service and manufacturing
- 23% built causal models. Had 5.14% higher ROE
74
Problems with BSC
- Window-dressing rather than internal marketing tool
- Manipulation (Ittner 2003)
- Links not validated
- Hard to measure costs
- bias, difficulty in measuring, alternative interpretations: magnified in sustainability world
75
Things to mention with budgeting
- applications to variance analysis and target culture
- responsibility accounting
- dysfunctional incentives: if want to inc resources allocated to their unit or if evaluated on performance relative to budgeted amounts then incentive to bias info going in
76
Comprehensive income definition
All operating income plus the changes in the value of assets and liabilities that are not derived in operations
- OCI: Change in BS that doesn’t flow through net income
- move away from dirty surplus - all changes in BS sweep through income
77
Sales variances
Price = (AP - SP) * AQ
Sales volume contribution variance = (actual volume - budgeted volume) * budgeted CM per unit
78
Making budgets format
- Sales
- Closing
- Opening
- Production
79
Underpinning issues of the conceptual framework / what to always mention
Recognition (timeliness, which statement), measurement, disclosure
- relevance and reliability feed into measurement basis
80
Controversial issues
```
OCI
Leases
Fair value
Goodwill
Banks - Level 3
Intangibles
Business combinations
```
81
Where is pressure coming from for OCI
```
Large companies (large pension liabilities)
Banks (lots of volatility)
```
82
What other information want when analysing statements
Competitive landscape, economic landscape, previous volatility to make more nuance analysis
- discontinuity in market forces?
83
Recent changes impact management accounting
- Robotics: more overhead costs
| - Technology increase traceability
84
Bright lines trade-off
Convenience and transaction structuring
85
Levels of variance analysis
Level 0: static vs actual
Level 1: flexible vs actual (reflects difference in activity levels) - add in in-between
Level 2: understand price and usage variance (cost control)
86
Defintion of accounting
Accounting is the process of identifying, measuring and communicating economic information, with the purpose of informing decision-making relating to the financial performance and financial position of an organisation.
87
Earnings management trade off
More flexibility may increase quality as the representation may be more accurate than if straightjacketed by regulation
greater flexibility allows greater scope for manipulation a la Enron
88
How can capitalise development
IFRS:
- technical feasibility, intention to complete, how generate benefit, availability of resources to complete, measure reliably
- i.e. costly/difficult to do and release proprietary info
89
Treatment of indefinite / fine lived asset
Indefinite: hold at cost subject to annual impairment review
Definite: amortise over useful life
90
Goodwill treatment
Occurs when price paid > value intangibles. Represents brands / synergies
Impairment: analyse fair value using DCF analysis then match that with value of goodwill
- easy to manipulate
- discretion on whether to impair
- if amortise then a constant earnings drag - may have been previous mgmt - also penalises those with high intangibles - discourage investment
- IFRS allow reversal to lower of recoverable amount and net carrying amount w/o impairment. Costly for a non-cash expense
91
Period vs product cost
Variable cost
Indirect
Product: become part of COGS
Period: all other costs other than period
Variable: change in direct proportion
Indirect: not specifically and exclusively identified with a given cost objective
92
Benefit of flexible budget
Removes uncontrollable volume variances from manager's performance evaluation
- enables variance analysis
93
Integrated reporting functions
Eccles and Serfeim (2014):
- information function: so investors make capital allocation decisions - financial reporting more focused on this
- transformative function: engage with stakeholders to get their input on how resources allocated - focus of sustainability reporting
- reg inhibit info
- trade off in accomplishing both - hard to address
94
Goodwill example
Carillion:
- Goodwill was worth the equivalent of 35% of total assets
- 5 years before 2017 (when collapsed), the group impaired not a penny of its goodwill pile, despite growing evidence that some of those assets might have slumped in value.
- is it in asset? in face of bankruptcy then no value
95
Materiality
Information provided should be all information that would have a significant influence on decisions of users
96
Define rules and principles
Rules-based can be defined as containing numerous specific requirements and much detailed implementation guidance in an attempt to address as many potential contingencies as possible.
Principle-based is a conceptual framework that consists of a hierarchy of underpinning principles.
97
Accruals
measure transactions at the time they take place rather than when cash changes hands
98
Fair value and the financial crisis
Barth and Landsman (2010):
- objectives differ: transparency vs stability
- no role in financial crisis but transparency of info with CDS was insufficient to properly value and assess risk
99
Controversial issues
Leases, goodwill, capitalising development
100
Cash flow budget ordering
```
Inflow
Outflow
Net
Balance start
Balance end
```
FHS
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