Recognition And Measurment (In Practice) Flashcards
Two standards that tell us when we must not recognise an element
-> in accordance with IAS 38 intangible assets, internally generated bands and internally generated goodwill must not be recognised
-> in accordance with IAS 37 provisions, contingent liabilities and contingent assets are not recognised
Which accounting standards allow preparers of the financial statements to chooses a measurement basis
-> IAS 16 PPE permits a choice between the cost model and the revaluation model.
-> IAS 38 intangible assets permits a choice between the cost model and the revaluation model. However, due to lack of an active market for many intangible assets, the cost model is more likely
-> IAS 40 investment property permits a choice between the cost model and the fair value model
-> IFRS 3 business combinations allows the non-controlling interest at acquisition to be measured at fair value, or at its proportionate share of the fair value of the subsidiary identifiable net assets
Advantages and disadvantages of historic cost accounting (IMPORTANT)
ADVANTAGES
-> accuracy = cost is known and can be checked
-> objectivity = its reliable which enhances comparability
-> consistency = leads to stable, non volatile pricing
DISADVANTAGES
-> non current asset value become quickly out of date
-> depreciation charge is unrealistically low
-> lower costs lead to higher profits, which may lead to too high dividends in real terms
-> comparisons over time are impossible
-> users are interested in current values not past values
Current cost accounting advantages and disadvantages (IMPORTANT)
Advantages
1. More realistic values given, is current replacement cost
2. More relevant to many decisions (dividend policy, employee wages, taxation)
Disadavantges
1. Difficult to determine current value
2. Subjective as estimates have to be made if no active market
3. Heavily impacted by market conditions at the time of assessment
What did Enron do wrong in accounting scandal
- Market to market accounting (fair value accounting)
-change in accounting policy from historical cost to mark to market accounting method
-this is a form of fair value accounting and it restates assets and liabilities at the market value for any given period
-lead to massively fluctuating values in accounts
-advocated the switch to hide billions of dollars of losses within the group but claiming the new plot it will show true economic value of the business
-so under this method, Enron recorded expected profits based on predicted future cash flows of the contract just signed
-these contracts were often unpredictable and difficult to estimate. If they recorded a loss they wouldn’t book the loss
-they were caught in a cycle of accelerating their income and having to keep on earning new contracts to keep on recognising more accelerated revenues to cover the growing losses in the off balance sheet entities - Revenue recognition
-aggressive policy
-when providing trading services a business applies the ‘agent model’ whereby it may report trading fees as revenue of the trade
-Enron recognised the full value of the trans adaption as trade revenue. Revenues increased rapidly - Hiding their debt
-resorted to the use of special purpose vehicles to hide their growing debts (off balance sheet entities)
-they created the SPV, a combination limited companies or limited liability partnerships and transferred assets which had rising market values and in return took cash or loan notes
-SPV then used stock to hedge an asset on the balance sheet of Enron. They assumed that stocks would continue to appreciate and not fail as hedge funds
-Enron didn’t hide existence of SPV and disclosed them to investors and public but no one understood the complexity of the transactions so no one questioned
Sarbanes-Oxley Act 2002
-> introduced as a measure to protect investors by enhancing transparency and criminalising financial manipulation
-> main aim to restore confidence of users of financial information, enhance governance, and protect investors
-> introduced the requirement for internal audit controls over financial reporting to be assessed annually
The act required that the annual financial statements include
1. Statement assets managements responsibility for the effectiveness of internal controls over financial reporting
2. Management conclusion on the effectiveness of internal controls over financial reporting
3. Disclosure of any material weakness
4. An attestation by our external auditors on the effectiveness of internal controls over financial reporting
Failure to comply with the Act results in
1. Criminal penalties, whoever
-certified an inaccurate statement in the annual report will be fined up to $1,000,000 or 10 years imprisonment or BOTH
-wilfully certifies an inaccurate statement in the annual report will be fined up to $5,000,000 or 20 years imprisonment or BOTH
3. Reputation damage
4. Fines/penalties
5. Share value diminution
Key things we have learnt from the enron scandal
-enrons management failed on all fronts in providing useful, relevant info that enables the users to assess both future cash flow and management stewardship
-they manipulated results
-highlights how critical auditor independence is to protect interest of investors
-complete misuse and abuse of power by all parties involved
Who regulated Enron scandal and did they do Jon effectively with regards to regulating (IMPORTANT)
- SEC = approved use of MTM accounting
- Auditors = paid to look the other way
- US congress = approved the deregulation of energy markets
- Internal audit = function was either non existent or failed in their duties
What measures taken to prevent such scandals from happening again (IMPORTANT)
- More independent non exec board members to keep an eye on potential corruption within the senior management
- Tighter regulations around independent internal audit controls and more regular internal audits within organisations
- Rotation of audit teams to prevent relationships being built up between senior manège,not and audit staff
