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Accounting Notes Financial Accounting, Analysis and Valuation Notes

Stream 3 Reading Fair Values, Imaginary Prices, Mystical Markets Notes

Updated Stream 3 Reading Fair Values, Imaginary Prices, Mystical Markets Notes

Financial Accounting, Analysis and Valuation Notes

Financial Accounting, Analysis and Valuation

Approximately 85 pages

AC330: Financial Accounting, Analysis and Valuation

These notes cover the AC330 Financial Accounting, Analysis and Valuation course at LSE. "The course addresses the theory and practice of financial reporting. Accounting practices are examined in the light of historical development, regulatory requirements, theories of income and capital and other approaches to accounting theory and to the use of accounting information in business analysis and valuation.

Financial accounting with particular ref...

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Introduction

  • Accruals give some indication of managerial expectations about the future

  • A sufficient understanding of fair value measurements of assets and liabilities is that they are based on actual estimates of specific market values

  • The appeal of fair value is that there is the perception that it increases the social value of accounting information

    • It minimizes the freedom for managerial manipulation

  • However, reliability may come at high cost as surely investors are interested in expected opportunities to earn profits above normal returns – super profits - as seen by management

  • They are supposedly objective, as actual market prices are empirical phenomena, publicly available and can be verified by all

  • However, additional assumptions are required that may not sit easily with the world in which accounting exists

  • Even the FASB draft on Fair Value Measurement (FASB 2004) does not contain a full case for fair values, being mainly concerned with problems in the measurement of fair values

  • There is a reluctance to discuss formally the rationale of fair value

    • This is also the case with the IASB

      • Standards utilizing fair value do not provide either a rationale or theoretical case for using fair value measurement

Fair values as estimates

  • Fair values are estimates of the market prices which would be obtained in contracts (transactions) between buyers and sellers of individual accounting items if these items were either to be sold on the market (exit prices) or replaced on the market (entry prices) even when such markets do not exist

  • Transaction costs do not enter into estimates of fair value prices

    • Because going concerns will at any given time not generally plan to either sell or replace their entire set of assets and their liabilities portfolio

      • Therefore will not incur transaction costs at the time of accounting measurement

    • Another argument is that such costs are not recoverable in the market anyway

  • Principle that fair values should not incorporate entity-specific views

  • It is not yet clear whether alterations in market values and estimates of market values incorporated into financial reports will be priced by the market in the same way as the accounting results flowing from corporate transacations

    • There is however, substantial evidence that fair values may be value relevant, i.e. have an effect on stock prices in some circumstances (Barth and Landsman, 1995)

  • As a result, fair values may differ from transaction prices in actual markets (even where markets are available)

Early definitions of fair value

  • USA Accounting Principles Board (APB) – 1973

    • Fair value ‘should be determined by referring to the estimated realizable values in case of transactions of the same or similar, assets, quoted market prices, independent appraisals, estimated fair values of assets of services received in exchange and other available evidence’

      • This is referring to exit value

  • Current definitions include:

    • FASB 1998 – The amount at which an asset could be bought or sold in a current transaction between willing parities, that is, other than a forced or liquidation sale

    • FASB 2004 – The price at which an asset or liability could be exchanged...

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