Lecture 9 Impacts of financial reporting decisions on individual financial statement users (module 7) & Asset measurement (module 8)

Lecture Overview u Module 7 - Impacts on Individuals u Review - assessing the impacts of financial reporting decisions u Introduction to behavioural research (7.1) u Overview of research results (7.2) u Strengths and limitations (7.3) u Compile list of factors to consider when making financial reporting decisions u Module 8 – Asset Measurement u Review - Historical cost versus present values (8.1) u Application - Upward revaluations of non-current assets ( )

Module 7 Impacts (of financial reporting decisions) on individual financial statement users

Impacts of Financial Reporting Decisions You - Preparing Financial Statements & Making Financial Reporting Decisions End user – Making Decisions on the Basis Of Financial Statement Information

Review - Assessing the Impacts of Financial Reporting Decisions u There are two ways to assess the impacts of financial reporting decisions: u Determine what impact the release of information had on share price? (capital markets research) u Determine the impact of the information on the decisions of individual information users (behavioural research)

Introduction to Behavioural Research u Examines the impact of accounting information on individuals u Decision making at the individual rather than the aggregate (share price) level

Focus of behavioural research u Investigates of the impact of alternative accounting and disclosure methods on decision making by INDIVIDUALS u For example, what is the impact of u disclosure versus recognition u alternative inventory valuation methods u capitalisation versus expense

Behavioural Research - Method is Experimental u Subjects (financial statement users) are divided into two or more groups u Individuals in each group are given financial statements prepared using different accounting/disclosure methods u Subjects are asked to make decisions based upon the information which they have been given

Comparison of Behavioural and Capital Markets Research u Both examine the impact of financial reporting decision on users of the info. u Capital markets research assesses the aggregate effect, while behavioural research assesses the effect on individuals u Capital markets research includes only investors, while behavioural research examines other types of financial statement users u Capital markets research assesses WHETHER the information is used, while behavioural research can asses HOW the information is used

Research Results u Our focus is on the impact of our financial reporting decisions on the users of annual reports u Only a small amount of this type of research u Research results relate to: u use of particular items of information u the form of information disclosure (presentation)

Research evidence - the use of information items u In making predictions of financial returns, analysts found to acquire EARNINGS and SALES information more often than other types (Pankoff and Virgil 1970; Mear and Firth 1987) u Some studies questioned the provision of current cost information, subjects relied more on historical cost information (Heintz 1973; McIntyre 1973)

Research evidence - the presentation of information u Different PRESENTATION FORMATS found to influence users’ decisions u including bar charts, line graphs, pie charts and tables u Studies examining decision making by loan officers based on whether information is incorporated within the financial statements or included as footnotes FOUND PRESENTATION MADE NO DIFFERENCE (Wilkins and Zimmer 1983)

Limitations of behavioural research u Research examining similar issues have generated conflicting results u difficult to determine causes of inconsistencies u Settings of studies often different to real- world settings u implications for generalisability u Very difficult to replicate information available in the workplace u Students often used as surrogates u Small number of subjects often used

Why is behavioural research useful? u Gives us an idea what impact our financial reporting decisions will have on the users of our information u Useful for regulators to know about these results when deciding on new or changed accounting standards u Can be undertaken by researchers prior to new regulations being developed

Factors to consider when making financial reporting decisions Complete the attached handout to make a list of factors to consider when making unregulated financial reporting decisions

Module 8 Asset Measurement

Review - The Fundamental Problem of Financial Accounting Theory Provision of relevant info. to aid investor Decision making Provision of reliable info. to control management behaviour

Review - Historical Cost versus Present Value u Relevance vs reliability - impossible to achieve both simultaneously u To use a present value model you need to know: u future cash flows (probability of occurrence) u discount rate u PV model involves estimation and compromise u these estimates make the information subject to error and therefore (unacceptably?) unreliable

Issue - Upward revaluation of non-current assets u Application of concepts covered in prior modules u Information asymmetry - managers have more information about the current value of some assets than outsiders u Regulation - what aspects of revaluation decisions are regulated and unregulated? u Determinants of revaluation decision u Impacts on financial statement users

Regulations (AASB 1010 & AASB 1041) u AASB 1010 deals with downward revaluations while AASB 1041 deals with upward revaluations u The decision to recognise an upward revaluation is VOLUNTARY u DISCLOSURES of current valuations of land and buildings required every 3 years u AASB 1041 specifies the accounting treatments to be followed, and disclosures to be made, in relation to recognised revaluations

Latest changes to revaluation standards u AASB 1041 revisions apply to reporting periods ending on or after 30/9/01 u allows choice of either cost or fair value basis of measurement for each class of non-current assets u if fair value is chosen, revaluations must be kept up to date u frequency of revaluations depends on materiality of value changes

Discretion remaining - Unregulated financial reporting decisions u Whether to recognise a revaluation for each asset class (becomes choice between cost and fair value basis under new rules) u Amount of revaluation increment (discretion relating to estimation) u Frequency of revaluation (less discretion under new rules) u Type of valuer (independent or directors)

Financial statement impacts of recognising a revaluation u increased assets u increased equity u decreased future profits if assets are depreciable

Predictions and Research Evidence about Asset Revaluations Complete the attached handouts to make lists of : - economic determinants of the revaluation decision - impacts of recognising a revaluation

For Tutorials u Required reading u module 7 u Text chapter 11, just sections identified in study book u module 8 u Selected Reading 8.1 plus study book u Self assessment questions u Questions from module 7 u Questions from module 8