Introducing 

Prezi AI.

Your new presentation assistant.

Refine, enhance, and tailor your content, source relevant images, and edit visuals quicker than ever before.

Loading…
Transcript

XYZ Co. Ltd. purchased publicly purchased financial securities A & B on January 1st. These financial securities were both classified under similar groups of assets, and where recorded initially at Amortized Cost. The investments' purchase price and fair values are as follows:

Cost FMV

(Jan.1) (Dec.31)

Financial Instrument A $100,000 $150,000

Financial Instrument B $200,000 $160,000

Financial Reporting and Agent Incentives: A Critical Approach

Presented by:

Aaron Corbin

Sarah Dandia

Hassan Mousavi

How to Classify Under IFRS 9?

As Consultants to the IASB, what would we propose to curb the Incentives of Managers to Reclassify Financial Assets?

How Classification is Determined under IFRS 9

IAS 39 to IFRS 9

Managers' Incentives

The Bigger Picture

Suggestion # 1 to IASB:

Audit Rotation

Does IFRS 9 solve all the issues?

Audit Rotation

No assurances services (full audit) should be performed by the same auditing firm for all public companies for longer than 3 consecutive years .

Suggestion # 1 to IASB: Audit Rotation

Suggestion 2 to IASB: Increased Government Supervision of the Auditing Procedure

Subsequently, firms must wait at least two rotation periods before returning to a previous auditor.

That is, a firm cannot return to the same auditing for within a space of 6 years.

The IASB should propose to the Government to establish a unit of well-paid, experienced, independent auditors that will review and examine the work of auditors; with emphasis on potential moral hazards, and fraudulent practices.

The Business Model

The Standard positively defines two such business models:

- A Business Model is to hold the financial asset in order to collect the contractual cash flows ('hold to collect')

A Business model in which assets are managed to achieve a particular objective by both collecting contractul cash flows and selling financial assets ('hold to collect')

The classification is determined by:

(1) The business model under which the Financial asset is managed.

(2) The contractual cash flow characteristics of the financial asset.

The Cash Flow Characteristic Test

Solely payments of principal and interest. The SPPI Test

The requirement is that the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

How Classification is Determined under IFRS 9

Through choice of reclassification, managers can potentially conceal private information from the market about the condition of their financial assets (INFORMATION ASSYMETRY).

Consequently, stakeholders' perceptions of management stewardship compared to the market's performance can be severely distorted.

The classification is determined by:

- The business model under which the Financial asset is managed.

- The contractual cash flow characteristics of the financial asset.

IFRS 9 VS IAS 39

Classes Under IFRS 9

1) FVTPL

2) FVTOCI

3) Amortized Cost

Classes Under IAS 39

1) FVTPL

2) Held to Maturity

3) Loans and Receivables

4) Available for Sale

Financial Assets

How Reclassification Takes Place

Moral Hazard

Management may be tempted to reduce effort, blaming negative performance on factors beyond their control.

OR

Biasing reported earnings to cover up.

Incentives of Managers

Other Incentives

  • Reputation/Image
  • "Tone on top"
  • Pressure from higher levels of management
  • Some stock option compensation schemes encourage the pursuit of short-term profits over long-term benefit of the company

In this way, the Managers would be able to:

- Improve the appearance of their Financial Statements

- Make it seem as though they are Managing the business better

- Be able to obtain higher bonuses

Thank You!

FVTPL to AC

If the assets are reclassified from FVTPL to AC, no future losses resulting from changes in Fair Value will be reported on the IS.

AC to FVTPL

If the assets are reclassified from AC to FVTPL, all future fluctuations in Fair Value will be cycled through the IS.

What would you do as the Manager?

XYZ Company Ltd.

Reclassify A

Reclassify

Both

Reclassify

Neither

Example 1 Reclassification from FVTPL to AC

Reclassy B

How to Classify Under IFRS 9?

Reclassify investment A from AC to FVTPL

Keep investment B at Amortized Cost.

Example 1:

Revenues $100,000

COGS (75,000)

Gross Profit 25,000

Operating Expenses (12,000)

Operating Income $18,000

Other income/losses

Unrealized loss -

Unrealized gain 50,000

Net Income $68,000

$100,000

(75,000)

25,000

(12,000)

$18,000

(40,000)

-

$(22,000)

$100,000

(75,000)

25,000

(12,000)

$18,000

(40,000)

50,000

$28,000

$100,000

(75,000)

25,000

(12,000)

$18,000

-

-

$18,000

Why?

Because we can now report a gain for A and hide the unrealized loss for B.

Balance Sheet

Categories of Classification under IFRS 9

As Accountants What Can we Learn From this Case?

IAS 39 to IFRS 9

#1

The Accountant's Dilema

# 2

#5

#4

# 3

Under IFRS 9, each financial asset is classified into one of three main classification categories:

- Amortized Cost (AC)

- Fair Value Through Comprehensive Income (FVTOCI)

- Fair Value through Profit and Loss (FVTPL)

Increased Legal Liability?

Management is unlikely to acceppt responsibility in troubled times for the company (despite being paid handsomely)

Regulatory Capture

  • Coined by Nobel prize winning economist George Stigler
  • Financial firms had so much money and power, they persuaded politicians and regulators to leave them alone
  • A regulator that is supposed to act in the public's interest but ends up acting in ways that benefit the industry that it is supposed to be controlling.

Be extra-speculative of banks' reported earnings

  • Very difficult to assess the quality of all the loans and assets reported on a banks B/S
  • The price of financial instruments are only worth what someone is willing to pay for it
  • In troubled times, this value can be very different from what banks report on their financials
  • Be wary of risks: liquidity, credit, funding

Will we EVER learn from history?

  • Asset price bubbles occur fairly often
  • A banking crisis always follows because banks finance the purchase of inflated securities
  • Crashes and collapses happen over and over again
  • Even increased regulations have been proven to not necessarily prevent the next one from happening
  • Human nature?
  • Will likely blame factors beyong their control (or lie)

OR

  • Will bias reported earnings to cover up (Moral Hazard)

(Cooper, 2013)

(Cooper, 2013)

What is REPO 105?

Background to IFRS 9

Why IFRS 9?

Strong Criticism from Investors of IAS 39 after the Financial Crisis of 2008

When will IFRS 9 Begin?

Officially on January 1st, 2018

Background to IFRS 9

What was wrong with IAS 39?

IAS 39 allowed companies to easily reclassify Financial Assets, thereby hiding unrealized losses from the market.

IFRS 9

Suggestion # 2 to IASB: Government Audit Unit

Why Should the Government Audit Auditing Firms?

Sarbanes-Oxley Act

Prevent possible collusion between Auditors and Management

Reduce Moral Hazard

Purpose # 2: Auditing of Audit Firms

Why?

Which firms?

Which Firms?

Firms which audit public companies with a market capitalization of 80bil.

or greater.

Suggestion # 2 to IASB: Government Audit Unit

Purpose 1: Audit of Selected Public Companies

Which public companies?

Public Companies which have a Market Capitalization of Greater than or Equal to

$80 billion dollars

PriceWaterHouseCoopers Report:

Top 100 Companies in the World by Market

Cap

http://www.pwc.com/gx/en/audit-services/capital-market/publications/assets/document/pwc-global-top-100-march-update.pdf

When Will They Do the Audit?

Which Public Companies?

When will they do the audit?

What is the Reason?

This audit will be done immediate after the year end close of these companies

What is the Reason for the Audit?

  • Higher Level of Scrutiny
  • Reduce any collusion between company and audit firm
  • Ensure that there are no loopholes being exploited
  • Reduce Moral Hazard and information assymetry

Suggestion # 2 to IASB: Government

Audit Unit

This Unit of Auditors will serve 2 Purposes

(1) To Conduct a supplementary audit of selected public companies

(2) To audit auditing firms.

Mandate

  • Discussion of Managers Incentives to Reclassify Financial Instruments
  • Background to IFRS 9
  • Incentives Managers to Reclassify
  • Suggestions to the IASB to curb incentives
  • REPO 105
  • Lessons Learned

Learn more about creating dynamic, engaging presentations with Prezi