Historical Cost Accounting Research Articles

Mixing Fair-Value and Historical-Cost Accounting: Predictable Other-Comprehensive-Income and Mispricing of Bank Stocks

Other comprehensive income (OCI) items are often considered to be transitory (Chambers et al. 2007; IASB 2013; CFA2014). In this paper we show that a significant portion of OCI, namely unrealized gains and losses (UGL) from available-for-sale securities (AFS), is non-transitory: a negative correlation between accumulated UGL in the current period and next period UGL is predicted and we show that this correlation is economically and statistically significant. This correlation is due to a mix of accounting methods of measurement of income from fixed-income securities: UGL are recognized based on fair values, whereas interest income is measured based on historical cost. We document that: (1) this negative correlation explains a previously unexplained negative correlation in other comprehensive income (OCI); and, (2) investors seem to price total UGL disregarding (or not realizing) the fact that reported UGL includes a predictable, accounting-driven component.

Accounting for banks, capital regulation and risk-taking

This paper examines risk-taking incentives in banks under dierent accounting regimes with capital regulation. In the model the bank’s decisions of capital issuance and investment policy are jointly determined. Given exogenous minimum capital requirement, the bank is more likely to issue equity capital in excess of the minimum required level and implement less risky investment policy under either lower-of-cost-ormarket accounting or fair value accounting than under historical cost accounting. But fair value accounting may induce more risk-taking compared to lower-of-cost-or-market accounting due to short term interest in the part of the bank. However, the disciplining role of lower-of-cost-or-market accounting may discourage bank’s incentive to exert project discovery eort

Toward an optimal hedging strategy considering earnings volatility through fair value accounted financial derivatives

Purpose The purpose of this paper is to determine a financial institution's optimal hedging degree under consideration of costly earnings volatility induced by fair value accounted derivatives. The discussion on the adoption of fair value accounting in the financial industry has been rather controversial in recent years. Under this accounting regime, the change in market values of specific assets must be considered as profit or loss. Critics argue that fair value accounting induces higher earnings volatility compared to historical cost accounting and, therefore, may initiate a downward spiral during recessions. Thus, increased earnings volatility induces costs, which can be explained by disappointed capital market expectations. Consequently, in general, a lowering of earnings volatility will be rewarded. Consistent with this theoretical finding, empirical research provides strong evidence that companies pursue income smoothing to reduce earnings volatility. In contrast to industrial corporations, financial institutions may easily reduce their earnings volatility by engaging in additional hedging activities. However, more intense hedging usually reduces expected profits. Design/methodology/approach Based on a research project initiated by a large German bank, this study quantitatively models the trade-off between the (utility of) costs of earnings volatility and the reduction of profit potential through additional hedging. Findings By conducting sensitivity analyses and simulations of the crucial factors of the trade-off, we examine relevant causal relationships to obtain first indications about the economic benefits of income smoothing. Originality/value To the best of our knowledge, we are the first to develop an optimization model that supports decision-making by attempting to determine an optimal (additional) hedging degree considering the costs induced by earnings volatility.

Does Fair Value Accounting Exacerbate the Procyclicality of Bank Lending?

ABSTRACTThis study investigates whether fair value accounting contributes to the procyclicality of bank lending. Using banks’ approval/denial decisions on residential mortgage applications to capture banks’ supply of credit, I find no evidence that fair value accounting has procyclical effects on bank lending over the past two business cycles. I further identify two reasons for this result. First, the main accounting item distinguishing fair value accounting from historical cost accounting—unrealized gains and losses on available‐for‐sale securities—does not affect lending decisions. Second, unrealized gains and losses on available‐for‐sale securities are not procyclical, as the risk‐free interest rate rises during some expansionary periods, resulting in unrealized losses, while the risk‐free interest rate (and sometimes the default spread) falls during some recessionary periods, resulting in unrealized gains.

Zmiana wyceny składników bilansowych na przykładzie MSR 41 „Rolnictwo"

The main aim of the article is to present IAS 41 "Agriculture" as a sign of evolution in IFRS's valuation. From a historical point of view, agricultural activity has been based on historical cost accounting. The introduction of IAS 41 "Agriculture" can be considered a revolution where valuation is concerned. The first part of the article outlines the philosophy and detailed regulations of IAS 41. Assumptions of biological asset valuation are then analysed using the example of the timber industry. The final part of the article presents the most controversial aspects of IAS 41, especially where early income recognition is concerned. Additional practical examples are provided, when the fair value of biological assets and agricultural produce and its impact on the income statement generate negative consequences for an entity's financial statement.

Investment Effects of Wealth Taxes Under Uncertainty and Irreversibility

The growing dissatisfaction with perceived distributional inequality and budgetary constraints gave rise to a discussion on the (re-)introduction of wealth taxes. Wealth taxes are typically levied on private wealth, in some countries also on corporate wealth. To avoid misleading statements concerning possible distributional consequences of wealth taxes, preceding analyses of the economic and particularly investment effects are necessary. As investments drive job creation, tax-induced changes in investment timing may significantly affect the income and wealth distribution. We analyze the impact of wealth taxes on investment timing under uncertainty and irreversibility and the propensity to carry out risky projects. Using a Dixit/Pindyck type real options model we find that wealth taxes have real effects. This means that higher wealth tax rates can either stimulate or depress the propensity to invest in risky projects. We find that apparently paradoxical wealth tax effects (accelerated investment due to higher wealth tax rates) are more likely for low interest rates and for high-risk investments. Using either historical cost or fair value accounting may affect investment timing ambiguously. Thus, the design of wealth taxes is crucial for the resulting delay or acceleration of investment. Although our model takes an individual perspective, our findings are also relevant for the current tax policy discussion on the introduction of wealth taxes. Our results indicate that wealth taxes are particularly harmful for specific classes of investments, for example low-risk investments. (authors' abstract)

Fair value accounting choice

Purpose– Profiting from a unique research opportunity in the Portuguese REIFs market, this paper aims to investigate the impact of fund managers ' accounting choice on funds ' returns distribution and analyses the relationship between fair value accounting choice and conditional accounting conservatism.Design/methodology/approach– According to Portuguese securities market regulation, fund managers of REIFs can fix the value of the fund properties between the acquisition cost and the average of the appraisal values assigned periodically by two independent appraisers. Therefore, through the analysis of fund managers’ actual choice to value REIF net asset value in comparison with a mandatory adoption of a pure fair value method (appraisers’ valuations), the paper investigates the impact of accounting choice on funds’ return series. On the other hand, an analysis at fund level is also conducted to determine the consequences of fair value accounting choice on the ability of fund managers in delaying the recognition of asset value decreases (bad news).Findings– Results indicate that in the period of financial crisis, significant differences in REIF returns according to the accounting method used to value properties are observed. There is also evidence that fund managers of open-end funds that are subject to greater market pressure to meet financial reporting objectives are more likely to smooth book value returns. Additionally, findings support the hypothesis that REIFs that use a more historical cost accounting model exhibit a lower degree of conditional accounting conservatism, suggesting that the use of fair value may be useful to reduce fund manager discretion in delaying the recognition of losses.Originality/value– This paper provides an empirical evidence of one possible positive effect of the use of fair value on the quality of financial reporting, evidencing how a more fair value accounting model may limit fund managers’ discretion.

The Critical Aspect on Fair Value Accounting and its Implication to Islamic Financial Institutions

Recently, fair value measurement and its implication in accounting standards have been increasing (Ramanna, 2006). One of the important aspects of financial reporting is measurement (Barth, 2007). Barlev and Haddad (2003) state that the fair value accounting(FVA) paradigm replaced the historical cost accounting (HCA) in the development of accounting standards that FVA is more value relevant that HCA probably did not provide the real financial information and income. However, previously studies mention that fair value accounting suffers from some serious limitations and disadvantages such as issues in market approach, income approach, and cost approach. Al-Yassen and Al-Khadash (2011) argue that accounting standard setters such as the International Accounting Standards Board (IASB) UK and the Financial Accounting Standards Board (FASB) U.S as well as other national accountingstandard setters provide high attention and long-term ambition to use fair value accounting as full measurement in all financial instruments. Islamic Financial Institutions (IFIs) that have different objectives and principles as well as have different financial products with conventional financial institution. This paper tries to explore critical aspects of the fair value accounting andits implications to Islamic Financial Institutions implications. This study concludes that that fair value accounting measurement provides many critical aspects to be implemented to Islamic Financial Institutions (IFIs). Additionally, AAOIFI proposed cash equivalent value as respond to fair value measurement that cash equivalent value when the attribute condition are present such as the relevance, reliability and understandability of the resulting information. Furthermore, fully adopting International Financial Reporting Standards (IFRS) issued by IFRSIASB, there will no specific standards for unique functions of Islamic Financial Institutions. Inaddition, the paper may be recommended to work together among Muslim countries to unity the potential harmonizing one set accounting standards for Islamic Financial Institutions such as AAOIFI?s standards.

Inflation Accounting: More Questions than Answers

The sole responsibility of accounting is to present what has transpired within a given period through reporting not what should have occurred or will occur. Despite fitting correctly into the definition of reporting business event, historical cost accounting in recent times has come under heavy criticism of lacking behind economic trends due to the use of original cost. Historical cost accounting has been challenge on principles of uniform monetary measure and matching concepts. These growing dissatisfaction with historical cost accounting as a method of reporting financial statements has made it necessary to consider alternative method which is accounting for price level changes. Unfortunately, this alternative has not been put to practice due to its unattractiveness. It is against this background that this paper attempts to discuss some novel questions with recommendations about the existing inflation accounting methods. Aside the traditional disadvantages of inflation accounting, this article have critically examine the restatement of items under inflation accounting against basic accounting, economics and finance principles. In addition the novel questions have been raised on the consistency and rationale behind the treatment of certain items under price level changes accounting. The article argues that, inflation accounting is not only inconsistent with accounting principles but also with related subjects such as economics and finance. In practice inflation accounting creates illusionary or imaginary profit which does not exist, thus capital maintenance concept is just a paper theory because much of the profit under inflation accounting is unrealised or holding gain Inflation accounting distorts the basic objective of reporting what happen within a period or at specific time. The greatest deterrent to adoption of price level changes accounting is what it is not: inflation accounting is not present value, net realizable value, or current market values or fair value and therein lies much of the opposition to its use. In line with these questions, the article recommends that, inflation accounting can only be meaningful with new accounting system since the existing system is based on historical cost accounting.

THE CRITICAL ASPECT ON FAIR VALUE ACCOUNTING AND ITS IMPLICATION TO ISLAMIC FINANCIAL INSTITUTIONS

The Critical Aspect on Fair Value Accounting And Its Implication To Islamic Financial Institutions . Fair value accounting (FVA) paradigm replaced the historical cost accounting (HCA) in the development of accounting standards that FVA is more relevant that HCA probably did not provide the real financial and income information. This paper tries to explore critical aspects of the fair value accounting and its implications to Islamic Financial Institutions implications. This study concludes that that fair value accounting measurement provides many critical aspects to be implemented to Islamic Financial Institutions (IFIs). AAOIFI proposed cash equivalent value as respond to fair value measurement that cash equivalent value when the attribute condition are present such as the relevance, reliability and understandability of the resulting information DOI: 10.15408/aiq.v6i2.1236

Fair Value Concept Specifics in Financial Reporting and Auditing

Abstract Investors have become the most important users of financial statements in modern business conditions, and mixed base of financial reporting has been established in order to meet their information needs and it includes elements of the concept of historical cost and the fair value concept, with an increasing shift towards the fair value concept. The primary task of fair value accounting becomes the expression of the fair value of the net assets at the reporting date, while the financial results represent the change in fair value of net assets between the two reporting periods. In our country the application of the "full IFRS" is mandatory for large enterprises and the application of IFRS for SMEs is mandatory for small and medium-sized entities, thus fair value accounting becomes an integral part of the financial statements of domestic companies. However, fair value accounting is not a suitable concept for our country characterized by shallow and underdeveloped financial market, companies whose owners are the company managers at the same time, and low level of economic and technological development. A financial statement audit in terms of the use of the fair value concept becomes much more demanding and complex than the audit of the financial statements based on historical cost accounting.

The “Triple Depreciation Line” instead of the “Triple Bottom Line”: Towards a genuine integrated reporting

The ‘Triple Bottom Line’ (TBL) is a major and increasingly used socio-environmental accounting framework. However, critical academic examinations of this model have been remained scarce and most importantly, no real alternatives have been developed. Thus this theoretical paper provides a contribution to fill this gap. Through a critical analysis of the TBL, we argue that it suffers from severe limitations. In particular, it does not protect human and natural capital (HNC). As an answer to these problems, we propose and discuss another accounting framework, the ‘Triple Depreciation Line’ (TDL), which extends to HNC the powerful capitalist accounting tool for preserving financial capital – the historical cost accounting (HCA) and its planned depreciation. To this end, we analyse and (re-)define the concept of capital in an ecological accounting context. We clearly specify the assumptions on which the TDL relies, to facilitate comparisons or dialogues with other accounting models and to avoid misunderstanding as in the case of the TBL. These axioms concern what we call the ‘social’ (axioms SA1–2) and ‘corporate’ (axioms AA1–4) capital maintenance. While the two first appeal to the most precise ontological investigation possible of HNC, the others imply mainly the recourse to the HCA and its depreciation.

The subprime crisis and the impact of accounting standards/fair value accounting: case of European and North African countries

The introduction of fair value accounting is frequently mentioned as an important link in the string of events which led to the financial crisis. The present study briefly introduces the concept of fair value accounting and discusses the controversial topic of trade-offs with historical cost accounting, which it replaced. It summarises the findings reported in the academic literature on the consequences of the entry into force of this new accounting regulation in the case of banks, with particular emphasis on the role played by fair value accounting during the financial crisis. Further, our study examines the impact of the accounting treatment on the volatility of the securities to the banking during the financial crisis of 2007/2009 using a sample banks from of European and North Africa countries. The empirical results indicate that the adoption of the method of fair value reflects a truer picture of the financial position of the bank. However, adopting the same method increases the sensitivity of the institution facing a financial crisis. The volatility of the banking securities is significant during the crisis. Overall, the finding indicates excessive volatility for the European countries and significant volatility for the North African countries during the crisis.

Accounting valuation models under international financial reporting standards: evidence from some European listed companies

The aim of this paper is to examine the value relevance of accounting information following the voluntarily IFRS adoption in the pre–IFRS period (from 2000 to 2004). Moreover, this paper compares the relevance of the two accounting valuation models as the historical cost versus Fair Value Accounting (FVA) following the mandatory IFRS adoption. We use a panel data collected from a sample of 106 firms listed at the stock exchange of three European countries (Germany, France and Belgium). The results suggest that the value relevance of accounting information in firms that voluntarily adopt IFRS decreases compared to in firms that report their financial statements into domestic standards (DS). Our findings confirm that the FVA model is more relevant than historical cost accounting model. This paper contributes to the existing literature by comparing the accounting quality of voluntary IFRS–firms and DS–firms and the choice of the more relevant accounting valuation models. This study highlights the importance of fair value for the improvement of investors' making decisions.

Conceptual framework and measurement: A survey on the international debate

In response to the ‘2011 Agenda Consultation’, the IASB launched in July 2013 a call for a new Discussion Paper on the ‘Conceptual Framework for Financial Reporting’. This article aims to offer a contribution to the debate on the effectiveness of the theme of ‘Measurement’, by investigating the use of the current evaluation models in the literature and practice of Financial Reporting. The article proposes at first a historical survey both of the international debate on Fair Value Accounting vs. Historical Cost Accounting and of the Italian theories on the valuation. Later the paper proposes some considerations about the key questions related to Measurement and the possible policy implications of the main research finding, by conceptualising a ‘mixed’ system combining fair value Accounting and historical cost Accounting to try giving a more rational base to the financial reports.

Comprehensive Income and Financial Performance Ratios: Which Potential Effects on RoE and on Firm's Performance Evaluation?

Abstract The reporting of comprehensive income is becoming increasingly important. The new version of IAS 1 (the so called IAS1-revised) issued by IASB on September 2007 provides the mandatory reporting of other comprehensive income items for the EU listed companies. This circumstance is of particular relevance in the Italian context, characterized by a strong historical cost accounting model and by concentrated ownership publicly traded companies. This study aims to examine the potential impact of unrealized gains and losses reporting on entities performance ratio, and thus on investors’ decision process, by investigating its effects on Italian listed entities. The results show that the first time adoption of comprehensive income reporting does significantly affect Italian listed entities performance, notwithstanding the apparent irrelevant spread existing between net income and comprehensive income book values.

The Critical Aspect on Fair Value Accounting And Its Implication To Islamic Financial Institutions.

The Critical Aspect on Fair Value Accounting And Its Implication To Islamic Financial Institutions. Fair value accounting (FVA) paradigm replaced the historical cost accounting (HCA) in the development of accounting standards that FVA is more relevant that HCA probably did not provide the real financial and income information. This paper tries to explore critical aspects of the fair value accounting and its implications to Islamic Financial Institutions implications. This study concludes that that fair value accounting measurement provides many critical aspects to be implemented to Islamic Financial Institutions (IFIs). AAOIFI proposed cash equivalent value as respond to fair value measurement that cash equivalent value when the attribute condition are present such as the relevance, reliability and understandability of the resulting information DOI:10.15408/aiq.v6i2.1236

Mark-to-market accounting and systemic risk: evidence from the insurance industry

One of the most contentious issues raised during the recent crisis has been the potentially exacerbating role played by mark-to-market accounting. Many have proposed the use of historical cost accounting, promoting its ability to avoid the amplification of systemic risk. We caution against focusing on the accounting rule in isolation, and instead emphasize the interaction between accounting and the regulatory framework. First, historical cost accounting, through incentives that arise via interactions with complex capital adequacy regulation, does generate market distortions of its own. Second, while mark-to-market accounting may indeed generate fire sales during a crisis, forward-looking institutions that rationally internalize the probability of fire sales are incentivized to adopt a more prudent investment strategy during normal times which leads to a safer portfolio entering the crisis. Using detailed, position- and transaction-level data from the U.S. insurance industry, we show that (a) market prices do serve as ‘early warning signals’, (b) insurers that employed historical cost accounting engaged in greater degrees of regulatory arbitrage before the crisis and limited loss recognition during the crisis, and (c) insurers facing mark-to-market accounting tend to be more prudent in their portfolio allocations. Our identification relies on the sharp difference in statutory accounting rules between life and P&C companies as well as the heterogeneity in implementation of these rules within each insurance type across U.S. states. Rather than promoting a shift away from market-based information, our results indicate that regulatory simplicity may be preferred to the complexity of risk-weighted capital ratios that gives rise, through interactions with accounting rules, to distorted risk-taking incentives and potential build-up of systemic risk.

Financialisation of global markets: the role of private sector accounting standard setting

Financial reporting often creates new realities rather than merely reflecting reality. How, then, would the globalization of International Financial Reporting Standards (IFRS), as a specific mode of presenting reality, affect our markets? Drawing on fair value accounting instead of traditional historical cost accounting, IFRS makes the business realm and society amenable to financialisation. This process of converting real markets into tradable components, particularly by the private sector, may not contribute to sustainable market growth. This paper introduces three case studies to illustrate the significant impact IFRS makes on real sector markets. These consequences would in turn affect financial markets in the long term.

Procyclicality of US Bank Leverage

In light of the current debate about the link between accounting and financial stability, we investigate the determinants of procyclical book leverage for US commercial and savings banks. We find that total asset growth and GDP growth are both positively related to book leverage growth. Our evidence is not consistent with the notion that fair value accounting contributes to procyclical leverage or that historical cost accounting reduces procyclicality. Overall, the business model of banks and the level of the regulatory capital ratio and book leverage seem to be more important for procyclical leverage than accounting or regulatory risk weights.