Accounting for Corporate Accountability - Royal Holloway

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Royal Holloway, University of London

School of Management

MN3245 – Accounting for Corporate Accountability

Study Guide

Autumn Term, 2011/12 Academic Year

Course outline

|Date - |Lecture |Workshop Topic | |Thursday | | | |29 Sep 11 |Objectives of financial | | | |reporting; conceptual | | | |frameworks | | |06 Oct 11 |Motives for voluntary |Conceptual frameworks – | | |reporting |transaction-based or | | | |value-based? | |13 Oct 11 |Reporting social and |Accountability and users | | |environmental impact | | |20 Oct 11 |Regulatory frameworks for |Voluntary reporting theories | | |financial reporting |and practice | |27 Oct 11 |The reporting entity – |Economic and social | | |defining the group for |consequences of accounting | | |consolidated statements |regulation | |03 Nov 11 |Accounting for pension |Impact of recent accounting | | |obligations |failures | |10 Nov 11 |Accounting for employee share |Accounting for pension | | |options |obligations | |17 Nov 11 |Off balance sheet finance |Accounting for employee share| | | |options | |24 Nov 11 |Revenue recognition |Lease accounting | |03 Dec 11 |Recap and revision lecture |Revenue recognition |

Course co-ordinator:

Professor Christopher Napier Room FBE133, Tel: 01784 276121, E-mail: [email protected] Office hours (Autumn term 2009/10) Monday, 11:00-12:00, Thursday, 10:30-11:30)

If you want to meet the course co-ordinator at any other time, please send an e-mail to arrange a mutually convenient time outside these office hours.

Aims of course

This course aims to:

• develop students’ knowledge and understanding of key contemporary issues involved in discharging corporate duties of accountability to third party stakeholders

• develop students’ knowledge and understanding of subjectivities inherent in externally published accounting information

• develop students’ appreciation of the economic consequences of corporate reporting practices

Learning outcomes

Upon successful completion of this course, students should be able to:

1. Demonstrate an awareness and understanding of corporate duties of accountability to external stakeholders.

2. Discuss and analyse the nature of subjective judgements involved in several complex areas of financial, social and environmental accounting and reporting.

3. Employ UK and international Generally Accepted Accounting Practice in analysis of the financial accounting treatment of a range of complex types of financial transactions.

4. Explain the broad nature of economic consequences which can potentially flow from different accounting and reporting practices

Teaching and learning methods

The course will be taught through 10 one-hour lectures and 9 one-hour workshops. Lectures will provide a broad outline structure for each topic covered. Workshops will be used to discuss issues in additional readings and/or work through numerical exercises related to the lecture material of prior weeks.

Textbooks

The set text for this course is:

• Alexander, D., Britton, A. and Jorissen, A. (2011) International Financial Reporting and Analysis, Andover: Cengage Learning (5th edition). ISBN:978-1-4080-3228-2.

In addition, the following supplementary text may be helpful in providing alternative perspectives on some of the material covered in this course:

• Deegan, C. and Unerman, J. (2011) Financial Accounting Theory: Second European Edition, Maidenhead: McGraw Hill. ISBN: 978-0-07-712673-5

• Elliott, B. and Elliott, J. (2012) Financial Accounting and Reporting, Harlow: FT Prentice Hall (15th edition). ISBN: 978-0-273-76079-5

The relevant chapters from these textbooks for each week’s topic are indicated in the following weekly course outline. In addition, several journal articles are identified – these should all be downloadable from the course Moodle page.

Assessment

The assessment for this course comprises an in-course assignment and an end- of-course examination. The in-course assignment carries a weighting of 30% and the 2 hour closed book examination carries a weighting of 70% towards the overall course mark. The word limit for the assignment is 2,000 words, including direct quotations, but not including your list of references/bibliography.

Assignment question

| | |Leading accounting standard setters, such as the International | |Accounting Standards Board and the Financial Accounting Standards Board| |in the USA, are increasingly moving towards the use of fair value | |measurements in place of historical cost measurements. However, this | |trend has been criticised on various grounds. Two of the main | |objections are that fair values are inherently subjective and therefore| |unsuitable for financial reporting, and that the use of fair values in | |financial statements is likely to encourage short-term behaviour by | |managers, which could work against the interests of investors and other| |stakeholders. | | | |Required: Discuss the two objections to the use of fair value | |measurement referred to above, and critically examine how far they are | |valid. |

A good answer will go a long way beyond mere description of the issues involved, including analysis and criticism. Some reading suggestions will be provided through Moodle, and good answers are likely to use other relevant sources.

The deadline for submission of your essay is Tuesday 8 November 2011 at 12:00 noon. Your essay must be submitted in accordance with the standard School of Management submission procedures. Please submit your essay as a Word file through the Turnitin plagiarism software (http://www.submit.ac.uk) – this will give you an automatic receipt, the date and time of which will be considered definitive as the time of submission. Also submit a printed version of your essay to the undergraduate office. Further details of the submission process will be given before the submission date.

Any essays submitted after the deadline will be subject to the standard Royal Holloway late submission penalties (10 percentage points deducted from the mark awarded for essays submitted up to 24 hours after the deadline, a mark of zero for any essays submitted more than 24 hours after the deadline). Extensions to the deadline will only be granted in very exceptional circumstances. Failure or inaccessibility of computer equipment will not be accepted as an adequate reason for granting an extension, so if you decide to leave printing of your essay until the morning of 8 November then you have made the choice to take a risk of having marks deducted if you experience problems accessing printers etc.

When writing an academic piece of work it is perfectly acceptable to quote or paraphrase items you have read, provided you enclose direct quotes in quotation marks and state the original source of the item. This requirement also applies if you copy, cut and paste, or paraphrase material found on the internet. Failure to attribute quotations in this manner will result in your assignment being penalised for plagiarism. All written academic work must have a bibliography attached, listing all items referred to in researching and writing the piece of work.

The aim is to return the assessed coursework by Monday 21 November 2011.

LECTURE PROGRAMME

Lecture 1 – Thursday 29 September 2011

Objectives of financial reporting; and conceptual frameworks

Objectives of lecture:

To recap and develop students’ knowledge and understanding of: • The concept of accountability • The role of corporate reporting • Conceptual frameworks for financial accounting

Key reading

Alexander, Britton & Jorissen, chapters 1 & 8

Supplementary reading

Deegan & Unerman, chapter 6.

Elliott & Elliott, chapter 9

Bence, D. & Fry, N. (2004), “Which way forward”, Accountancy, November 2004, p. 88

Marlow, D. (2009), “Comment that matters”, Accountancy, October 2009, pp. 68-69

Fraser, I. (2009), “More than words”, Accountancy, November 2009, pp. 38-39

McKernan, J. F. (2007), “Objectivity in accounting”, Accounting, Organizations and Society, Vol. 32, No. 1-2, pp. 155-180.

Lecture 2 – Thursday 6 October 2011

Motives for voluntary reporting

Objectives of lecture:

To develop students’ knowledge and understanding of: • The distinction between mandatory and voluntary elements of corporate reports • Legitimacy theory • Stakeholder theory • Institutional theory

Key reading

Deegan & Unerman, chapter 8

Supplementary reading

Alexander, Britton & Jorissen, chapter 10

Deegan, C. (2002), “The legitimising effect of social and environmental disclosures - a theoretical foundation”. Accounting, Auditing & Accountability Journal, Vol. 15, No. 3, pp. 282-311.

O'Dwyer, B. (2005), “Stakeholder democracy: Challenges and contributions from social accounting”. Business Ethics: A European Review, Vol. 14, No. 1, pp. 24-41.

Unerman, J. & Bennett, M. (2004), “Increased stakeholder dialogue and the internet: towards greater corporate accountability or reinforcing capitalist hegemony?” Accounting, Organizations and Society, Vol. 29, No. 7, pp. 685-707.

Lecture 3 – Thursday 13 October 2011

Reporting social and environmental impact

Objectives of lecture:

To develop students’ knowledge and understanding of: • The role of sustainability reporting • Stages of sustainability reporting

Key reading

Deegan & Unerman, chapter 9

Supplementary reading

Alexander, Britton & Jorissen, chapter 10 (pages 193 to 210)

Elliott & Elliott, chapter 32.

Adams, C. A. (2004), “The ethical, social and environmental reporting- performance portrayal gap” Accounting, Auditing & Accountability Journal, Vol. 17, No. 5, pp. 731-757.

Dillard, J. F., Brown, D., & Marshall, R. S. (2005), “An environmentally enlightened accounting” Accounting Forum, Vol. 29, No. 1, pp. 77-101.

Gray, R. (2002), “The social accounting project and Accounting, Organizations and Society: privileging engagement, imaginings, new accountings and pragmatism over critique” Accounting, Organizations and Society, Vol. 27, No. 7, pp. 687-708.

Gray, R. (2010), “Is accounting for sustainability actually accounting for sustainability. . .and how would we know? An exploration of narratives of organisations and the planet”, Accounting, Organizations and Society Vol. 35, No. 1, pp. 47-62.

Lecture 4 – Thursday 20 October 2011

Regulatory frameworks for financial reporting

Objectives of lecture:

To develop students’ knowledge and understanding of: • The regulatory framework for accounting in the UK and European Union • Economic consequences of accounting regulation

Key reading

Alexander, Britton & Jorissen, chapter 3

Supplementary reading

Deegan & Unerman, chapters 3 and 4.

Elliott & Elliott, chapters 9

Broadbent, J. & Laughlin, R., (2002), "Accounting choices: Technical and political trade-offs and the UK's private finance initiative", Accounting, Auditing & Accountability Journal, Vol 15, No 5, pp. 622-654.

Sleigh-Johnson, N. (2010) “Where now for UK GAAP?”, Accountancy, May 2010, pp. 64-65.

Lecture 5 – Thursday 27 October 2011

The reporting entity – defining the group for consolidation purposes

Objectives of lecture:

To develop students’ knowledge and understanding of: • The main issues arising in consolidated accounts • Creative accounting with use of special purpose entities

Key reading

Alexander, Britton & Jorissen, chapters 25, 26 and 28 (pages 708-709 – you will not be expected to be able to prepare consolidated accounts, but it is useful to understand the basic approaches to consolidation and relevant regulations)

Supplementary reading

Elliott & Elliott, chapter 22

Hines, R. D. (1988), “Financial accounting: in communicating reality, we construct reality”. Accounting, Organizations & Society, Vol. 13, No. 3, pp. 251-261.

Unerman, J. & O'Dwyer, B. (2004), “Enron, WorldCom, Andersen et al: a challenge to modernity”, Critical Perspectives on Accounting, Vol. 15, No. 6-7, pp. 971-993.

Sanderson, I. (2010), “What REPO 105 really means”, Accountancy, April 2010, pp. 28-29.



Lecture 6 – Thursday 3 November 2011

Accounting for pension obligations

Objectives of lecture:

To develop students’ knowledge and understanding of: • Distinction between defined contribution and defined benefit pensions • Conceptual difficulties in accounting for defined benefit pension obligations • Accounting for pension obligations under IAS 19 • Key differences between IAS 19 and the UK’s FRS 17

Key reading

Alexander, Britton & Jorissen, chapter 21 (pages 499 to 526)

Supplementary reading

Elliott & Elliott, chapter 15 (sections 15.1-15.17)

Napier, C. J. (2009), “The logic of pension accounting”, Accounting and Business Research, Vol. 39, No. 3, pp. 231-249.

Peters, B. (2010), “Far from final”, Accountancy, June 2010, pp. 68-69.

Lecture 7 – Thursday 10 November 2011

Accounting for employee share options

Objectives of lecture:

To develop students’ knowledge and understanding of: • The role of employee share options • Conceptual difficulties in accounting for employee share options • Accounting requirements for employee share options (IFRS 2)

Key reading

Alexander, Britton & Jorissen, chapter 21 (pages 486 to 499)

Supplementary reading

Elliott & Elliott, chapter 15 (sections 13:18-13:22)

Crook, K. (2004) “Learning to share”, Accountancy, April 2004, pp 84-85

Franklin, W. & Giles, L. (2004) “Life expectancy”, Accountancy, September 2004, pp. 88-89

Franklin, W. (2004) “End of a relaxed regime”, Accountancy, November 2004, pp. 84-85

Osborne, J. (2005), “Grappling with the practicalities”, Accountancy, June 2005, pp. 68-69

Osborne, J. (2007), “Good in principle”, Accountancy, November 2007, pp. 74- 75.

Ravenscroft, S. & Williams, P. F. (2009), “Making imaginary worlds real: the case of expensing employee stock options”, Accounting, Organizations and Society, Vol. 34, No. 6-7, pp. 770-786.





Lecture 8 – Thursday 17 November 2011

Off balance sheet finance

Objectives of lecture:

To develop students’ knowledge and understanding of: • Reasons for using off balance sheet finance • Accounting for leases (IAS 17)

Key reading

Alexander, Britton & Jorissen, chapter 15.

Supplementary reading

Elliott & Elliott, chapter 18

Collings, S. (2010), “In a tangle”, Accountancy, August 2010, pp. 70-71.

Lecture 9 – Thursday 24 November 2011

Revenue recognition

Objectives of lecture:

To develop students’ knowledge and understanding of: • Problems of determining when revenues and gains should be included in the income statement • Financial reporting standards on revenue recognition (IAS18, FRS5 Application Note G, new IASB proposals)

Key reading

Alexander, Britton & Jorissen, chapter 18.

Supplementary reading

Elliott & Elliott, chapter 8.

O’Donovan, B. (2010), “Money, money, money”, Accountancy, August 2010, pp. 68-69.





Lecture 10 – Thursday 1 December 2011

Recap and revision lecture

Objectives of lecture:

To: • Recap the course • Revise areas as requested by students

WORKSHOP PROGRAMME

Workshop 1 – Thursday 6 October 2011

Conceptual frameworks

It has been claimed that financial reporting has increasingly moved away from recording transactions and reporting on stewardship, that is, how well a company and its management use the resources invested by shareholders, and possibly by other stakeholders. This has been replaced by reporting values, with an emphasis on providing information to help investors make their investment decisions. Those who hold this view point to the focus on the balance sheet (financial position) rather than the income statement (financial performance) in conceptual framework documents. Do you agree with this? Does it matter?

Workshop 2 – Thursday 13 October 2011

Accountability and Users

Think of different examples of accountability – these need not involve companies, and accountability need not be financial. What are the common factors in accountability relationships? To whom do you think companies should be accountable?

Workshop 3 – Thursday 20 October 2011

Voluntary reporting theories and practice

It has been claimed that the predominant reason for companies disclosing voluntary information in accounting reports is to protect, and increase, the relative power and wealth of managers and providers of financial capital. Critically evaluate this claim, supporting your discussion with both theoretical arguments and practical examples.

Workshop 4 – Thursday 27 October 2011

Economic and social consequences of accounting regulation

“Accounting standards merely regulate the reporting of economic transactions, they have no impact upon the underlying economic performance or social impact of an entity.” Do you agree or disagree with this claim? Give both theoretically based reasons and practical examples.

Workshop 5 – Thursday 3 November 2011

Impact of accounting failures

Drawing upon alleged accounting failures such as Enron, WorldCom, and the 2008 credit crunch, critically evaluate claims that financial accounts objectively reflect an underlying economic reality.

Explore the impact that accounting failures at Enron and WorldCom, and the 2008 credit crunch, may have had on the level of trust placed in corporate financial statements.

Workshop 6 – Thursday 10 November 2011

Accounting for pension obligations

Brno plc operates a defined benefit pension scheme. On 1 January 2005, the present value of its pension fund obligations amounted to £100 million, and the market value of its pension fund assets also amounted to £100 million. The company’s policy is to recover any actuarial surpluses of pension fund assets over pension fund obligations by reducing future contributions from the company to the pension fund. The following information relates to Brno plc’s defined benefit pension scheme for the financial years ended 31 December 2005 and 31 December 2006:

| |2005 |2006 | |Discount rate at beginning of year |6.0% |5.0% | |Expected rate of return on pension scheme|10.0% |8.0% | |assets | | | |(forecast at beginning of year) | | | |Current service cost |£15m |£17m | |Benefits paid from the pension scheme |£12m |£18m | |Contributions paid into the pension |£10m |£14m | |scheme | | | |Present value of pension scheme |£105m |£120m | |obligations at end of year | | | |Market value of pension scheme assets at |£110m |£112m | |end of year | | |

You should assume that all cash flows related to the pension scheme occur at the end of each year. Ignore taxation.

Required:

a) In accordance with the accounting requirements of IAS 19 (using the ‘equity recognition approach’ option for the treatment of any actuarial gains or losses), calculate the following amounts to be included in the financial accounts of Brno plc for each of its financial years ended 31 December 2005 and 31 December 2006, and identify the accounting statement in which each item would appear: i) The net pension asset or liability ii) The pension operating cost (or credit) iii) The net pension financing cost (or credit) iv) The actuarial gain or loss

b) Accounting standards such as IAS 19 have been blamed for the decline of defined benefit pension schemes in the UK. How far is this allocation of blame fair?

Workshop 7 – Thursday 17 November 2011

Accounting for employee share options

On 1 January 2005 Wolt plc issued options over 500 of its £1 ordinary shares to each of its 2,000 employees. These share options can only be exercised by an employee if that employee remains employed by Wolt plc for the whole of the three year period ending on 31 December 2007. The directors of Wolt plc estimated on 1 January 2005 that 30% of their 2,000 employees would have left the company by 31 December 2007.

The option exercise price is £6.50 per share, and the market price of Wolt’s £1 ordinary shares was £4.35 on 1 January 2005. It has been calculated that the fair value of each of these employee share options on 1 January 2005 was £1.25 per share option.

150 of the employees who had been granted share options left the company during 2005, and on 31 December 2005 the directors of Wolt plc revised their vesting estimate to 25%.

A further 250 of the employees who had been granted share options left the company during 2006, and on 31 December 2006 the directors revised their vesting estimate to 28%.

A further 120 of the employees who had been granted share options left the company during 2007, and on 31 December 2007 all remaining employees exercised their options. The market price per £1 ordinary share in Wolt plc was £9.25 on 31 December 2007.

Required:

a) Calculate the expense (charge) to be included in Wolt plc’s income statement in respect of these share options each year from the year ended 31 December 2005 to the year ended 31 December 2007, in accordance with the provisions of International Financial Reporting Standard number 2 (IFRS 2).

b) Show how the above share options would be treated in the balance sheet of Wolt plc as at 31 December 2005 and 31 December 2006 in accordance with the provisions of IFRS2.

c) Critically evaluate how the accounting treatment of share options required by IFRS 2 conforms to the International Accounting Standards Board’s conceptual framework.

Workshop 8 – Thursday 24 November 2011

Lease Accounting

Latir plc was incorporated and commenced business on 1 April 2003. On that date it entered into the following leases:

1. A five year lease for machinery at a rental of £450,000 per annum payable in advance. The present value of the lease payments at 1 April 2003 was estimated as £1.9 million, equal to the market value of the machinery leased. Latir plc is responsible for insuring and maintaining the machinery during the period of the lease.

2. A three year lease for computer equipment, with an annual rental of £50,000 payable in arrears. The present value of the lease payments at the beginning of the lease was estimated as £120,000, which was the same as the market value of the computer equipment on that date. Latir plc is responsible for insuring and maintaining the computer equipment until the end of the lease.

3. A 15 year lease for the new building occupied by the company. The annual rent payable for the building is £300,000, payable quarterly in advance. The present value of the lease payments had been estimated as £2.6 million on 1 April 2003, when the market value of the land and building was £4 million. Latir is responsible for maintaining and repairing the building during the lease, but insurance is the responsibility of the landlord.

Latir plc has not entered into any other leases, and has not purchased any fixed assets. Its accounting policy is to depreciate leased assets, where appropriate, on a straight line basis over the term of the lease and to apportion interest charges on finance leases using the sum-of-the digits method.

Required:

a) Show how the above leases will be reflected in the financial statements of Latir plc for the year ended 31 March 2005 (its second year of operation) in accordance with the requirements of International Accounting Standard 17 (IAS 17), including relevant notes to the accounts. Clearly explain why you have adopted the accounting treatment you have chosen for each of the leases. (Note: you are NOT required to show the comparative figures for the financial year ended 31 March 2004 which would normally also appear in the 31 March 2005 accounts)

b) Without carrying out any further calculations, explain why and how the accounting treatment of leases you have adopted in your answer to part (a) of this question would change if the distinction between operating and finance leases were removed, so all leases were accounted for on the same basis.

Workshop 9 – Thursday 1 December 2011

Revenue Recognition

Clementi Airways operates a long-haul air passenger service from London to Sydney via Bahrain and Singapore four times weekly. Because the flying time is considerably longer than more direct flights, Clementi has difficulty in selling all seats in the business class section of its planes. In order to increase demand, Clementi has advertised a special offer. Passengers booking a return flight from London to Sydney departing and returning between 1 September and 15 November 2011 would be charged a return fare of £2,000 (which is considerably less than the fare charged by other airlines), and would be given a voucher exchangeable for an additional free return flight between London and Sydney departing and returning between 15 January and 15 April 2012. About 1,000 customers took advantage of the offer.

Clementi must now decide how to account for the revenue relating to these fares in its financial statements for the year ended 31 December 2011, and various members of the accounting staff have been asked for suggestions.

1) Ali suggests that the easiest way of accounting is to treat half of the fare (£1,000) as revenue in 2011 and the remaining half as revenue in 2012.

2) Bassam notes that the second flight is described as “free” and therefore all of the £2,000 should be recognised in 2011.

3) Khaldoun points out that the incremental costs of carrying a business class passenger from London to Sydney and back again (in-flight service, additional fuel, ground handling, ticketing and administration) are £200, and this should be allowed for. So Clementi should recognise £1,800 in 2011 and carry forward £200 for 2012.

4) Davoud argues that the transaction is not complete until the second flight has been taken, and therefore Clementi should recognise no revenue until 2012. He would be prepared for the incremental cost of the first flight to be carried forward rather than expensed in 2011, and offset against the revenue when this is recognised in 2012.

5) Eliezer comments that about half of the passengers holding vouchers will not in fact use them. He suggests that Clementi should recognise £1,500 per ticket in 2011 and £500 per ticket in 2012 to allow for this.

6) Fatimah reminds her colleagues that an alternative marketing approach that had not been adopted was to sell return flights between London and Sydney taken between 1 September and 15 December 2011 for £1,700, with no voucher being offered. She recommends that Clementi should recognise revenue of £1,700 in 2011 and the remaining £300 in 2012.

Required:

a) International Accounting Standard 18 Revenue defines revenue as “the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants”. What problems arise in deciding whether revenue can be recognised from the sale of goods and supply of services, and how does IAS18 provide guidance on how to deal with these problems?

b) Evaluate the six suggestions for recognising Clementi Airways’ revenue by reference to IAS18 and consider whether IAS18 leads to a reasonable accounting treatment in this case. Would the IASB’s current (2010) proposals for revenue recognition lead to any change in your answer?

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