Financial Accounting

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Contents
Part A............................................................................................................................................................. 3
1. POSITIVE ACCOUNTING THEORY........................................................................................................... 3
1.1. Positive Accounting Theory........................................................................................................... 3
1.2. Positive accounting theory Vs Normative theory ......................................................................... 3
1.3. Agency Theory Vs Contracting Theory .......................................................................................... 3
1.4. Different Types of Agency Cost ..................................................................................................... 3
1.5. Criticism on Positive Accounting Theory ...................................................................................... 4
1.6. Efficient Market ............................................................................................................................ 4
1.7. Types of Form efficiency ............................................................................................................... 4
2. SOCIAL ACCOUNTING............................................................................................................................ 5
2.1. Corporate social responsibility .......................................................................................................... 5
2.2. Example of Environmental issues ................................................................................................. 5
2.3. Social Reporting ............................................................................................................................ 5
2.4. Types of Social accounting ............................................................................................................ 5
2.5. Corporate accountability .............................................................................................................. 5
2.6. Role of Government in regulating environmental issues ............................................................. 6
2.7. Compliance with social reporting ................................................................................................. 6
Part B:............................................................................................................................................................ 8
Financial capital maintenance .................................................................................................................. 8
Physical capital maintenance .................................................................................................................... 8
Part C:............................................................................................................................................................ 9
Financial instruments ................................................................................................................................ 9
Recognition of financial instruments ........................................................................................................ 9
Changes in AASB139 ................................................................................................................................. 9
Effectiveness of AASB9 ........................................................................................................................... 10
References .................................................................................................................................................. 11

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Part A

1. POSITIVE ACCOUNTING THEORY

1.1. Positive Accounting Theory
Positive accounting Theory (PAT) make predictions about events occurring in real world in
order to translate them into accounting form. The predictions in PAT are comprised on three
main hypotheses i.e. Bonus plan hypothesis, debt covenant hypothesis and political cost
hypothesis (Accounting Scholar.com, 2017).

1.2. Positive accounting theory Vs Normative theory

Positive accounting theory is objective in nature and based on facts. Normative theory (NT) is
subjective in nature and explains well with logics what should be done and which economic
policy should be adopted (Brachmann, 2017). PAT has a major focus on economic statistics and
financial events whereas NT forms value judgement to urge accountants for subjective morality.
PAT is either correct or in-correct. There is no need to prove or conclude positive accounting
theory with logics. On the other hand normative theory is backed by logical reasons for its
existence with facts and figures.

1.3. Agency Theory Vs Contracting Theory

Agency theory explains the relationship between a principal and agent. Whereas contract theory
demonstrates how economic actors establish contractual arrangements. Agency theory promotes
the view that managers act at the expense of shareholders by risking their capital (Ghazinoori,
2013). On the other hand, Contract theory works on the other hand constructs a healthy
relationship between management of a business and its stakeholders. Agency theory only
surrounds one relationship between a principal and his agents. The contract theory covers all
agreements related to legal relationship between an organization and its stakeholders (Li &
Kolotilin, 2016).

1.4. Different Types of Agency Cost

Agency costs are internal costs which incur due to conflict of interests between principal and
agents in a business. There are three main types of agency costs i.e. monitoring cost, bonding cost
and residual costs (Wilkinson, 2013).

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Monitoring costs refers to arrangements made by principal to monitor costs of agents.
Bonding costs are incurred by agents as an opportunity cost to be associated with contract of
agency.
Residual cost is incurred by both principal and agent due to conflicting interests of both parties
(Wilkinson, 2013).

1.5. Criticism on Positive Accounting Theory

Positive Criticism Theory received several criticism from economists for lack of prescription and
no contribution for improvement in accounting practice. According to criticism received from
several analysts, it is stated that the theory is not value free. PAT only focus on increasing wealth
and lacks moral regime (S.Suwaldiman, 2003). The consumers following PAT have opposing
effects on financial performance and position. It lacks universality by ignoring organization
specific relationships. The economists accused PAT for its lack of clarity and confusion. The
theory does not serve the purpose of a healthy economy due to its major focus on material
aspects and lack of moral behavior.

1.6. Efficient Market

An efficient market is the market with all pertinent information which is open and available for
all participants at the same time simultaneously. In an efficient market, the prices respond
immediately to the market information and trends.

1.7. Types of Form efficiency

Weak form efficiency: This type of efficiency reflects that a market is efficient which reflect all of the
market information available. It states that the rate of return on market has to be independent of future
events.
Semi-strong form efficiency: This type of efficiency reflects that a market is efficient which reflect all of
the information which is available publicly. This hypothesis states that a business stock adjust so quickly
in order to merge new information received (Oblivious Investor, 2017).
Strong form efficiency: This type of efficiency reflects that a market is efficient which reflect all of the
information which is available publicly, in market and privately. It states that no investor would receive
profit than the average investor in market.

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 2. SOCIAL ACCOUNTING
2.1. Corporate social responsibility
Corporate social responsibility is the contemporary business framework which promotes
environment friendly business practices. It is considered as an integral part of sustainable
development in modern business culture (Tuan, 2012). It takes into account interests of all
stakeholders while setting business practices rather than just focusing on investors and
shareholders.

2.2. Example of Environmental issues

Environmental issues are widely impacting businesses in contemporary business structure.
Global warming is the biggest problem the world is currently facing which is effecting the
structure of global corporate culture (Tuan, 2012). The environmental issues are impacting the
sustainability and development of businesses leading to drastic effects on economy of a country.
Environmental issues have a significant impact on accounting due to adverse economic effects.

2.3. Social Reporting

Social reporting is defined as a definable domain of a business which has impact on society.
Companies share with their stakeholders and general public a compact report about its activities
including all information, internal or external to keep them informed about activities of the
company having social impact (Kaur, 2017).

2.4. Types of Social accounting

Social accounting have five major areas i.e. National social income accounting, social auditing,
financial social accounting in profit oriented organizations, managerial social accounting in
profit oriented organizations and financial or managerial social accounting for nonprofit
organization (Agarwal, 2017). These all five types of social accounting classes deal with profit
and non-profit oriented organizations for effective functioning of corporate culture.

2.5. Corporate accountability

Corporate accountability is the functioning of a publically traded company in its non-financial
areas including sustainability, environmental issues and social responsibility. It promotes the
wellbeing of all stakeholders other than shareholders. It states that a company should not only

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focuses on betterment and prosperity of shareholders, rather it should focus on growth of other
stakeholders as well (Thomsen, 2004). Due to intense competition in global market, it has
become necessary for all corporate companies to deal with the issues by offering high value to all
stakeholders. They are required to be responsible for their acts and decisions taken. Corporate
accountability ensures that the organization is involved in ethical investment for wellbeing of all
stakeholders.

2.6. Role of Government in regulating environmental issues

Government has a direct role in dealing with environmental issues by introducing several programs
and pre-dispositions. Government assigns several environmental protection agencies for
betterment of environment. These agencies regulated several programs to deal with environmental
issues such as pollution, ethical issues and fabrication of a company’s corporate social
responsibility framework. Government play an active role in maintaining sustainability and eco-
friendly behavior to protect the environment (PATIMES.ORG, 2017). Federal government of any
country place a closed check and intact monitoring systems to look after the activities of corporate
and public sector and its impact on environment. It limits the illegal activities for disposing off
waste materials and other activities. Government of a country take crucial steps to ensure that
corporate social responsibility framework is adopted and implemented by each business for a
secure environment.

2.7. Compliance with social reporting

Social reporting had introduced as a voluntary framework for protection of environment. The
companies adopted it as an environment friendly policy to keep stakeholders satisfied in long
run. The compliance of social reporting regarding non-financial activities of a company has
become mandatory in several territories of world since last few decades. Despite of huge
awareness and demand of corporate social reporting, many countries in the world have devised
no legal policies to implement and enforce social reporting for companies. It has led for an
option for companies which has monopoly in their respective market whether to follow the social
reporting framework of not. European Union has devised a compact policy for implementation of
CSR framework for promotion of accountability and transparency (Chaplier, 2014). Companies

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in European Union like Unilever and Ikea has adopted CSR as its mandatory framework to keep
stakeholders satisfied in long run.

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Part B:
The two concepts of capital and capital maintenance under IFRS Framework include

Financial capital maintenance

This concept of capital maintenance states that assets are linked with net assets of a company
which are calculated after deducting all liabilities from all assets i.e. Current and Non-current. It
is concluded on the basis of financial capital maintenance that a business earns profit when its
net assets at the end of a financial year are more than net assets at the beginning of the year (Lee
& Chen, 2010). The closing assets are calculated after deduction of distribution to owners or
shareholders each year.

Financial capital maintenance concept is lined up with financial statements of a company. It is

supported by the equation of balance sheet i.e.

Assets – Liabilities = Equity

Opening equity (net assets) + Profit – Distributions = Closing equity (net assets)

Further it is divided in two classes i.e. money financial capital maintenance and real financial
capital maintenance. In the first concept, the profit is calculated if the closing assets are more
than opening assets at historical cost. It has no concern with inflation or change in price value of
money (Lee & Chen, 2010). On the other hand the latter concept the profit is calculated only if
the closing assets are more than opening assets at current market prices. This model takes into
account the inflation effect while calculating profit at the year end.

Physical capital maintenance

This concept basis the efficiency or growth of a business on number of units produced or its
production capacity. Physical maintenance concept state that a business earns profit only when
its net production capacity at the end of a financial year is more than net production capacity at
the beginning of the year. It is calculated after making adjustments for distributions made to
shareholders or any increase in equity.

Physical capital maintenance concept in IFRS refers to production and operational capability of a
company (Gebhardt, et al., 2014). A financial capital maintenance concept is useful for investors
or shareholders who are interested in growth of their invested capital. Whereas physical capital

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maintenance is useful for users of financial statements of a business who are concerned with
operating capacity of the organization.

Part C:
Financial instruments
A financial instrument is a legal contract which gives rise to a financial asset and financial
liability of equity instrument. A financial asset acquired as a result of a financial instrument is in
the form of cash, equity instrument or contractual right (simpli learn, 2017). A contractual rights
as an asset gives a right to an entity to receive cash or any other financial asset for other party or
to exchange financial assets or liabilities with the other entity. The financial liability arising as a
result of financial instrument state that the cash or financial asset has to be delivered in exchange
or another financial asset or liability. There are number of financial instruments such as currency
notes, shares, loans, debentures, accounts receivables or payables and financial derivatives.

Recognition of financial instruments

Financial instruments are created for settlement of future liabilities or to fulfill current finance
needs. Financial instruments are also created to mitigate risks associated with several business
transactions such as forward, futures and swap contracts. There are two methods of recognition
of financial assets. Initially all financial instruments are recognized on cost basis, later on it is at
the option of business entity to choose fair value measurement or cost measurement (IAS Plus,
2017). In case assets are recognized on cost basis subsequently, it is required to expense out the
interest income or expenses I added in its cost. In case the assets are recorded on fair value
measurement, interest is charged to profit and loss account.

Changes in AASB139
AASB 39 deals with De-recognition of financial instruments created by a company in company
once asset have been exchanged or liabilities have been settled. The requirements for De-
recognition of financial instruments were quiet complex for companies as per rules of IAS 39. In
order to draw simple and principal based rules for effective and timely de-recognition of
financial instruments, IASB received several complaints from entities in corporate sector (IAS
Plus, 2017). In order to deal with the drawn issues, it is suggested that a new standard has to be

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produced to deal with the problem. For that reason AASB 9 has been introduced which will be
completely implemented after Jan 2018.

Effectiveness of AASB9
The new standard has offered less complex and extensive rules and regulations for business
entities for easy de-recognition of financial instruments. It presents easy rules for classification
and measurement of financial instruments in financial assets of a company. It provides a logical
approach to enable companies for classification of financial assets driven by cash flow model
chosen by the business. It proposes a single impairment model being applicable on all financial
instruments (Imran, 2016). The major purpose of introducing this new standard was to remove
the complexity of the financial instruments de-recognition treatment. This standard fulfills the set
objectives by simplifying requirements of de-recognition.

It has also presented a reformed model of accounting for hedge and derivatives. As per
requirements of the new standard, companies have to make open disclosures to intact risk
management activity. It also presents a substantial overhaul of hedge accounting to align
accounting treatment for financial instruments in accordance with other assets and liabilities
(Imran, 2016). Due to implementation of AASB 9 the users of financial statements will now be
able to get enhanced and clear disclosures of company’s financial performance.

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References
Accounting Scholar.com, 2017. Positive Accounting Theory (PAT). [Online]
Available at: http://www.accountingscholar.com/positive-accounting-theory.html
[Accessed 28 Aug 2017].

Agarwal, M., 2017. Concept of Social Accounts and Its Features. [Online]
Available at: http://www.economicsdiscussion.net/national-income/social-accounting/concept-of-
social-accounts-and-its-features/7644
[Accessed 28 Aug 2017].

Brachmann, S., 2017. Differences Between Positive & Normative Accounting. [Online]
Available at: http://thefinancebase.com/differences-between-positive-normative-accounting-1663.html
[Accessed 28 Aug 2017].

Chaplier, J., 2014. EU to force large companies to report on environmental and social impacts. [Online]
Available at: https://www.theguardian.com/sustainable-business/eu-reform-listed-companies-report-
environmental-social-impact
[Accessed 28 Aug 2017].

Gebhardt, G., Mora, A. & Wagenhofer, A., 2014. Revisiting the Fundamental Concepts of IFRS. Abacus,
50(1), pp. 107-116.

Ghazinoori, A., 2013. Agency & stewardship, A. Ghazinoori, Lecture 4, Advanced Theory in Organization
Management. [Online]
Available at: https://www.slideshare.net/AmirhosseinGhazinoori/agency-stewardship-a-ghazinoori-
lecture-4-advanced
[Accessed 28 Aug 2017].

IAS Plus, 2017. IAS 39 — Financial Instruments: Recognition and Measurement. [Online]
Available at: https://www.iasplus.com/en/standards/ias/ias39
[Accessed 28 Aug 2017].

Imran, A., 2016. What are the benefits of IFRS 9 Financial Instruments (replacement of IAS 39)?. [Online]
Available at: https://www.bayt.com/en/specialties/q/311082/what-are-the-benefits-of-ifrs-9-financial-
instruments-replacement-of-ias-39/
[Accessed 28 Aug 2017].

Kaur, P., 2017. Social Reporting: Meaning, Uses and Scope. [Online]
Available at: http://www.yourarticlelibrary.com/accounting/financial-reporting/social-reporting-
meaning-uses-and-scope/57360/
[Accessed 28 Aug 2017].

Lee, G. & Chen, Y., 2010. Asset Liquidity, Cost of Capital and IFRS Adoption. SSRN Electronic Journal, pp.
21-24.

Li, H. & Kolotilin, A., 2016. Explainer: what is contract theory and why it deserved a Nobel Prize. [Online]
Available at: http://theconversation.com/explainer-what-is-contract-theory-and-why-it-deserved-a-

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nobel-prize-66826
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Oblivious Investor, 2017. Efficient Market Hypothesis: Strong, Semi-Strong, and Weak. [Online]
Available at: http://obliviousinvestor.com/efficient-market-hypothesis-strong-semi-strong-and-weak/
[Accessed 28 Aug 2017].

PATIMES.ORG, 2017. The Role of Government Regulation and Leadership in Increasing Sustainability.
[Online]
Available at: http://patimes.org/role-government-regulation-leadership-increasing-sustainability/
[Accessed 28 Aug 2017].

S.Suwaldiman, 2003. Critique to The Logic and The Normative Senses of Positive Accounting Theory.
Sinergi, 6(1), pp. 25-28.

simpli learn, 2017. Significance of Financial Instruments in Capital Management. [Online]

Available at: https://www.simplilearn.com/financial-instruments-rar18-article
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Thomsen, S., 2004. Corporate values and corporate governance. Corporate Governance: The
international journal of business in society, 4(4), pp. 29-46.

Tuan, L. T., 2012. Corporate social responsibility, ethics, and corporate governance. Social Responsibility
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Wilkinson, J., 2013. Agency Costs. [Online]

Available at: https://strategiccfo.com/agency-costs/
[Accessed 28 Aug 2017].

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