Theory

Question 1 (25 marks)Several accountin" rel="nofollow">ing standards in" rel="nofollow">include ceilin" rel="nofollow">ing tests (also called impairment tests). a. What is a ceilin" rel="nofollow">ing test? Identify two IASB accountin" rel="nofollow">ing standards that contain" rel="nofollow">in a ceilin" rel="nofollow">ing test and describe the test. (7 marks) b. Ceilin" rel="nofollow">ing tests are usually regarded in" rel="nofollow">in this course as one-sided examples of the measurement approach. However, they can also be regarded as examples of conservative accountin" rel="nofollow">ing, as assets are written down but not written up. Ceilin" rel="nofollow">ing tests are an example of conservative accountin" rel="nofollow">ing. Why do bondholders favour ceilin" rel="nofollow">ing tests? How do bondholders reward the firm for conservative accountin" rel="nofollow">ing such as ceilin" rel="nofollow">ing tests? (6 marks) c. Explain" rel="nofollow">in briefly why auditors favour ceilin" rel="nofollow">ing tests. (6 marks) d. Outlin" rel="nofollow">ine the accountin" rel="nofollow">ing for research and development (R&D) under IASB standards. Is this accountin" rel="nofollow">ing conservative? Why? Explain" rel="nofollow">in why accountants account for R&D as they do. (6 marks) Question 2 (25 marks) Most firms hedge at least some of their risks. Hedgin" rel="nofollow">ing can take two basic forms—namely, natural hedgin" rel="nofollow">ing and hedgin" rel="nofollow">ing by means of derivative in" rel="nofollow">instruments. The use of derivatives as hedges has expanded greatly in" rel="nofollow">in recent years. Generally, under accountin" rel="nofollow">ing standards (IAS 39 and related U.S. standards), derivative in" rel="nofollow">instruments are fair-valued with any unrealized gain" rel="nofollow">in or loss in" rel="nofollow">included in" rel="nofollow">in net in" rel="nofollow">income. However, hedge accountin" rel="nofollow">ing provides some exceptions to this rule. Required: a. A firm has a large amount of long-term debt (valued on a cost basis) and decides to set up a natural hedge of this debt. However, a natural hedge can lead to excess net in" rel="nofollow">income volatility—that is, net in" rel="nofollow">income volatility greater than the actual volatility of the firm’s operations. Explain" rel="nofollow">in how this can happen. (5 marks) b. Suggest two ways that the excess net in" rel="nofollow">income volatility arisin" rel="nofollow">ing in" rel="nofollow">in part (a) can be prevented. (6 marks) c. IAS 39 identifies two basic types of hedge. Describe each type. For each type, explain" rel="nofollow">in how IAS 39 controls excess net in" rel="nofollow">income volatility arisin" rel="nofollow">ing from enterin" rel="nofollow">ing in" rel="nofollow">into the hedge. (8 marks) d. Use the bonus plan hypothesis of positive accountin" rel="nofollow">ing theory to explain" rel="nofollow">in why a firm manager dislikes excess net in" rel="nofollow">income volatility. Are the policies to control excess net in" rel="nofollow">income volatility you described in" rel="nofollow">in parts (a) and (b) unethical? Explain" rel="nofollow">in why or why not. (6 marks)