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

2016 ◽  
Vol 17 (3) ◽  
pp. 310-327
Author(s):  
Eva Marie Ebach ◽  
Michael Hertel ◽  
Andreas Lindermeir ◽  
Timm Tränkler
Keyword(s):  
Fair Value ◽  
Income Smoothing ◽  
Sensitivity Analyses ◽  
Financial Industry ◽  
Fair Value Accounting ◽  
Trade Off ◽  
Content Type ◽  
Earnings Volatility ◽  
Market Values ◽  
Optimal Hedging

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.

Fair value and banking contagion

2016 ◽  
Vol 7 (3) ◽  
pp. 215-236 ◽  
Author(s):  
Leila Gharbi ◽  
Halioui Khamoussi
Keyword(s):  
Data Model ◽  
Banking Sector ◽  
Fair Value ◽  
Islamic Banks ◽  
Fair Value Accounting ◽  
Content Type ◽  
Gcc Countries ◽  
Conventional Banks ◽  
Value Changes ◽  
The Impact

Purpose This paper aims to explore empirically the impact of fair value accounting on banking contagion in a comparative context between Islamic banks and conventional banks. Design/methodology/approach The analysis of the impact of fair value changes on banking contagion is carried out through a panel data model. This study covers 20 Islamic banks and 40 conventional banks operating in the Gulf Cooperation Council (GCC) countries during nine years from 2003 to 2011. Findings Empirical evidence shows that there is a significant change in dynamic volatility in GCC banking sector because of financial crisis 2008. However, results fail to confirm the hypothesis that fair value accounting is significantly associated with an increase of banking contagion for both Islamic and conventional banks operating in GCC countries. Originality/value The outcome of this study provides some insights for academicians, accountants as well as regulators in terms of enhancing the effectiveness of accounting practices.

scholarly journals Fair Value Accounting and Earnings Management Using LLP and Realized Gains and Losses: Study in Banking Industry Listed on Indonesia Stock Exchange

2018 ◽  
Vol 14 (2) ◽  
pp. 126-137
Author(s):  
Ice Maria Ulfa ◽  
Bambang Subroto ◽  
Zaki Baridwan
Keyword(s):  
Earnings Management ◽  
Empirical Evidence ◽  
Banking Industry ◽  
Stock Exchange ◽  
Fair Value ◽  
Fair Value Accounting ◽  
Loan Loss ◽  
Trade Off ◽  
Gains And Losses ◽  
The Impact

Abstract: Fair Value Accounting and Earnings Management Using LLP and Realized Gains and Losses: Study in Banking Industry Listed on Indonesia Stock Exchange. This study examines whether earnings management can be limited by the implementation of fair value accounting in banking industry. The main contribution of this study is  providing provide empirical evidence about the impact of fair value accounting on earnings management in Indonesia. Earnings management is proxied by loan loss provision (LLP), the realized of gains and losses, and the trade-off between realized gains and losses and LLP following Bratten et al (2013). The study provides empirical evidence that earnings management is still performed by banks, by using LLP, realized gains and losses and also occurs trade-off between LLP and realized gains and losses as means to perform earnings management in accordance with the needs of management. If banks are exposed to fair value accounting, managers will have more flexibility in reporting banks’ financial performance to present a desired earning, by  providing them with additional earning managements tools. These findings can be informative for policymakers, banking practitioners, and academics.  Keywords: earnings management, fair value accounting, LLP, realized gains and losses, trade-off LLP and realized gains and losses.Abstrak: Akuntansi Nilai Wajar dan Manajemen Laba menggunakan CKPN dan Realized Gains and Losses: Studi pada Industri Perbankan yang terdaftar di Bursa Efek Indonesia. Studi ini bertujuan untuk meneliti apakah manajemen laba dapat dibatasi oleh penerapan akuntansi nilai wajar dalam industri perbankan. Kontribusi dari penelitian ini adalah untuk memberikan bukti empiris tentang dampak penerapan akuntansi nilai wajar pada manajemen laba di Indonesia. Manajemen laba diproksikan oleh cadangan kerugian penurunan nilai (CKPN), realized of gains and losses, dan trade-off antara realized of gains and losses dan CKPN mengikuti model penelitian Bratten et al (2013). Studi ini memberikan bukti empiris bahwa manajemen laba masih dilakukan oleh bank menggunakan CKPN, realized of gains and losses dan juga terjadi trade-off antara CKPN dan realized of gains and losses sebagai sarana manajemen laba sesuai dengan kebutuhan manajemen. Konsekuensi dari paparan bank terhadap akuntansi nilai wajar dapat meningkatkan fleksibilitas manajer dalam melaporkan penghasilan yang diinginkan dengan memberikan mereka alat manajemen laba. Temuan-temuan tersebut dapat bersifat informatif bagi pembuat kebijakan, anggota industri perbankan, dan akademisi. Kata kunci: manajemen laba, akuntansi nilai wajar, CKPN, realized gains and losses, trade-off CKPN dan realized gains and losses.

The localised accounting environment in the implementation of fair value accounting in Indonesia

2022 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Bernadia Linggar Yekti Nugraheni ◽  
Lorne Stewart Cummings ◽  
Alan Kilgore
Keyword(s):  
Emerging Economies ◽  
Accounting Standards ◽  
Fair Value ◽  
Successful Implementation ◽  
Fair Value Accounting ◽  
Structured Interviews ◽  
Content Type ◽  
Emerging Country ◽  
Government Involvement

Purpose This case study aims to investigate the role of actors in the implementation of fair value standards in an emerging country, Indonesia. Design/methodology/approach This study uses semi-structured interviews with important actors within the local accounting profession, standard setting and regulatory environment, to analyse fair value accounting implementation. This study also incorporates information from press releases and newspapers, to provide a more comprehensive picture of fair value implementation. Findings First, professionals undertake routine actions, cultivate interests and strategically navigate their environment during the process of fair value standard implementation. Second, the role of appraisers becomes more prominent during this process. Third, government involvement is significant in ensuring the successful implementation of global accounting standards. Research limitations/implications First, differing localised contexts, including communities and actors, may shape how an emerging country undertakes the diffusion and implementation of global standards, which in turn can also lead to institutional change. Second, government involvement is crucial in supporting the implementation of global accounting standards within emerging economies. Third, implementing market-based measurements within emerging economies characterised by a lack of an active and liquid market may present challenges. Practical implications Third, implementing market-based measurements within emerging economies characterised by a lack of an active and liquid market may present challenges. Originality/value This study applies the concept of Institutional Work within Institutional Theory to explain how fair value standards are implemented within a localised emerging economy characterised by unique actor roles and goal-directed action.

Fair value accounting, earnings management, and the case of bargain purchase gain

2019 ◽  
Vol 28 (2) ◽  
pp. 229-253
Author(s):  
Steven Lilien ◽  
Bharat Sarath ◽  
Yan Yan
Keyword(s):  
Design Methodology ◽  
Fair Value ◽  
Control Group ◽  
Fair Value Accounting ◽  
Market Returns ◽  
Accounting Earnings ◽  
Content Type ◽  
Level 3 ◽  
Accounting Earnings Management

Purpose The purpose of this paper is to investigate the association between bargain purchase gains (BPGs) booked by the acquirer and smoothing of acquirers’ earning performance across time. Design/methodology/approach The authors use a sample of 122 bargain purchase acquisitions in non-financial industries from 2009 to 2012 and a pair-match control group of 122 goodwill acquisitions. Findings The authors find that BPGs, and in particular, the Level-3 fair value estimates of intangible assets acquired, have consistently been used to smooth earnings but that such smoothing activities are not associated with long-term market returns. Originality/value This study is the first one to investigate bargain purchase acquisitions in a broad range of non-financial industries and suggests that managers are using the valuation of intangibles to avoid unfavorable earnings even though these valuations are not credible to investors.

scholarly journals The (un)suitability of fair-value accounting in emerging economies: the case of Vietnam

2019 ◽  
Vol 15 (2) ◽  
pp. 170-197 ◽  
Author(s):  
Lisa-Uyen Nguyen
Keyword(s):  
Financial Reporting ◽  
Institutional Environment ◽  
Fair Value ◽  
Business Environment ◽  
Future Research ◽  
Critical Examination ◽  
Fair Value Accounting ◽  
Structured Interviews ◽  
Corporate Misconduct ◽  
Content Type

Purpose This study aims to explore the suitability and challenges of implementing fair value accounting (FVA) in Vietnam, an emerging/transitioning economy. While such implementation would enable convergence with International Financial Reporting Standards, standard setters and auditors have raised practical concerns about its adoption. Design/methodology/approach This qualitative study uses semi-structured interviews with regulators and auditors, together with an analysis of two fraud cases that illustrate the business environment in Vietnam. Public, private and capture theories guide the analysis. Findings The business and institutional environment in Vietnam creates several impediments to FVA being effectively implemented and transparently applied. Given the major challenges identified regarding the infrastructure necessary for this valuation system, the premature adoption of FVA may become a catalyst for corporate misconduct. Research limitations/implications The findings are derived from data aggregated from two fraud cases and interviews, and as such, the results may not be generalisable to other settings. However, these findings may inform future research, particularly after the Ministry of Finance provides further guidance on the use of FVA in Vietnam. Practical implications A timely and critical examination of the challenges of implementing FVA in a transitioning economy is provided, and the two fraud cases reveal the complexities of the business environment in Vietnam. Originality/value This research gives voice to the tensions that developing countries are confronting as they seek to balance external pressures with internal constraints. The introduction of an assemblage of three theoretical lenses enables insights into contemporary issues associated with applying FVA in such settings.

On theoretical engorgement and the myth of fair value accounting in China: a reply

2020 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Kathryn Bewley ◽  
Cameron Graham ◽  
Songlan Peng
Keyword(s):  
Accounting Standards ◽  
Movement Analysis ◽  
Fair Value ◽  
Research Approach ◽  
Fair Value Accounting ◽  
Political Factors ◽  
Content Type ◽  
Accounting Research

PurposeThis article is a reply to “On theoretical engorgement and the myth of fair value accounting in China” Nobes (2019) from the authors of “Adaptability to fair value accounting in an emerging economy: A case study of China's IRFS convergence” (Peng and Bewley, 2010) and “The Winding Road to Fair Value Accounting in China: A Social Movement Analysis” (Bewley et al., 2018).Design/methodology/approachThis article engages directly with the arguments of the criticism.FindingsThis article argues that the author of the commentary misunderstands the purpose, content and findings of both papers. By providing only a narrowly focused technical analysis of the new Chinese accounting standards, the author fails to see that their qualitative research approach reveals important, complex social and political factors at play in China's attempts to adopt modern international accounting principles. The commentary expresses a view that accounting is a neutral technology that needs only to be clearly defined and enumerated to be correctly implemented, whereas this research takes a much broader and deeper perspective. The authors seek to understand how China was able to successfully adopt fair value accounting standards in 2006, whereas an earlier attempt to introduce fair value in 1998 had led to abuse of fair value measurements and the eventual repeal of fair value regulations in 2001.Practical implicationsThis article helps clarify the purpose of qualitative accounting research, the role of theory in such research and the usefulness of theory in describing and explaining empirical case facts related to changes in accounting standards, particularly in an international context.Originality/valueThis article contributes to a better appreciation of qualitative accounting research.

Fair value accounting choice

2015 ◽  
Vol 8 (2) ◽  
pp. 130-152 ◽  
Author(s):  
Inês Pinto ◽  
Manuel Caldeira Pais
Keyword(s):  
Financial Reporting ◽  
Fair Value ◽  
Accounting Conservatism ◽  
Accounting Choice ◽  
Fair Value Accounting ◽  
Content Type ◽  
Fund Managers ◽  
Asset Value ◽  
Accounting Model ◽  
The Impact

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.

Fair value accounting and the financial crisis: a literature-based analysis

2016 ◽  
Vol 14 (1) ◽  
pp. 49-71 ◽  
Author(s):  
Elisa Menicucci ◽  
Guido Paolucci
Keyword(s):  
Financial Crisis ◽  
Literature Review ◽  
Empirical Studies ◽  
Relevant Literature ◽  
Fair Value ◽  
Research Literature ◽  
Fair Value Accounting ◽  
Comprehensive Overview ◽  
Content Type

Purpose The aim of this paper is to review the main results of accounting research literature examining the role of fair value accounting (FVA) within financial crisis. This research analyzes theoretical and empirical studies on the controversial topic about FVA and its alleged pro-cyclicality in the context of the financial crisis to offer solid reflections for improving the fair value research agenda. Design/methodology/approach This paper consists of a descriptive literature review. Theoretical and empirical research studies were investigated and then systematized in a framework to guide a literature-based analysis and critique of the relevant literature published about this topic. Findings The review reveals that there has been only a limited amount of research into the role of FVA within the financial crisis. This topic has not been researched extensively, and there is no empirical evidence that FVA caused the financial crunch and the subsequent financial crisis. Research limitations/implications The restricted amount of literature that directly deals with FVA in the context of the financial crisis is the main limitation of this paper. The specificity of the theme narrows the coverage. However, the adopted research methodology enabled the main contributions concerning this issue to be collected, to realize a concise and comprehensive portrait of the debate surrounding FVA and the financial crisis. Practical implications This paper can be of use to both researchers and practitioners interested in investigating strengths and weaknesses of the fair value concept for accounting purposes. The paper sets out the main findings of the academic literature and identifies future avenues of theoretical and practical research which may support standard setters to draw up improved accounting regulation. Originality/value Few existing studies consist of a literature review that examines theoretical and empirical researches on the influence of FVA on the financial system. This review offers a comprehensive overview on research literature concerning the responsibility of FVA in causing the financial crisis. The main contribution of this paper relates to further understanding the role and effects of accounting matters concerning fair value in a broad sense within the context of the financial crisis.

scholarly journals A note on auditing fair value of investment properties

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Bo Nordlund ◽  
Johan Lorentzon ◽  
Hans Lind
Keyword(s):  
Fair Value ◽  
Financial Reports ◽  
Content Type ◽  
Market Values ◽  
Substantial Risk ◽  
Fair Market ◽  
Depth Interviews ◽  
Practical Implications

PurposeThe purpose of this article is to study how fair values in financial reports are audited.Design/methodology/approachThe study is a qualitative case study based on in-depth interviews.FindingsOne important finding is that auditors anchor in the figure presented by the company, and despite the auditing efforts, there is a substantial risk of management bias in the fair values reported. There is a risk for confirmation bias.Research limitations/implicationsRelatively, few respondents were employed in this study, but their background and competence lead to the assessment that the study provides a representative picture of what is being investigated.Practical implicationsAuditors may need to develop ways of performing auditing of fair values to reduce the risks identified in this study.Social implicationsThis study presents a perspective of the auditing process enabling an evaluation of the quality of fair value estimates regarding investment properties in the financial reports. This study also provides users of financial reports as investors, bankers and other institutions with an enhanced understanding of reported estimates of fair (market) values.Originality/valueVery few studies have investigated how auditors evaluate fair values of investment properties. This study contributes by giving users of financial reports an enhanced understanding of the quality of reported estimates of fair (market) values.

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