Assignment 220
Delp10
B207BPowerpoint-Week93.pptxB207B
Shaping Business Opportunities II
Block 3- Session 7
Accounting for values – Creating value in the long term
Aims and objectives
This session will first explore how shareholder value can be created and the problems of short-term thinking for long-term value creation. It will then consider some of the problems associated with measuring values from an accounting perspective. It will next examine measurement choices in financial reporting. The session will also provide you with practical examples of the different measures of valuation based on historical cost accounting (HCA) and fair value accounting (FVA).
Learning outcomes
explain how shareholder value is created and the different approaches to shareholder value
understand how different financial reporting measurement bases work, their reliability and their relevance
identify the arguments for and against using key measurement bases.
Aims and objectives & Learning outcomes
Session 7: Accounting for values- creating value in the long term
7.1 Shareholder value
Maximizing shareholder wealth is assumed to be the key objective of a business.
Nevertheless, increasing shareholder value is still very much at the core of management decisions. Shareholders invest into a business and want to be rewarded with financial returns. Shareholders appoint managers to act on their behalf and expect management to take decisions that will maximize these returns.
Conflicts often arise between shareholders and management over the short and long term. This can occur as managers sometimes take short-term decisions that achieve immediate results (e.g. to support the next quarter’s results) but that can destroy value in the longer term.
In the short term, managers might be rewarded with a bonus for hitting a particular target but if they have destroyed value, then the long-term results for shareholders will be adversely affected.
Session 7: Accounting for values- creating value in the long term
7.1 Shareholder value
One of problems of creating shareholders’ value caused by companies focusing on the short term. Many issues as:
companies who focus purely on the short term can suffer from poor performance in the long-run
management should be encouraged to think long term even if it has some short-term downside
companies should think creatively and not focus on financial engineering
companies should reward long-term thinking
senior executives should bear the risks of ownership as shareholders do.
Session 7: Accounting for values- creating value in the long term
7.2 Measuring issues
If companies align their internal performance measurement systems on short-term profits or accounting returns, this is also not a good indicator of value creation.
However, it is necessary for a company to undertake financial reporting to measure the financial condition of the business so that the owner(s) can make decisions.
The term ‘measurement’ can give a misleading impression of certainty and objectivity. When we consider measurement in financial reporting, however, there is a lot more controversy surrounding the tool that is selected to measure value. While measurements in financial reporting are expressed in monetary terms and therefore indicate value, in accounting terms value can mean different things.
Session 7: Accounting for values- creating value in the long term
7.2 Measuring issues
The controversy surrounding the question of measurement in financial reporting has resulted in a movement away from the traditional basis of measurement (historical cost) towards a new basis (fair value).
Session 7: Accounting for values- creating value in the long term
7.3 Measurement choices
Measurement means the process of determining the monetary amount at which the elements of the financial statements are to be included in the balance sheet and income statement of a company.
It is important to stress that there has been a tremendous amount of debate and disagreement on the merits of different measurement bases.
Session 7: Accounting for values- creating value in the long term
7.4 The problem with historical cost accounting
There have been many studies published that have examined the driving force behind long-term returns for companies. Some studies have shown that share returns in the long-run are more closely associated with historical data than current cost financial data.
In practice, historical cost accounting (HCA) is the approach favored by most accountants. HCA records the value of an asset as the price at which it was originally purchased.
In contrast, fair value accounting (FVA) identifies the actual market value of an asset or liability at the measurement date to overcome the limitations of measuring the actual value of an asset or liability subsequent to acquisition date. FVA aims to give a fair value to an entity regardless of market conditions.
Session 7: Accounting for values- creating value in the long term
7.4 The problem with historical cost accounting
Key arguments for historical cost include:
It is the most objective measurement approach – amounts are determined based on actual transactions.
There is a clear audit trail – amounts can usually be proven by documentation.
Key arguments against historical cost include:
Amounts determined may not be relevant to current decision-making if there is a long time span since the transaction occurred. Historical cost does not take into account changes in the value of money over time. In other words, it ignores price inflation.
The amount paid for an item or received for an item may not necessarily be indicative of its value.
Judgement involved in determining depreciation rates can create inconsistencies and opportunities for manipulation.
Inability to determine the cost of some items, as items may be donated with no actual cost to the entity, or they may be internally generated rather than purchased.
Session 7: Accounting for values- creating value in the long term
7.4 The problem with historical cost accounting
Key arguments for fair value include:
It is the most relevant measurement approach for current decision-making. The amount that will be received for an item or that will need to be paid for an item is decision-useful information.
It is objective if determined by reference to the market price for an item. The market price is set by forces outside the entity. It is not biased by judgement and cannot be manipulated or influenced by management.
Key arguments against fair value include:
It is subjective where a market price is unavailable. Some items are not regularly traded in an active market and an estimate of the items’ fair value must be made.
The focus on exit values is not logical and contradicts the going concern assumption. Assets are measured as if they are all going to be sold off, which is not usually the case.
Market prices can be volatile and therefore sometimes may not be indicative of the true value of an item. Short-term fluctuations in fair value may be irrelevant and cause confusion from a user perspective.
Session 7: Accounting for values- creating value in the long term
Session summary
The way items are measured in accounting impacts on the quality of accounting information produced. In order to fulfil the decision-usefulness objective, the financial statements produced must contain good quality accounting information that will assist decision makers in making the right (appropriate) decisions.
Poor quality accounting information, resulting from the use of inappropriate measurement methods, may mislead users and this could potentially cause them to make wrong (inappropriate) decisions. If accounting information leads to wrong or inappropriate decisions it is not useful.
Selecting a different base measurement yields different results and illustrates that accounting is as subjective as any other discipline.
Session 7: Accounting for values- creating value in the long term
Session 8
Accounting for values – A broader perspective
Aims and objectives & Learning outcomes
Aims and objectives
This session first discusses the concept of shared value and explains the connections between societal and economic progress. It explores whether shared value could unleash the next wave of global economic growth. It then considers the ecosystem of creating shared value and examines the key elements involved. This includes a shared measurement system and activities that can be mutually reinforced through constant communication. The session finally provides some case studies from companies on creating shared value.
Learning outcomes
understand the concept of shared value
identify the conditions in which shared value is created
explore examples of shared valued in well-known global companies.
Session 8: Accounting for values- A broader perspective
8.1 Creating shared value
Michael Porter and Mark Kramer (2011) argued that companies can move beyond corporate social responsibility (CSR) and can gain a competitive advantage by incorporating social and environmental considerations in their strategies. They suggested that by treating societal challenges as business opportunities, companies could add a new dimension of corporate strategy to their portfolio and contribute towards social progress.
The impact of creating shared value has been significant. Several leading companies such as Nestlé and Coca-Cola have also encompassed shared value in aspects of their operations.
Session 8: Accounting for values- A broader perspective
8.1 Creating shared value
Corporate social responsibility is widely perceived as a cost center, not a profit center.
In contrast, creating shared value is about new business opportunities that create new markets, improve profitability and strengthen competitive positioning. CSR is about responsibility, whereas creating shared value is clearly about creating value.
Session 8: Accounting for values- A broader perspective
Creating shared value, defined as “pursuing financial success in a way that also benefits society”, has become increasingly important to companies as they look for new economic opportunities and seek to regain the public’s trust.
Companies do not function in isolation and they are part of an ecosystem where societal conditions may curtail markets and restrict productivity. Further barriers might also include government policies and cultural norms.
To engage with all the players in their respective ecosystems it has been suggested by some academics that businesses should initiate efforts collectively. This ‘collective impact’ can involve companies teaming up with governments, non-governmental organizations (NGOs), and even their rivals to capture the economic benefits of social progress.
8.2 The ecosystem of shared value
Session 8: Accounting for values- A broader perspective
The ecosystem of shared value’, (Kramer and Pfitzer, 2016).
The collective impact approach has resulted in successful collaborations in the social sector; it can also guide corporations to catalyze change in their ecosystems.
Companies that turn to collective impact will not only advance social progress but also find opportunities for economic success that their competitors miss.
Governments, NGOs, corporations, and community members all have essential roles to play
8.2 The ecosystem of shared value
Session 8: Accounting for values- A broader perspective
One of the key ideas from the (Kramer and Pfitzer) article is the power of collective impact to change values. The five elements, which must be put in place for collective impact to achieve large-scale social change, can be summarized as follows:
1- All participants have a common agenda for change including a shared understanding of the problem and a joint approach to solving it through agreed upon actions.
2- Collecting data and measuring results consistently across all the participants ensures shared measurement for alignment and accountability.
3- A plan of action that outlines and coordinates mutually reinforcing activities for each participant.
4- Open and continuous communication is needed across the many players to build trust, assure mutual objectives, and create common motivation.
5- A backbone organization(s) with staff and a specific set of skills to serve the entire initiative and coordinate participating organizations and agencies.
8.2 The ecosystem of shared value
Session 8: Accounting for values- A broader perspective
