AY19/20 Semester 2 AC3103 Seminar 2 1

Discussion Questions – Value Relevance of Accounting Information

Question 1

ABC Ltd is a retail company listed on a major stock exchange. Financial analysts had predicted
that the company would report a net income of $10 million for its financial year ended 31
December 2018. However, on 20 February 2019, the company reported its 2018 net income to
be $8 million. No other news about ABC Ltd was released to the public and there was no
significant economy-wide events affecting share prices on 20 February 2019.

(a) Would you expect a change in the stock price of ABC Ltd on 20 February 2019? If so,
why?

(b) Consider the two situations below:

i. The deviation of forecasted earnings from actual earnings is completely accounted

for by the closing down of a number of its retail outlets.

ii. The deviation of forecasted earnings from actual earnings is completely accounted
for by a fire in ABC Ltd’s largest retail outlet, which had caused the outlet to be
closed temporarily for three months.

Do you expect the change in ABC Ltd’s stock price, if any, to be different in each of
the two scenarios above?

Question 2

Tai Sin Electric Limited, a company listed on the SGX mainboard, manufactures, distributes,
and services cable and wire products. On 15th May 2017, after the stock market closed, the
company reported its unaudited financial statements for the 9 months ended 31st March 2017.
Profit after tax increased by more than 8% to $15.866 million. (See attached.)

However, your friend was surprised that the company’s share price closed lower at $0.44 the
following day, $0.005 lower than its previous day’s closing price. On the same day, the
Singapore STI Composite Index fell to 3,227.71 from its previous day’s closing at 3,264.21.
Observing that both Tai Sin’s share price and the STI Composite fell by the same relative
magnitude (1.12%), your friend attributed Tai Sin’s fall in share price totally to the fall in the
overall stock market and concluded that the company’s reported financial performance had just
met investors’ expectation.

You noted that the SGX website reported Tai Sin’s beta to be 0.462. Assuming market
efficiency and the daily risk-free interest rate to be effectively zero, do you agree with your
friend’s assessment of Tai Sin’s financial performance?
AY19/20 Semester 2 AC3103 Seminar 2 2

Question 3
Adapted from AC3103 AY16/17 Sem 2 Examination Question 1(b) and 1(c).

Note: Part (b) and (c) can be answered independently of part (a). Ignore part (a).

(b) On 3 March 2017, the day of Pasio Ltd’s earnings release, the company’s share price
fell 5 cents to $2.55. Pasio’s beta is 1.1. On the same day, the Singapore STI Composite
Index fell to 3,158 from its open at 3,228.

As evidenced by its share price performance on 3 March 2017, did Pasio’s earnings
release meet investors’ expectation? Explain and show calculations.

In your explanation and calculations, you are to assume (i) the daily risk-free interest
rate was effectively zero; (ii) securities markets efficiency; and (iii) no other significant
firm-specific information about Pasio was available on 3 March 2017.

(c) On the same day of Pasio’s earnings release, Ellio Ltd (Ellio) also released its earnings.
Ellio is Pasio’s direct competitor and both firms are of same size in terms of revenue
and total assets. Ellio’s beta is also 1.1. Ellio reported an earning figure that deviates
from investors’ expectation in the same direction and by the same magnitude as that of
Pasio’s. However, Ellio’s share price fell more than that of Pasio’s.

Which firm has a higher ERC (earnings response coefficient)? Explain.

Discussion Questions – Measurement Approach and Fair Value Accounting

Question 4

The measurement approach to decision usefulness is an approach to financial reporting under

which accountants undertake a responsibility to incorporate current values (instead of historical
costs) into financial statements proper, providing that this can be done with reasonable
reliability, thereby recognizing an increased obligation to assist investors to predict firm
performance and value.

What are the possible reasons for the underlying increased emphasis on current values?
AY19/20 Semester 2 AC3103 Seminar 2 3

Question 5

When a software developer sells a computer program to a customer, typically it will promise
to provide updates for a period from date of sale at no additional cost to the customer. As such,
the company will recognize a certain percentage of the sales proceed (e.g., 80%) as revenue,
and regards the remaining percentage (20%) as obligations to be extinguished over the future
years.

For example, Microsoft Corporation disclosed the following note for revenue recognition for
its financial year ended June 30 2018:
“Revenue from distinct on-premises licenses is recognized upfront at the point in time when the
software is made available to the customer. In cases where we allocate revenue to software
updates, primarily because the updates are provided at no additional charge, revenue is
recognized as the updates are provided, which is generally ratably over the estimated life of
the related device or license.”
(a) How is the 20% sales proceed allocated to service obligations viewed under historical
cost accounting?
(b) Suggest one or more ways to determine the amount of the company’s future service
obligations under the measurement approach.
(c) Compare the relevance and reliability of your suggested approach(es) with the matching
approach of writing the obligations off over future years.

Question 6

Refer to Penman (2007), “Financial reporting quality: is fair value a plus or a minus?”
Accounting and Business Research Special Issue: International Accounting Policy Forum: 33-
44.

(a) Why is there a need to identify a specific group of user of financial statements when
analyzing the pluses and minuses of fair value accounting? Which is the user group that
Penman had defined in this article and for what purpose(s) does this user group need
accounting information for?

(b) Penman distinguished conceptual issues from the measurement issues when discussing
the merits of fair value accounting versus historical cost accounting.

(i) Comparing fair value accounting to historical cost accounting in their ideal form,
which one is conceptually superior?

(ii) Briefly summarize Penman’s discussion on the measurement issues of fair value
accounting.

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