ACCT 5341 Syllabus
Bob Jensen
at Trinity University
| [02] Ausaf, Shuja | [03] Dai, Wan Li |
| [05] Devins, Sean | [06] Donohue, Alexia |
| [07] Gutierrez, Eugenia | [08] Heinkel, Mark |
| [10] Hobbs, William | [11] Hoffman, Robert |
| [14] Ifrah, Laury | [15] Johnson, Colin |
| [17] Lee, Matthew | [18] Menchaca, Ruth |
| [19] Nguyen, Nancy | [20] Poppe, Amanda |
| [22] Ramirez, Ricardo | [23] Roberts, Michelle |
| [29] Sandoval, Nikki | [30] Thompson, Anne |
| [31] Vogtsberger, Carl | [32] White, Steven |
1. You should check your email daily in case there are revisions of this assignment!
2. Each
student partnership must turn in one floppy disc containing the Excel file
assignment.
Notebook File 1 is for study purposes and must contain Possible Quiz Question answers written in pencil. It may also be used in most, possibly not all, examinations. Notebook File 1 need not be turned in during class. Prior to the next class, your Notebook File 1 must be examined by an ACCT 5341 Teaching Assistant. Your files need not be fully complete, and the TA is not going to assign a grade to your work. The TA will, however, try to help you in places where you are having difficulties. Try to meet with the TA during scheduled lab hours. Details for contacting the TA are given in the syllabus.
Computer File 2 is to start with a reproduction of any EXCEL file that is assigned this week to your partnership. Each partnership must be prepared to explain the example pertaining to this file.
Reading Assignments for This Week
Please keep your answers to all possible quiz questions for the entire semester. They may reappear in future quizzes and they may help in your course project.
If a case assignment or other question points to a particular section of a textbook chapter, you are responsible to take notes on that particular section in its entirety.
Helpers and links can be found at http://WWW.Trinity.edu/rjensen/acct5341/index.htm
If
you are having trouble finding something try a Google search.
Especially note that you can add terms and phrases at http://www.google.com/advanced_search?hl=en
For example, you can add a phrase in the second cell and individual words in the
top cell. You can fill in both cells
simultaneously to narrow your search.
Also note
that you can seek definitions in Google. In
the top cell type in --- define “phrase” where your phrase can be one word
like “contango” or “backwardation” or a phrase like “asian option”.
It is important to first type in the word “define” without quotation marks.
Second try a search within the standard itself. You can find digital versions of FAS 133 in the fasb folder on Drive J and IAS 39 in the iasb folder. Both folders are on the path J:\courses\Acct534
A suggested reference for this course may be downloaded as follows:
One of the best documents the FASB generated for FAS 133 implementation is
called "Summary of Derivative Types." This document also
explains how to value certain types. It is no longer available from the
FASB, but it can be downloaded free from J:\courses\acct5341\fasb\sfas133\derivsum22
Questions for Class 02
Each
student must submit an mentor attestation form.
This form is to be signed and turned in each week in class. These
forms can be found at http://www.trinity.edu/rjensen/acct5341/AttestMentor.htm
Notebook File 1 Question 01
What are financial instruments derivatives? Illustrate
how derivative contracting works with five futures contracts entered into on
some day in January of the current year as a speculation in corn (No. 2 Yel. Cent.,
Ill.). Assume that you took a "long" position to
"purchase" the corn a forward price. Since futures contracts can
be settled for cash, you do not necessarily have to take physical delivery when
the contracts mature. Assume that you already had a futures margin account
with a sufficient balance that enabled you to enter into these contracts without
any cash payments..
[Hint 1: Bob Jensen's Glossary a http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm]
[Hint 2: In addition to FAS 133, students may find
definitions and examples in "Summary of Derivative Types"
---
J:\courses\acct5341\fasb\sfas133\derivsum22
Especially note pp. 32-48.[
Hint 3: One thing you can do when looking for market exchange prices is to find them in Section C of The Wall Street Journal. I have left a copy in N314 Chapman for you to look at, although students do not all have to use prices for the same day. It is a good idea for all students to become familiar with Section C of The Wall Street Journal. However, the Internet is sometimes faster than having to fumble through hard copy. The
There are a number of Internet sources, including the CBOT itself at http://www.cbot.com/ Look under Quotes and Data, Agricultural Futures.
You can read about contract specifications by clicking on the tab "Education" and choosing the alternative for "Contract Specifications." This should take you to http://www.cbot.com/cbot/pub/page/0,3181,21,00.html
Especially note the definitions at http://cbotdataexchange.if5.com/FeaturesOverview.aspx
A glossary and tutorials are listed at http://www.cbot.com/cbot/pub/page/0,3181,909,00.html
The CBOT tutorials hang up quite often when downloading.
The CME tutorials are easier to download and use --- http://www.cme.com/edu/
The CME Glossary is at http://www.cme.com/edu/res/glos/index.html
Also note the FAQs --- http://cbotdataexchange.if5.com/Helpfaq.aspx
Note that sometimes when you click on "Home" that it does not take you back to the "Real Home" at http://www.cbot.com/
Choose
the day you are studying this question. For
example, suppose you go to www.cbot.com on
The prices you first see listed are the forward prices. To find spot prices, click on the link called "Charts." Scroll down to the bottom of the charts page and change the "Month" to "Nearby." For example, if it currently reads "Mar" for the month, change March to "Nearby."
At times you will see a Free Historical Data spot price table on the right side of the home page of the CBOT. You must have a paid subscription to Realtime Services for current spot rates. A great free foreign exchange (FX) spot rate provider is at http://www.xe.com/ucc/
| Bob,
The USDA Agricultural Marketing Service provides daily prices for commodities at multiple U.S. locations. Go to: http://www.ams.usda.gov/marketnews.htm . Another place to get cash price data is from Farmers Supply at: www.farmersupply.com .For LIBOR rates, the following site gives regularly updated LIBOR rates: http://www.libor-loans.com/libor_rate.html .I hope that this helps. Regards, Fred Seamon |
To find details regarding each futures contract at the CBOT, click on "Futures Contract Specs." There you will find that each contract is for 5,000 bu. and each tic is 1/4 of a cent which is the increments that traders flash with hand signals in the pit of the trading floor at the CBOT.
Note that the CBOT frequently changes how it reports data. The screens that you get today may not be exactly like the screens you see below.
You
may enter into any one or more contracts to go long on corn which means that you
have contracted to buy 5,000 bu. of corn on the expiration date.
You may either pick up your corn or you may net settle for cash equal to
the difference between the contracted forward price and the closing spot price. If
the spot price is higher than the forward price, you will receive cash.
If it is less than the forward price you will pay in the difference on
each contract.
You
may enter into any one or more contracts to go short on corn which means that
you have contracted to sell 5,000 bu. of corn on the expiration date.
You may either deliver your corn or you may net settle for cash equal to
the difference between the contracted forward price and the closing spot price. If
the spot price is lower than the forward price, you will receive cash.
If it is higher than the forward price you will pay in the difference on
each contract.
Futures
contracts have zero value on the day you enter into the contracts.
However, they may have positive or negative value each day afterwards
until the expiration date. You may
by and sell these contracts at any time. However,
the final settlement of the contract does not arise until expiration date.
The person or company holding the contract on expiration date gets the
ultimate settlement.
What
makes futures contract unique from virtually all other derivative contracts is
that futures contracts settle for cash daily. For
example, a person that holds a sixty day contract for the full sixty days may
earn or lose $1 million over the entire 60 days but the settlement on the last
day may actually be very small or even zero since other settlements took place
on 59 preceding days.
The CME is at http://www.cme.com/ There are some nice tutorials under "Getting Started, Basics of Futures and Options, Trading Scenarios)
The Wall Street Journal online market data require an online WSJ subscription With such a subscription, the Web link is http://interactive.wsj.com/documents/mktindex.htm
Note that spot prices are not generally given with the futures prices. Even in Section C of the WSJ, you must look on different pages for spot prices and futures prices. The following corn futures and spot prices were taken from the WSJ database for January 18, 2002 corn (Number 2 Yellow delivered in Central Illinois):
To understand how prices are interpreted, note the Help link circled above.
From http://www.cbot.com/cbot/pub/cont_detail/1,3206,1213+14389,00.html
|
REQUIRED
Notebook File 1 Question 02
What is the political history of SFAS 133 and what political issues remain?
Why did FASB compromises with political factions make SFAS 133 unduly complex?
[Hint 1: See "Highlights: Damn the Torpedoes --- Full Speed Ahead," Journal of
Accountancy, July 1998, Page 4]
[Hint 2: Listen to the the audio clips of Russ Mallot in
http://www.cs.trinity.edu/~rjensen/000overview/133suma.htm. ]
[Hint 3: See the transcription of Jim Leisenring in Tape 31 at http://www.trinity.edu/rjensen/acct5341/speakers/tape31.htm.]
Notebook File 1
Question 03
What major accounting rules applied to derivatives before the FASB’s SFAS 133?
What FASB standards were superseded by SFAS 133 ? Discuss in terms of
forwards, futures, options, and swaps. You need not take up foreign
exchange (FX) derivatives for this question.
[Hint 1: See the PricewaterHouse Coopers summary
table in my Hedge
Accounting Glossaries & Experts at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
]
[Hint 2: In addition to FAS 133, students may find definitions and
examples in "Summary of Derivative Types" ---
J:\courses\acct5341\fasb\sfas133\derivsum22
Especially note pp. 49-52.]
Question 04
What are the controversial disclosure rules required by the SEC for derivatives?
[Hint 1: Look up the term "Disclosure" in Bob Jensen's SFAS 133 Glossary]
[Hint 2: T.J. Linsmeir and N. D. Pearson, "Quantitiative Disclosures of
Market Risk in the SEC Release," Acccounting Horizons, Vol. 11, No. 1, March
1997, 107-135. ]
[Hint 3: Go to the commentary by Walter Teets.
Notebook File 1
Question 05
What is the IASB
and what are the major differences between IAS 39 and SFAS 133?
Note: You do not have to go into each detail concerning minor
differences between IAS 39 and SFAS 133 even though these details are provided
in the green sections of my Hedge
Accounting Glossaries & Experts at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
[Hint 1: Note
that the differences between IAS 39 and SFAS 133 are highlighted at http://WWW.Trinity.edu/rjensen/acct5341/speakers/pacter.htm#SFAS133diffs1.]
Hint 2: Paul Pacter has some comparisons of
SFAS 133 and IAS 39 at http://www.IASB.org.uk/news/cen8_142.htm.]
Notebook File 1
Question 06
Neither the FASB or the IASB does not require fair market value accounting for all financial
instruments although there are some instruments such as available-for-sale
instruments under FAS 115 that must be carried at current values. Be able
to define the difference between a financial instrument versus a derivative
financial instrument. Can you
think of why corporations and accounting firms actively resist the movement to
adjust all financial instruments to fair value? Why is fair value
accounting the only feasible way to book some derivative financial instruments
such as forward contracts, futures contracts, and swaps?
[Hint: . There is a movement both internationally and in the U.S. to require that all financial instruments, in addition to derivatives, be adjusted to current values at least every 90 days. This would effectively eliminate historical cost accounting for all asset and debt financial instruments. But the movement at the present time is being so strongly resisted that it has little chance of being written into standards in the near future. To answer the question on the theoretical side, think of what fair value accounting does to an enormous fixed-rate bond that a firm strongly intends to hold to maturity.]
FASB's Exposure Draft for Fair Value Adjustments to all Financial Instruments
On December 14, 1999 the FASB issued
Exposure Draft 204-B entitled Reporting
Financial Instruments and Certain Related Assets and Liabilities at Fair Value.
This document can be downloaded from http://www.rutgers.edu/Accounting/raw/fasb/draft/draftpg.html
(Trinity University students can find the document at J:\courses\acct5341\fasb\pvfvalu1.doc
).
If an item is viewed as a financial instrument rather than inventory, the accounting becomes more complicated under SFAS 115. Traders in financial instruments adjust such instruments to fair value with all changes in value passing through current earnings. Business firms who are not deemed to be traders must designate the instrument as either available-for-sale (AFS) or hold-to-maturity (HTM). A HTM instrument is maintained at original cost. An AFS financial instrument must be marked-to-market, but the changes in value pass through OCI rather than current earnings until the instrument is actually sold or otherwise expires. Under international standards, the IASB requires fair value adjustments for most financial instruments. This has led to strong reaction from businesses around the world, especially banks. There are now two major working group debates. In 1999 the Joint Working Group of the Banking Associations sharply rebuffed the IAS 39 fair value accounting in two white papers that can be downloaded from http://www.IASB.org.uk/frame/cen3_112.htm.
Financial Instruments: Issues Relating to Banks
(strongly argues for required fair value adjustments of financial
instruments). The issue date is August 31, 1999.
Trinity University students may view this paper at J:\courses\acct5341\IASB\jwgbaaug.pdf.
Others may go to the IASB download site at http://www.IASB.org.uk/pix/banksjwg.pdf.
Accounting for financial Instruments for Banks (concludes
that a modified form of historical cost is optimal for bank accounting).
The issue date is October 4, 1999
Trinity University students may view this paper at J:\courses\acct5341\IASB\jwgfinal.pdf
Others may go to the IASB download site at http://www.IASB.org.uk/pix/jwgfinal.pdf.]
Notebook File 1
Question 07
How does the FASB justify the need for SFAS 133?
[Hint 1: See Paragraphs 233-243 of SFAS 133 ]
Notebook File 1 Question 08
What are the major types of derivatives risk?
[Hint 1: In addition to FAS 133,
students may find definitions and examples in "Summary of
Derivative Types" --- J:\courses\acct5341\fasb\sfas133\derivsum22
Especially note pp. 19-21 and 84-85.]
[Hint 2: Bob Jensen's Glossary a http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm]
Notebook File 1 Question 09
What derivative contracts are excluded from coverage by
SFAS 133?
[Hint: see Paragraph 10 of SFAS 133.]
Notebook File 1
Question 10
What is the purpose of the DIG and what are the main categories of DIG issues to
date? For this question, you can ignore the actual issues under each
category.
[Hint: The DIG issues up to September 2000 are in the back portion of your FAS 133 book. Also see Bob Jensen's Glossary at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm. For the latest issues, visit the DIG web site at http://www.fasb.org/derivatives/ .]
Notebook File 1 Question 11
Contrast and compare short-term versus long-term interest rates. What implications do your
answers have for bond pricing.
[Hint: See "Summary
of Derivative Types" --- J:\courses\acct5341\fasb\sfas133\derivsum22
Especially note pp. 23-25.
Partnership Assignment
Computer File 2 (EXCEL) Assignment
Solve wtdcase2.xls in the TUCC
Network Path J:\courses\acct5341\0assign\wtdcase2.xls
Definitions are given at
http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#UnderlyingBases
Note: This partnership assignment is in the nature of an on-the-job assignment where the answers cannot be obtained from any particular assigned readings. Partners are required to seek out answers from sources that are not assigned readings for the week.
Required: Fill in the blank cells and provide answers to questions listed
in the Questions sheet of of wtdcase2.xls in the TUCC
Network Path J:\courses\acct5341\0assign\wtdcase2.xls
You should fill in the answers in the Answers worksheet of the assignment's
Excel workbook.
Submit your partnership answers in an attached Excel file to Dr. Jensen. Be sure to put the names of the partners on the top of the spreadsheet answer. Also change the name of the file. For example, if Ausaf and Dai are partners, name the file wtdAusafDai.xls. Dr. Jensen's email address is rjensen@trinity.edu
*************************************
You will
find the WTD Case solutions on the path
J:\courses\acct5341\answers\wtdcase2a.xls
The first spreadsheet is just a shell.
The second spreadsheet has the answers.
Be prepared to solve a similar case with different numbers for PLA, exit value,
entry value, and economic income adjustments.
More importantly, be prepared to discuss the advantages and limitations of each
alternative basis of reporting earnings and financial position.
I placed
copies of Page 34 of the 1981 United States Steel Corporation annual report in
your mail boxes. This report was
audited when FAS 33 was still in effect. FAS
33 required historical cost accounting accompanied by PLA and current cost
(replacement cost) supplements. You
will see on Page 34 how the 1981 net income amount was $1.077 billion on a
historical cost basis. With PLA
adjustments of historical cost, the net income is reduced to $164.5 million in
terms of constant-dollar measurement. With
current (replacement) cost adjustment, the net income is transformed into a net
loss of ($168) million.
This
dramatically illustrates how companies making decisions on a historical cost
basis may be misled into overstating dividends and into thinking that they are
doing much better than they are after changing purchasing power of currency and
changing replacement costs are taken into consideration (if they intend to
remain going concerns). Farmers
would say this is analogous to “eating your seed corn.”
It is very sad the FAS 33 was rescinded due to the power of the
corporations to control accounting standards.
Theory
Question 1: Price level and
replacement cost adjustments in times of inflation lead to gains in some
accounts and losses in others What
accounts will show gains and what accounts will show losses in periods of
inflation?
Theory Question 2: About 90% of the companies who compared historical cost, PLA, and replacement cost net income measures in 1981 showed highest net income using historical cost. However, the other 10% showed that historical cost net income was lower than PLA and replacement cost net income. What circumstances led to each type of outcome.
Theory Question 3:
During a period of inflation, a company that holds speculative forward contract to purchase sell (short position) 25,000 bushels of corn at a forward price of $2.60 per bushel in six months will most likely have a
a. Purchasing power loss that will be reported in conventional financial statements.
b. Purchasing power loss that will not be reported in conventional financial statements.
c. Purchasing power gain that will be reported in conventional financial statements.
d. Purchasing power gain that will not be reported in conventional financial statements.
e. None of the above
| Answer e is is the correct answer, because the value of
the forward contract adjusts itself for purchasing power gains or losses
as well as for other market gains and losses in corn. This makes
the forward contract a non-monetary asset. For example, consider a
speculative short position to sell the corn at a forward price of $2.60
per bushel on July 1 when the earlier spot price on January 1 was
$2.00. Suppose the spot price moves to $3.60 per bushel on July
1.
Further suppose that the $1.60 change in spot prices includes a purchasing power loss of $0.10 for each inflated dollar. The gain on the forward contract of $1.00=$3.60-$2.60 has no purchasing power gain or loss, because the $3.60 and the $2.60 amounts are both measured in terms of July 1 dollars. Hypothetically, the investor could buy 25,000 bushels of corn on July 1 at the contracted forward price of $2.60 and sell the same corn for $3.60 on July 1. What really happens is that the forward contract is net settled and the investor gets $1.00 in cash on July 1 for each bushel of corn. And since the forward contract cost $0 on January 1, there is no monetary loss over the six month contract period. All transactions on July 1 are in terms of July 1 purchasing power of the dollar. If the investor instead put $2.00 under his pillow for six month, the there would be a purchasing power loss of $0.20, because the $2.00 on January 1 would buy more goods and services than the $2.00 under the pillow on July 1. The $2.00 under his pillow is a monetary asset subject to purchasing power gains and losses. Supposed a farmer had 25,000 bushels of corn that he purchased for $2.00 per bushel as of January 1. Assume he has no forward contract. Unlike the $2.00 under his pillow, the price of his corn inventory will adjust for inflation. Inventory is a non-monetary asset. Monetary assets like cash, savings accounts, accounts receivable, and fixed-rate bond investments will not adjust for inflation like non-monetary assets. If he hedges and locks in a profit of $0.60 on his $2.00 January 1 corn with a $2.60 July 1 purchase (long-position) forward price, he will have a purchasing power loss such that his real hedged gain is less than $0.60. His $2.00 January 1 dollars could have purchased more goods and services on January 1 than each $2.00 on July 1 if there was inflation. Since his forward contract hedge locked him into a $2.60 forward purchase price, he cannot take advantage of any change in corn spot prices between January 1 and July 1. He does not have the inflation protection that he had when holding speculations in inventory held on January 1 or a forward contract that is a speculation (without any inventory on hand in January 1). His paper profit of $1.60=$3.60-$2.00 gain on the inventory sale has purchasing power loss. His loss of -$1.00=$2.60-$3.60 has no purchasing power gain or loss since this is all net settled in terms of July 1 dollars. The locked in profit of $0.60=$1.60-!.00 thus has some purchasing net purchasing power loss. Thus hedges that lock in profits do not necessarily lock in price-level adjusted profits. Speculations do not lock in profits, but they may shut out purchasing power gains and losses. Thus students must be carefully read the original question. The correct answer is "e" (None of the above) when the forward contract is a speculative short position investment. If the forward contract is a hedge of inventory inventory profit with a long forward postion, the correct answer is "a" if the inventory is sold when the forward contract is net settled on July 1 for a paper profit of $1.60 per bushel to offset the forward contract loss of $1.00 per bushel. |
Addendum added January 29, 2005:
I
want you to do three things with respect to the wtdcase2a.xls partnership
assignment for Week 2.
I
want you to be able to derive the answers on a calculator (without the aid of
Excel) if I give you a similar problem on a quiz or on an examination.
I
want you to be able to explain the theoretical arguments for and against each
basis for valuation of a booked asset or a booked liability.
I stress that the valuation alternatives illustrated in the wtdcase
are applied to booked items that appear on the balance sheet and income
statement. I also want you to
appreciate that virtually all these valuation approaches are required for some
booked items under some circumstances in current GAAP,
When we say “GAAP is based on historical cost” we are only speaking
in very aggregated terms. Some
individual booked items are not based on historical cost even under current GAAP.
Can you provide illustrations where each valuation method is required
under current GAAP.
I
want you to explain when a particular alternative to unadjusted historical cost
(HC) valuation will lead to higher or lower earnings outcomes when compared with
HC valuation. Last week I
particularly stressed that you must be able to explain when PLA will increase
and when PLA will decrease reported earnings for a firm relative to unadjusted
HC. When FAS 33 was in effect, we
found that around 85% of the reporting firms reported lower earnings after
adjusting for inflation. But there
were 15% that showed higher earnings after PLAs.
Are
you able to explain why, in theory, PLA leads to higher versus lower earnings?
Can
you explain what types of assets and liabilities lead to purchasing power gains
and losses?
By Yourself Reading Assignments (take hand-written notes of assigned readings)
Strong Chapters 1, 2, and 8 . Take notes on the key points.
SFAS 133 Paragraphs (1-27, 206-311, 351-370) and Example 1 beginning in Paragraph 105.
Pay particular attention to Paragraphs 6-11.Take the Self Tests on Pages 33 and 193 of your Strong textbook.
Students should search for answers to the following questions.:
How do futures contracts differ from forward contracts? Where are futures contracts commonly obtained in the United States?
What are settlement prices? What are price limits?
How should one be able to derive the today's spot price from the forward price?
What is meant by marking to market?
What are basis and maturity mismatches?
What are strip hedges versus stack hedges?
How does normal backwardation differ from contango?
What is a synthetic option? (See Page 40)
This relates to the term "synthetic" in FIN 46, such as synthetic lease --- http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm
A synthetic instrument is the artificial creation of an asset or liability using combinations of other assets or liabilities. For example, call option or a put option (which amounts to a synthetic long stock), or a long put option and a short call option (a synthetic short stock). In the area of futures contracts, a synthetic long futures position is created by combining a long call option and a short put option for the same expiration date and the same strike price. A synthetic short futures is created by combining a long put and a short call with the same expiration date and the same strike price.
The word "synthetic" also may relates to a term called "structure" in finance but not in all contexts. The term "structure" is ambiguous until placed in a particular context. In one context a "structured note" is a derivative financial instrument or combination of such instruments whose value is based on an "underlying" index. It may also refer to using a swap to change the cash flows of a financial instrument. It can be a synthetic substitute for a financial instrument that is not a derivative. In another context, "structured" may mean something else entirely. Structured financing may, in one context, refer to financing based upon anticipated cash flows rather than current value of an asset or collateral.
Questions 9, 10, and 11 on Page 194 of your Strong textbook.
Hint: You may also find answers to the above questions in my glossary at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
Addendum for Reference
