Risks and Hedging

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Question 1 (25 marks)

Most firms hedge at least some of their risks. Hedging can take two basic forms—namely, natural hedging and hedging by means of derivative instruments. The use of derivatives as hedges has expanded greatly in recent years.

Generally, under accounting standards (IAS 39 and related U.S. standards), derivative instruments are fair-valued with any unrealized gain or loss included in net income. However, hedge accounting provides some exceptions to this rule.

Required:

  1. 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 income volatility—that is, net income volatility greater than the actual volatility of the firm’s operations. Explain how this can happen.
    (5 marks)
  2. Suggest two ways that the excess net income volatility arising in part (a) can be prevented. (6 marks)
  3. IAS 39 identifies two basic types of hedge. Describe each type. For each type, explain how IAS 39 controls excess net income volatility arising from entering into the hedge. (8 marks)
  4. Use the bonus plan hypothesis of positive accounting theory to explain why a firm manager dislikes excess net income volatility. Are the policies to control excess net income volatility you described in parts (a) and (b) unethical? Explain why or why not. (6 marks)

 

accounting standards- ceiling tests

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Question 1 (25 marks)
Several accounting standards include ceiling tests (also called impairment tests). Required:
a. What is a ceiling test? Identify two IASB accounting standards that contain a ceiling test and describe the test. (7 marks)

The ceiling test is an accounting standard that stipulates that capital assets such as property, plant and equipment must be written down if their net carrying value exceeds the net recoverable amount. This is to prevent overvaluation of capital assets.

b. Ceiling tests are usually regarded in this course as one-sided examples of the measurement approach. However, they can also be regarded as examples of conservative accounting, as assets are written down but not written up. Ceiling tests are an example of conservative accounting. Why do bondholders favour ceiling tests? How do bondholders reward the firm for conservative accounting such as ceiling tests? (6 marks)

The Bondholders favour ceiling test as they prefer to use a conservative accounting standards to value the firm as this will indicate the risk of their investments the likelihood of them receiving their interest / coupon and also this helps determine the value of their bonds at that point. By having an idea of the firm value this will permit the bondholders to make decisions on their investment strategies regarding their bonds.

c. Explain briefly why auditors favour ceiling tests. (6 marks)

Auditor favour ceiling tests as this permit the company to be valued fairly or even undervalued rather than overvalued. This situation protects auditors from being faced by lawsuits, as it’s less likely to be sued by stakeholders for undervaluation of a company.

d. Outline the accounting for research and development (R&D) under IASB standards. Is this accounting conservative? Why? Explain why accountants account for R&D as they do. (6 marks)

IAS 38 requires that research costs are completely excluded from the balance sheet and are expensed as incurred…

 

Porter’s Five Forces, an overview

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Porter’s Five Forces, an overview

 

Porter’s Five Competitive Forces were developed by Michael E. Porter in his 1980 book, Competitive Strategy: Techniques for Analyzing Industries and Competitors. Since then, this tool has become an important method in analyzing an organizations industry structure in a strategic process. Corporate strategy should meet the opportunities and threats in the organizations external environment and should be based on an understanding of industry structures and the way they change. Porter’s Five Forces Analysis can provide valuable information for three aspects of corporate planning:

 

Statistical Analysis:

The Five Forces Analysis allows determining the attractiveness of an industry. It provides insights on profitability. Thus, it supports decisions about entry to or exit from an industry or a market segment. Moreover, the model can be used to compare the impact of competitive forces on their own organization against their impact on competitors. may have different options to react to changes in competitive forces from their different resources and competence’s. This may influence the structure of the whole industry.

 

Dynamical Analysis:

The Five Forces Analysis can reveal insights about the potential future attractiveness of the industry. Expected Political, Economic, Socio-demographic, Technological, Legal, and Environmental changes can influence the five competitive forces and thus have impact on industry structures. Useful tools to determine potential changes of competitive forces are scenarios.

 

Analysis of Options:

With the knowledge about intensity and power of competitive forces, organizations can develop options to influence them in a way that improves their own competitive position. The result could be a new strategic direction, new positioning, or differentiation for competitive products.

 

There are some assumptions that Porter makes with his Five Forces model:

  • The first being that buyers, competitors, and suppliers are unrelated and do not interact and collude;
  • The second is that the source of value is structural advantage and creates barriers to entry; And,
  • Third, is that uncertainty is low, allowing participants in a market to plan for and respond to competitive behavior.

 

While Porter’s Five Forces is an effective and time-tested model, it has been criticized for failing to explain strategic alliances. In the 1990s, Yale School of Management professors Adam Brandenbuger and Bare Nalebuff created the idea of a sixth force, “complementors,” using the tools of game theory. In their model, complementors sell products and services that are best used in conjunction with a product or service from a competitor. Intel, which manufactures processors, and computer manufacturer Apple could be considered complementors in this model. More information can be found at Strategic CFO.

 

 

 

There are five competitive forces that shape every industry and every market. They determine the intensity of competition and the profitability and attractiveness of an industry. Corporate strategy should modify the competitive forces to improve the condition of the organization. Through the analysis, management can decide how to exploit certain characteristics in their industry.

 

 

 

 

The first is entry of competitors, or how easy or difficult is it for new entrants to start to compete, which barriers do exist.

The easier it is for new companies to enter the industry, the more cut-throat competition there will be. Factors that can limit the threat of new entrants are known as barriers to entry. Some examples include: Existing loyalty to major brands, incentives for using a particular buyer (such as frequent shopper programs), high fixed costs, scarcity of resources, government restrictions or legislation, entry protection (patents, rights, etc.), economies of product differences, brand equity, switching costs or sunk costs, capital requirements, access to distribution, absolute cost advantages, learning curve advantages, and expected retaliation by incumbents.

 

The second is the threat of substitutes, or how easy can our product or service be substituted, especially cheaper.

What is the likelihood that someone will switch to a competitive product or service? Because of the type of service, there are very few substitutes in other industries. If the cost of switching is low, then this poses to be a serious threat. Here are a few factors that can affect the threat of substitutes: buyer propensity to substitute, relative price performance of substitutes, buyer switching costs, perceived level of product differentiation, fad and fashion, and technology change and product innovation. The main issue is the similarity of substitutes. For example, if the price of coffee rises substantially, a coffee drinker is likely to switch over to a beverage like tea because the products are so similar. If substitutes are similar, then it can be viewed in the same light as a new entrant.

 

The third is the bargaining power of buyers, or how strong is the position of buyers and can they work together to order large volumes.

This is how much pressure customers can place on a business. If one customer has a large enough impact to affect a company’s margins and volumes, then they hold substantial power. Here are a few reasons that customers might have power: small number of buyers, purchases of large volumes, switching to another (competitive) product is simple, the product is not extremely important to the buyer, they can do without it for a period of time, customers are price sensitive, buyer concentration to firm concentration ratio, bargaining leverage, buyer volume, buyer switching costs relative to firm switching costs, buyer information availability, ability to backward integrate, availability of existing substitute products, buyer price sensitivity, and price of total purchase.

 

The fourth is the bargaining power of suppliers, or how strong is the position of sellers and are there many or only few potential suppliers and is there a monopoly.

This is how much pressure suppliers can place on a business. If one supplier has a large enough impact to affect a company’s margins and volumes, then they hold substantial power. Here are a few reasons that suppliers might have power: there are very few suppliers of a particular product, there are no substitutes, the product is extremely important to the buyer, they cannot do without it, the supplying industry has a higher profitability than the buying industry, supplier switching costs relative to firm switching costs, degree of differentiation of inputs, presence of substitute inputs, supplier concentration to firm concentration ratio, threat of forward integration by suppliers relative to the threat of backward integration by firms, and cost of inputs relative to selling price of the product.

 

The last force is the rivalry among the existing players, or is there a strong competition between the existing players and is one player very dominant or all equal in strength and size.

Highly competitive industries generally earn low returns because the cost of competition is high. A highly competitive market might result from: many players of about the same size, no dominant firm, little differentiation between competitor’s products and services, a mature industry with very little growth, and companies can only grow by stealing customers away from competitors. For many industries, this is the major determinant of the competitiveness of the industry. Sometimes rivals compete aggressively and sometimes rivals compete in non-price dimensions such as innovation, marketing, etc.

 

 

The list below provides ideas on how to reduce the power of the five forces to negatively impact a firm. Remember: The forces are in the market but the market impacts a firm’s operations! Not all of these approaches will specifically apply in a given scenario but they are among the concepts leaders and managers typically consider when attempting to improve their firm’s short and long-term possibilities.

 

 

  • Bargaining Power of Suppliers
    • Partnering
    • Supply chain management
    • Supply chain training
    • Increase dependency
    • Build knowledge of supplier costs and methods
    • Take over a supplier
  • Reducing the Treat of New Entrants
    • Increase minimum efficient scales of operations
    • Create a marketing / brand image (loyalty as a barrier)
    • Patents, protection of intellectual property
    • Alliances with linked products / services
    • Tie up with suppliers
    • Tie up with distributors
    • Retaliation tactics
  • Reducing the Competitive Rivalry between Existing Players
    • Avoid price competition
    • Differentiate your product
    • Buy out competition
    • Reduce industry over-capacity
    • Focus on different segments
    • Communicate with competitors
  • Reducing the Bargaining Power of Customers
    • Partnering
    • Supply chain management
    • Increase loyalty
    • Increase incentives and value added
    • Move purchase decision away from price
    • Cut put powerful intermediaries (go directly to customer)
  • Reducing the Threat of Substitutes
    • Legal actions (which may include legislation or other government actions)
    • Increase switching costs
    • Alliances
    • Customer surveys to learn about their preferences
    • Enter substitute market and influence from within
    • Accentuate differences (real or perceived)

 

 

 

Customer Care and the Benefits of the Good Customer Care

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1.      Understanding Customer Care and the Benefits of the Good Customer Care :

 

No matter the business there is the necessity for a business to understand customer care and the benefits of the good customer care.  In order for a business to exist and remain sustainable over time, customer satisfaction is mandatory.  There are several advantages of giving good customer service that will also enable a business to profit to include (Bhasin, 2016):

  • Retaining of the repeat customer as the happy customer will return over and over again. This is a process that also enables the company brand to be well known thereby allowing the organization to gain the advantage over competitors;
  • Allows the business to be endorsed. This is a benefit afforded a company when the customer is satisfied with people talking to family and friends which is the best advertising of all.  This is referencing for the business allowing for the increase in revenue;
  • Giving the organization as well as the employee’s confidence as satisfied customers talk with the employees praising the business thereby boosting employee morale. Over time confidence is built in a way that causes the company to grow the business because of being empowered to do so. This is a positive internal as well as external process;
  • A holistic marketing scenario which is created with motivated employees who understand the mindset of the customer. This process makes the customer happy allowing the overall business to become a holistic marketing scenario with everyone participating in the ultimate satisfaction of the customer; and
  • The company gaining the competitive advantage as customer service and the employees enable the competitive advantage.

These are major benefits to any business that practices these processes enabling customer retention as well as the overall competitive advantage in the market.

 

1.1              Basic Principles Associated with Good Customer Care

The basic principles that are associated with good customer care include (Spencer, 2015):

  • Listening which is of importance to the customer. Listen carefully at what the customer says as this will enable the building of a strong business relationship.  This means listening to the words while paying attention to the ideas that are discussed by the customer.  This is information that can be used to increase customers;
  • Responding as it is very important to respond quickly to the customer if it is a response about the customer having a positive experience or a negative with the customer being dissatisfied. Taking too long to respond to the customer gives the impression of the organization not caring about the customer’s experience which is not a good thing;
  • Exercising patience as the customer may need employee assistance concerning how to operate the website or how to use the product that was just purchased. By exercising patience with the customer the employee demonstrates the importance of the patrons and the value that the customer brings to the business;
  • Being courtesy which sounds simple but is sometimes overlooked relative to customer service. Thanking the customer for the purchase, asking if you can be of assistance or simply smiling and welcoming the customer to the business are simple acts of kindness that mean a great deal to the customer;
  • Being a team player allows everyone to be a part of the customer satisfaction process. Being a team member involves the understanding of the importance of deadlines as well as the notification to the client quickly should there be any delay in the receipt of a product or service; and
  • Caring which is of great importance because customers can tell when they are not valued. There are little things that are noticed that may be overlooked by the employees.

It is always of importance for the organization to deliver stellar customer service at all times enabling the continued success of the organization.

 

1.1              Company Outline of Customer Care Policy

The customer outline of customer care policy is a guideline for the organization and the employees. The outline can provide excellence and professionalism in providing customer service, both inside and outside the organization within the limits of available, well-managed resources (“Sample Customer Service Policy And Values Statement“, 2016).  This outline can list the mission and company values, policy statement, response standards, acknowledgements, resolution, response procedures, contact information and any additional comments that the organization believes to be of importance.

 

1.2              Benefits of Customer Service Standards

There are many benefits for the organization having customer service standards; however, two of the most important benefits include managing the customer’s expectations as the organization’s service standards set the expectations that the customers are expecting from the business (Kime, 2016).  An example of this process is having a response time for the customers with the company and the customer knowing the response time expectation. The second benefit to this process is that it sets the employees’ expectations thereby enabling the success of customer service standards.

 

1.3              Outline of Common Obstacles to Upright Customer Care

Organizations understand the common barriers to good customer care thereby ensuring the continued success of the business (Business Matters, 2013).  A few common barriers to good customer care include (Business Matters, 2013).

  • Failure concerning complaints which means that there should be a short of a response time as possible when resolving complaints. With complaints becoming more complicated there needs to be the ability to ensure that the complaint goes to the right person as quickly as possible;
  • Inability to understand the needs and/or wants of the customer as there is the need to ensure that employees are trained and that action is taken immediately versus having the customer wait for a longer period of time bringing about more frustration; and
  • Not having procedures to define what a complaint is which means that many organizations have the tendency to think that every complaint needs an official process as a simple process should exist for less serious complaints.

1.4              Examples of Good Practice in Customer Care

Organizations realize that customers will do business with a business that they like and that treats them with respect.  Examples of good practice relative to customer care involve (1) setting the customer’s expectations by delivering the promised product/service as advertised; (2) listening first before speaking enabling a productive conversation that will allow the satisfaction for the customer because of hearing what the customer desires; (3) ensuring that customer service standards are drafted in a way that is understood by the employee and customer; and (4) organizations should treat their employees as their first customer as the attitudes as well as the behaviors of the employees will affect the service as well as satisfaction of the customer.

 

2.      Know How to Meet Customer Needs

Meeting customer needs involves listening to the customer and responding when the customer reveals needs and expectations relative to the products and/or services.  It is the responsibility of the organization to understand how to meet the customer needs continuously with the process beginning by listening to the employees.  Effective communication is vital for the success of understanding and knowing how to meet customer needs.

2.1              Differences between Internal and External Customer

The external and internal customers fulfill different roles; however, both are of importance to the viability of the business.  The external customers are the people that buy the organization’s products and services while the internal customers are the people or possibly a partner receiving services to deliver the businesses’ products/services (Joseph, 2016).

2.2              Identification of Needs and Expectations of the Customer

Identification of needs and expectations of the customer involve paying attention to the customer and their buying habits.  A need actually solves a problem that could be real or imagined by the customer (Sven, 2016).  Expectations are what are anticipated when the item is purchased by the customer. This is how the customer rates the organization.

2.3              How to Effectively Deal with Complaints Relative to Area of Responsibility

One of the most effective ways to deal with complaints relative to the area of responsibility is to handle the complaint as quickly as possible. This process begins by listening actively to the customer thereby understanding the complaint, finding out what caused the complaint and then solving the problem while also ensuring that the problem will not be repeated.  This is a positive process that brings satisfaction to the customer while also revealing to the organization changes that can be made to prevent problem reoccurrence.

2.4              Dealing with Difficult Customer Behavior

Dealing with difficult customer behavior is challenging; however, the process must take place.  The employee or manager must adjust their mindset realizing that there will be a confrontation.   The next step is to listen actively, repeat what has been said and to be empathic to the customer.  The last step is to apologize sincerely and to fix the problem as quickly as possible. It is also important to follow up with the customer.

 

3.      The Importance of Collecting, Storing, and Interpreting Customer Feedback

This process is of concern as customer feedback enables the organization to meet the needs of the customer.  Collecting information concerning complaints as well as satisfactory comments allows the organization to know what is being done to meet the customer satisfaction and what needs to change; storing the information allows the organization to review what has already occurred to improve processes; and the interpreting of customer feedback allows the business clear understanding of how to meet customer need.

3.1              The Importance of Customer Feedback

Customer feedback is vital to an organization because the information gained can allow the organization to improve processes both internally and externally.  Customer fulfillment is vital to business success.  Meeting customer satisfaction occurs by knowing what the customer desires.  This knowledge can be gained via customer feedback.

3.2              Different Approaches of Gathering Formal/Informal Response from Customers

Different methods of gathering responses from customers include a company website as well as Facebook and/or Twitter accounts with an interactive page that customers can write comments.  In this manner the business gains information rapidly and also responds quickly directly to the customer.  Response cards can also be used and can be filled out at the store by the customer.  Online surveys can also be used with the customer submitting information via email.

 

3.3              How to Improve the Satisfaction of the Customer

Interacting with the customer enables the success of this process.  This can be done by taking notes and repeating what has been said to ensure accuracy.  Greeting the customer when they enter the store which is a method of signifying the customer has value.  Another way to improve customer satisfaction is to assist the customer which can involve answering their questions in a timely manner or assisting them when they are seeking information.

 

3.4              Implications of the Data Protection Act for Gathering, Accumulating and Using Customer Feedback

Data protection is of importance. The Data Protection Act is mandatory with a requirement under law that an organization comply with the act.  Staff must be trained in the correct use of data with the assurance that personal information will be safely stored electronically or that the manual form of storing will be safe.  This is a process that is of benefit to the customer, the employees and the organization.

 

 

 

 

 

4.      References

Bhasin, H. (2016). 7 Amazing Advantages of giving good customer service. Marketing91.com.       Retrieved 20 December 2016, from http://www.marketing91.com/advantages-of-good-     customer-service/

 

Business Matters,. (2013). What are the biggest barriers to customer service?.         Bmmagazine.co.uk. Retrieved 20 December 2016, from    http://www.bmmagazine.co.uk/in-business/biggest-barriers-customer-service/

 

Joseph, C. (2016). What Is an Internal Customer & an External Customer?.            Smallbusiness.chron.com. Retrieved 20 December 2016, from    http://smallbusiness.chron.com/internal-customer-external-customer-11698.html

 

Kime, C. (2016). Two Benefits of Having Customer Service Standards – Lessonly. Lessonly.           Retrieved 20 December 2016, from http://www.lessonly.com/blog/two-benefits-of-           having-customer-service-standards/

 

Law Center NI,. (2010). Data Protection and Confidentiality Policy. Lawcentreni.org. Retrieved   20 December 2016, from http://www.lawcentreni.org/data-protection.html

 

Sample customer service policy and values statement. (2016). gym.net. Retrieved 20 December      2016, from             https://usagym.org/docs/Member%20Services/bestpractices/2015/5_07customerservice.p     df

 

Spencer, L. (2015). 6 Very Effective Principles to Improve Your Customer Service & Make Your     Clients Happy. Vandelaydesign.com. Retrieved 20 December 2016, from     http://www.vandelaydesign.com/customer-service/

Sven,. (2016). How to Identify Customer Needs and Expectations. Userlike Live Chat. Retrieved    20 December 2016, from https://www.userlike.com/en/blog/identify-customer-needs-   expectations