Question

Question 4 Ethics a) From a positive accounting theory perspective, would the managers of companies have incentives to classify hedges as cash flow hedges or as fair value hedges, and if so why? b) Comment on derivatives and their use from an Aristotelian ethical perspective.

Answer 1

Explanation:

A] :

Positive accounting theory is focused on the actions to be taken regarding the organization for new proposed accounting standards.

Positive accounting theory helps the firm to take into consideration of reconciliation of market securities with economic results.

There are three types of hypotheses about PAT

• bonus plan
• debt-equity plan
• the political plan

The managers have incentives to classify hedges as cash flow hedge or fair value hedge as

• fair value hedge: means hedge to "changes in fair value" of securities with respect to risk related to securities in the market.
• cash flow hedge: is defined as a hedge to "variables in cash flow " which is associated with a particular risk component of securities in the market.

Therefore the manager of the firm can classify hedges on both the 'cash flow and fair value hedge '' basis in the books of accounts as securities are both long term and short term hedged.

B].

Derivatives are "securities in the market" which are helpful in hedging the position in the market against the losses which can be incurred due to fluctuations in the currency, commodities prices or share value.

The Derivatives are based on :

• Bonds
• commodities
• currencies
• market indexes
• weather data Etc.

As per the Aristotelian ethical perspective, the derivatives should be used to safeguard one's securities against losses to be incurred in the market.

The derivatives should not be used for speculations or for the purpose of earning profits from derivatives. Aristotle believes that 'derivative hedging is just a state of mind free from fear of losses.