Accounting theory & Accountability essay on stock exchange
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Accounting Theory and Accountability
Measurement - Historical Cost-Module 1
(Godfrey Chapter 6)
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The 4 key Learning Objectives in this lecture about HC measurement
The principal assumptions underlying historical cost (HC)
Reasons for the dominance of the historical cost model
Criticisms of historical cost accounting
Alternatives to historical cost accounting - more detail in later lectures
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Three main income and capital measurement systems
The historic cost accounting system emerged after the 1929 Wall Street collapse
In the 1960s several alternatives were developed
current cost accounting
financial capital maintenance (the purchasing power of the financial capital)
physical capital maintenance (the physical ability to produce goods and services)
exit price accounting
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Historic cost accounting
BUS310 2013
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Separation of ownership and control
information asymmetry
Most critical objective of accounting is accountability - stewardship (conservatism)
The income statement is paramount
transaction based
revenue recognition
matching
profit measurement
Historical Cost
Defined in the Conceptual Framework as:
Assets are recorded at the amount of cash or cash equivalents paid or the fair value of consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.
Arguments for historic cost accounting
Relevant in making economic decisions
Based on actual, not merely possible, transactions
Data have been found to be useful
The best understood concept of profit
Must guard data against internal modifications
Profit based on alternatives may not be useful
Market prices can be supplementary data
Insufficient evidence to reject it
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Criticisms: Objective of accounting
Stewardship is only a secondary objective
Providing the decision making needs of users is the primary objective and historic cost data is a failure in this regard
Historic cost information is
not objective
can be easily manipulated
does not maintain the entity’s capital
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Criticisms: Information for decision making
Is irrelevant when evaluating past decisions
After acquisition, historic cost data is fictional
Connected to inconsequential measures of capital
Produces only flawed measures of profit
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Criticisms: Basis of historic cost
The going concern assumption does not justify the use of historic cost accounting
many businesses fail
no businesses continue indefinitely doing only or at all what they are presently doing
all businesses, except those presently existing, cease operations
All businesses have alternatives and choices going forward
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Criticisms: Matching
Is a practical impossibility
Is totally arbitrary
The balance sheet is important
Resulted in non-assets being classified as assets and non-liabilities being classified as liabilities
Leads to volatility and smoothing
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Criticisms: Notions of investor needs
Distorts and conceals
Its goals are ill-conceived
Creative accounting is commonplace
Incentives to produce misleading data
Today, investors pay little attention to historic cost accounting data about a firm
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The End
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