Accounting theory & Accountability essay on stock exchange
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Accounting Theory and Accountability (Godfrey Chapter 6)
Measurement – Fair Value
Part 2
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The 5 key Learning Objectives in this lecture about alternative measurements to HC
Role of Fair Value in accounting
Evaluate the traditional definitions of fair value
Key Aspects of the new definition of fair value
The nature of current cost accounting and exit price accounting
Criticisms of current cost and exit price accounting
Why these alternate models have not replaced historical cost
Changing responses to measurement issues in accounting standards
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The Focus on an Exit Price — Why?
An “exit price” embodies expectations about the future cash inflows and outflows associated with the asset or liability from the perspective of market participants at the measurement date.
It is current
It is specific
Exit price accounting
Exit price = selling price = fair market value
Has two major departures from historic cost accounting:
the values of non-monetary assets are selling prices and any changes are included in profit as unrealised gains
changes in the general purchasing power of money affect both financial capital and profits
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Exit price accounting
Represents clean surplus accounting
The income statement explains all of the differences existing between the opening and closing balance sheets
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Arguments for exit price accounting
Objectivity
market prices are relatively more objective than most believe
A measure of risk
can indicate the financial risk of purchasing an asset
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Arguments against exit price accounting
Profit concept
does not provide a meaningful concept of profit
the critical event does not relate to the performance of the firm
does not produce realistic financial reports
Additivity
violates the principle of exclusion of anticipatory calculation that it claims to reject
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Arguments against exit price accounting
The valuation of liabilities
valuing liabilities at face value and not market value is internally inconsistent
Current cost or exit price
at what stage of the operating cycle should exit price dominate asset valuation?
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A global perspective and international financial reporting standards
Current cost in the United States
an experiment but abandoned (1976 -1984)
Current cost in the United Kingdom
implemented but abandoned (1975 – 1985)
Current cost in Australia
recommended but abandoned (1976 – 1980’s)
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International accounting standards and current costs
IASB/FASB have agreed that fair value is the best measurement basis (2004)
the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction
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International accounting standards and current costs
Historic cost accounting still generally applied
Distinct movement toward current value systems
IASB moving toward exit prices (2004)
But still a mixed valuation approach
Fair value means – current market entry price, current market selling price, historic cost and discounted future cash flows
There is no mention in the standards of capital maintenance concepts
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A mixed measurement system and international standards
Market values - exit prices - are implied in the ‘fair value’ approach in international financial reporting standards
A lack of a theoretical concept of valuation, capital maintenance and profit measure, has resulted in a still mixed measurement system and a lack of consistency
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The End
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