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Theory and Current Issues in Accounting

Question:

Discuss about the Theory and Current Issues in Accounting.

Answer:

Introduction

In this report, the theory related to recent issues that occur, on a regular basis with accounting procedures and policies are being discussed and some objects related to the financial accounting will be stated. The related elements of accounting are listed with a comparative description and the usage. The elements of accounting and their significance are being analysed with respect to the current issues of accounting (AASB, 2016). The essay contains the theory and issues of accounting which is derived from the International Conceptual Framework and other references are also from U.S, GAAP and Chinese National Accounting that provides an overall knowledge of the accounting issues as it covers multifarious accounting rules and theories. Accounting methods and its issues directly affect the financial structure and accounting policies that leaves a strong impression on the business and money flow (Adibah Wan Ismail & Dunstan, 2013). More updated accounting methods are in the favour of everyone such as the lenders, investors and other creditors. For formulating these accounting policies there must be a sound knowledge of accounting methods and its basics so that the issues that are raised can be taken proper care.

Elements of Financial Statements

As per financial standards AASB 101, there are some financial elements that form the backbone of any financial statement such as:

Assets: An asset is an economic resource that is at the disposal of the company at present that is in control of an entity which may be created or acquired in the past (Ahmed & Wang, 2013). Any economic resource is a potential entity to create economic benefit of all kinds.

Liability: Liability is a type of obligation in the form of an economic resource of an entity that may be transferred to another entity as a result of any past occurrences (Baker & Burlaud, 2015). It has to be fulfilled by the current entity.

Equity: Equity is a type interest that is of residual nature which is left after deducting all the liabilities from the assets of an entity (Bonin, 2013). This can be of profitable nature or even compensatory that can be used for asset creation of another nature.

Income: Income can be termed as an increase in asset and deduction in liabilities of an entity which may further result in the enhancement of equity of a particular entity (Brown & Tarca, 2014). Income is not qualified for the people who hold the claim for equity.

Expenses: Expenses are the opposite of income which may be defined as increase in liabilities and decrease in assets of an entity that may further result in deduction in equity of the. Expenses are not qualified for the holders of equity (Christensen & Zeng, 2015).

Measurement Methodologies Used During Preparation of Financial Reporting

There are certain methodologies to measure the financial reports on accounting that may include the five based of measurement (Deegan, 2012). These bases are discussed as follows:

Historical Cost: It is the amount that is paid for the asset or it may be termed as the amount received for the asset of the amount that was expected to be paid as the cost of the asset. In recent days historical cost accounting is done to express the expected cost that can be recovered by the use or sale of the asset after passage of some time. According to the policy AASB 129, the recoverable amount must be higher than the historical cost (Frias‐Aceituno & Garcia‐Sánchez, 2014).

Historical cost is useful, as the information given by this method is relevant due to its conservative nature. In finding out historical cost the unrealised asset gains are not recognised. This may result in the reduction of dividends that have to be paid out. This will benefit the creditors and other lenders. When the business is taxed on the basis of reported profit, it comes as an advantage from the point of view of a taxpayer as it evades the difficulty of finding cash for paying taxes on intangible assets. The comparative neutrality of historical cost makes it one of the best practices for solving conflicts of interest in the system of interest payments.

These measurement methods also have some demerits. The information of costs indicated by this method may be irrelevant in many situations as it is outdated and one cannot deduce the current financial position of any company (Healy & Palepu, 2012). This method also ignores intangible assets that are created internally that are very critical for the business of the firm and the instruments that have no cost.

Value to Business: Value of business method is used to measure the capacity of an asset of a particular entity to generate business. It also answers the question that what worse situation an asset would concur if the asset is not available is the business.

Information organized by value to business method of measurement can be of relevance in some aspects of business than other base methods. This method is based typically on replacement cost that is of interest to potential competitors. They can use this information to assess the cost of launching themselves in a specific market (Horngren & Tan, 2012).  In the same way the prevailing investors can assess the vulnerability of any market from newcomers. This method may also help competitive authorities to deduce the ease of entry and value of returns a new entrant is going to make. By this method they may form a judgement of the rate of returns in a market. Investors also assure themselves about the specific market’s business is maintaining its operative proficiency or not.

Value to business method also has some shortcomings. Information provided by this method is not most relevant on performance or financial position for general users (Horton & Serafeim, 2013). Some people find it irrelevant as profit of business indicated by this method is shown by maintaining operational capital rather by financial capital.

Fair Value: The concept of fair value revolves around the transactions which are currently in process. The fair value can be termed as the value at which an asset or a liability could be sold or bought in an ongoing transaction between two parties who are willingly in the deal that is a transaction without any forced liquidation. The prices of asset sale and purchase are considered as same in this method. It is not an exact or real value but a hypothetical value that ranges between actual selling price and actual buying price (Kang & Gray, 2013). As it is a complex method to understand and apply IFRS 3, has prescribed a definition for fair price as a combination of present value, current replacement cost, estimated value, calculation of reference to a dynamic market and depreciated replacement cost (AASB, 2016). Fair value infers the acknowledgment of liabilities and assets which are unrecognised by the historical cost. Fair value also recognises the gains when they arise rather than when they are realized. Increase in fair value income directly signifies the increase in value of assets of the business during the period of accounting.

Fair value is of little use in the management procedure except for some areas of financial services. It is established by Ernst & Young those measurements of fair value is made on rejected alternative as its base. Since Fair value shows the value of assets which are realised when all the liabilities have been settled and all the assets have been sold out at the date of balance sheet (Nobes, 2014). It can be contemplated by the fact that assets sold separately yield much less value than the assets sold in bulk. Therefore, for business parties interested in market value of assets that fair value of separate assets is not of much relevance. Fair value is a volatile value that can indicate misleading values.

Realisable Value: Realisable value of an asset is the sum for which an asset could be sold and the realisable value for a liability is the sum for which it could be settled. Measurement of realisable value is generally made on the net basis that is net of asset’s selling cost and liabilities’ settlement cost when they are grossed up (Palmer, 2013). Another view of realisable value can be that it can be calculated of the basis of cost of disposal in the normal course of business for fair value as established in IFRS 3. Realisable value of an entity is the value that amounts to the sale of an inventory in the normal business transaction. It is an entity-specific value.

Information provided by the realisable value as a base may not be relevant in other measurement methods.  Realisable value denotes the net realisation costs and current market prices that affect the investors, regulators ad lenders to find out what value can be realised on the disposal of assets (AASB, 2016). Realisable value also shows that what value can be realised in a forced sale which makes it relevant where the current business has a limited life. Accountants can be misled which is concerned with the prospective value of realisation in the balance sheet. This leads to overestimation of the assets at the time of sale.

Criticisms of realisable value are the same as of that of the fair value. It is noticed that the dominance of net measurements and its use in the business are neither intended nor expected to be sustainable.

Value in use: It is the value of a liability or an asset of discounted nature that is attributable to the cash flows. Since cash flows are generated by the business or small units of business rather than separate assets, value in use is based on application in business than value to separate liabilities and assets (Mackenzie & Hanekom, 2012). Value in use denotes the gains in assets as they rise and are realised but they are actually profits made by the business unit rather than gains concurred by the liabilities or assets or transactions done on individual assets.

It can be stated that information given by value in use is more relevant in the measurement method system than other measurement techniques. This information is relevant in the scenario of present value indicated in the cash flows of the ongoing business. Almost all the major stakeholders such as lenders, investors, creditors and employees are affected by the value in use (Rahman, 2013). This information is also used for analytical purposes by private equity investors. Moreover, value in use provides business valuations based on future cash flows, it is used by the current trendsetters and is considered as the main theme of financial reporting. It helps in predicting future cash flows. When the value in use is applied to the business it reaps valuation goodwill in any other obsolete liabilities or assets.

As this method is widely used in the business and is mainly concerned with predictions, other economists believe that business trends are set by the market and not by the analysis done of the value in use (Christensen & Leuz, 2013). It is also said that value in use is not of much use without specifying the forecasts, sensitivities and assumptions.

Conclusion

In the above discussion, theories and issues of accounting is thoroughly discussed within the ambit of financial elements and measurement methodologies used in preparing the financial statements. The definition of methods, their relevance in measurement of financial statements under different circumstances and usage under various scenarios is elaborated with proper criticism of every measurement method. This discussion gives an idea of the issues related to accounting and to how the things work when it comes to measuring different methods. Some measures are conventional and some are developed by the accountants as per the changing needs and requirements of financial statements so that an apt method can be chosen and used which yield the best result. As it can be noticed the value in use is the more far-fetched and better method for measuring financial statements. It is the most relevant and practical method with least drawbacks and gives the business an edge over other methods. It is most reliable in comparing market value of assets. Financial elements are the basics of financial accounting without which any financial statement cannot be made. These theories provide the base for further analysis and deduction based on which business units make their financial statements and accounting is done. This method of measurements and theories provide a comparative study of accounting techniques and helps the entities to choose what is best for the use. 

Reference

AASB, C.A.S., (2016). Consolidated Financial Statements

Adibah Wan Ismail, W., Anuar Kamarudin, K., Van Zijl, T. & Dunstan, K., (2013). Earnings quality and the adoption of IFRS-based accounting standards: Evidence from an emerging market. Asian Review of Accounting,21(1), pp.53-73.

Ahmed, A.S., Neel, M. & Wang, D., (2013). Does mandatory adoption of IFRS improve accounting quality? Preliminary evidence. Contemporary Accounting Research, 30(4), pp.1344-1372.

Baker, C.R. & Burlaud, A., (2015). The historical evolution from accounting theory to conceptual framework in financial standards setting. The CPA Journal, 85(8), p.54

Bonin, H., (2013). Generational accounting: theory and application. Springer Science & Business Media

Brown, P., Preiato, J. & Tarca, A., (2014). Measuring country differences in enforcement of accounting standards: An audit and enforcement proxy.Journal of Business Finance & Accounting, 41(1-2), pp.1-52.

Christensen, H.B., Lee, E., Walker, M. & Zeng, C., (2015). Incentives or standards: What determines accounting quality changes around IFRS adoption?. European Accounting Review, 24(1), pp.31-61.

Deegan, C., (2012). Australian financial accounting. McGraw-Hill Education Australia.

Frias‐Aceituno, J.V., Rodríguez‐Ariza, L. & Garcia‐Sánchez, I.M., (2014). Explanatory factors of integrated sustainability and financial reporting.Business Strategy and the Environment, 23(1), pp.56-72.

Healy, P.M. & Palepu, K.G., (2012). Business Analysis Valuation: Using Financial Statements. Cengage Learning.

Horngren, C., Harrison, W., Oliver, S., Best, P., Fraser, D. & Tan, R., (2012).Financial Accounting. Pearson Higher Education AU.

Horton, J., Serafeim, G. & Serafeim, I., (2013). Does mandatory IFRS adoption improve the information environment?. Contemporary Accounting Research, 30(1), pp.388-423.

Kang, H. & Gray, S.J., (2013). Segment reporting practices in Australia: Has IFRS 8 made a difference?. Australian Accounting Review, 23(3), pp.232-243.

Nobes, C., (2014). International Classification of Financial Reporting 3e. Routledge.

Palmer, P.D., (2013). Exploring attitudes to financial reporting in the Australian not‐for‐profit sector. Accounting & Finance, 53(1), pp.217-241.

Rahman, A.R., (2013). The Australian Accounting Standards Review Board (RLE Accounting): The Establishment of Its Participative Review Process. Routledge.

Mackenzie, B., Coetsee, D., Njikizana, T., Chamboko, R., Colyvas, B. & Hanekom, B., (2012). Wiley IFRS 2013: Interpretation and Application of International Financial Reporting Standards. John Wiley & Sons.

Christensen, H.B., Hail, L. & Leuz, C., (2013). Mandatory IFRS reporting and changes in enforcement. Journal of Accounting and Economics, 56(2), pp.147-177.

 

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