Accounting: Prudence Concept

When talking about accounting, the first thing we should know is the history of its development. Traditionally, the development is from inductive to deductive. Inductive theory assume what is done by the majority is the most appropriate practice. However, It did not seek to evaluate the logic or merit of

Historically ,it is seen that there are numerous number of disputes in the field of financial reporting among different professionals, regulators and theoretitions .most of these disputes are related to the valuation of financial reporting components.the current curve in the progress of valuation is the push for and against the fair value approach.the purpose of this research is to examine the arguments on the use of fair value accounting and to identify the issues related to implementation of fair value accounting standards. Further, the results of literature related to role of fair value accounting within financial crisis are also investigated.

The most controversial topic of today’s time in the world of accounting is fair value. However, one common point of confusion is the scale of businesses affected by fair value, and when fair value came onto the scene. According to Robert Herz and Linda MacDonald “...the use of fair value in financial reporting is not new. In fact, it has been in place for decades, principally for financial assets. But even then, fair value is not required for all assets.” (2008) The idea of using fair value measurements goes back at least to the 1930’s when Kenneth MacNeal wrote Truth in Accounting. It wasn’t until 1993, however, until the FASB released SFAS 115. SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. (FASB 1993) In 2006 the FASB released SFAS 157, which established a framework for measuring fair value. SFAS 157 also requires significantly more disclosures about fair value estimates than ever before. (FASB 2006) Finally the FASB issues SFAS 159, which permits entities to choose to measure many financial instruments and certain other items at fair value. (FASB 2007) These statements set the stage for the discussion of the advantages and disadvantages of fair value. Also discussed, will be the problems with implementation of a full fair value measurement system. That discussion will be followed by a brief summary.

Positive accounting theory (PAT) offers one such attempt to make accurate predictions regarding real world events as captured by accounting transactions and to explain why firms choose between various accounting techniques. PAT attempts to explain a firm's choice of accounting methods on the basis of self-interest. PAT also provides a framework for

Accounting Information is the pearl of any organization. It is how a business provides its investors as well as other stakeholder parties’ direction towards a healthy economic decision in favor of the business. Regulation of these information and standardizing the process would lead to that organization solving the problem of ‘information asymmetry’. (Watts & Zimmerman, 1978)

Cost accounting is used by most companies whether manufacturing or service to keep track of their daily activities. It is essential in understanding the costs of running any enterprise. In other words they aid in determining the costs of inputs and outputs used in production. It involves analyzing and evaluating different approaches in order to determine the most suitable method that management can use suitably and one that can aid in future planning. Cost accounting is therefore an essential tool in decision making. Decisions made may involve pricing levels, future investment, production levels and coming up with a good competitive strategy. Different industries use different cost accounting method depending on the type of services provided or product manufactured.

For example, the business entity means that commercial expenses are kept separate from personal expenses and the monetary unit is generally the U.S. dollar. Next, there are four basic principles that cover historic costs, revenue recognition, matching and full disclosure. For instance, the historical cost principle mandates that companies report their asset and liability acquisition costs instead of reporting the fair market value. On the other hand, the revenue recognition principle states that companies must only record earned revenue, not received revenue. This forms the basis of accrual basis accounting. Finally, there are four basic constraints, which include objectivity, materiality, consistency and conservatism. To illustrate, the objectivity principle mandates that financial statements produced by the company’s accountants must be based on factual evidence. Conversely, the consistency principle means that the company must use the same accounting methodology for every accounting period. Overall, the GAAP provides structured consistency and transparency to all aspects of accounting and financial

During the last 20/30 years there has been an increase in trade and communication. It is easier for people to do business across the world as the new technology allows this to be possible. The problem with this is that different countries have different ways of accounting standards, and therefore there is a problem on how to account standards. Hence, during the last years the debate on whether to use Fair presentation or the True and fair View is becoming a major concern. Fair presentation and the true and fair concept may seem as a similar concept, however, they do differ as well. While the former is the concept for

The main idea behind this principle is that when we face with two reasonable possibilities for recording a transaction you should err on the side of being conservative. This statement means recording uncertain losses while refraining from recording uncertain gains. Therefore, when you follow the conservatism principle you end up recording lower asset amounts on your balance sheet and lower net income on the income statement. Overall, adhering to the conservatism principle leads to lower profits being recorded on your statements.

First and foremost, advocates claim that fair value accounting provides accurate asset and liability valuation on an ongoing basis to financial information users. This statement could be supported through the research of Zijl and Whittington (2006), which concluded that fair value is estimated by a market price obtained from an active and well-informed market. In other words, we could ensure that the fair value

The main purpose of financial reporting is to deliver transparent financial information regarding a company to the investors and general public. The financial crisis of 2008 had shown that absence of transparency in the financial statements may have an adverse effect on investor confidence. High quality accounting information is an essential criterion for well- functioning economy as investors rely on this information for investment purposes. Value relevance is thus one of the basic attributes of accounting quality. (Francis et al. 2004)

In contrast, Historical Cost accounting is defined by recording assets or liabilities on its acquired cost. The nominal value that a company paid for an asset or recorded a liability. This measurement is based on a cost principal that states to record assets/liabilities at the acquisition value. In this approach, assets or liabilities are adjusted to its net realizable value in a systematic manner. For example, depreciation of fixed assets, amortization of intangible assets, and depletion of natural resources. These rational and systematics approaches to adjust assets’ value to bring these instruments to its carrying value, deviating from the recorded historical cost.

In accounting there are many perspectives on how fair value accounting is relevant and beneficial for financial users. In the eye of standard setters assessing the quality usefulness of fair value information is somewhat a common question for potential and current

In today’s businesses, there has been an increase in the demand for financial reporting and also, the need to have reliable measurements of fair value and its disclosures. The need for reliable information has caused continuous change to accounting policies which has posed a challenge not only to management of companies, but also to auditors. The frequent changes in accounting principles pose a challenge for managers in measuring accounting estimates accurately and are an exceedingly difficult task. Fair value accounting is a financial reporting approach in which companies are required to measure and report on an ongoing basis certain assets and liabilities at estimates of the prices they would receive if they were to sell the assets or would pay if they were to settle their liabilities. Under fair value accounting, companies report losses when the fair values of their assets decrease or liabilities increase. Those losses reduce companies’ reported equity and may also reduce companies’ reported net income.

Both speakers have made credible arguments towards the contradictory nature of the International Accounting and Financial Reporting Standards. Accounting standards are a method of regulating the reporting of everyday transactions within the profession, alongside laws, regulations and codes of professional bodies (Guest Lecturer, 2014). Regulatory regimes are necessary as they aim to achieve a uniform objective that published accounts in the market are to show a true and fair view of the entity they purport to represent. However, the qualitative characteristic “true and fair” is very much subjective to the professional publishing the accounts. As it is open to interpretation, certain entities can use this vulnerability to their advantage