The provided essay describes about the conceptual framework on quality of accounting records such as financial statements. According to Australian accounting standard board it has emphasized the relevance of faithful representation and neutrality in financial statements. After this, the essay provides a brief on historical cost accounting. It is basically recording of assets and liabilities at their purchase cost, which means the change in market value of assets and liabilities are ignored. Furthermore, the essay describes about the impact of potential users on the measurement basis of the company as chosen by international accounting standard board (Ernst and young, 2010).
Qualititative criteria
The financial statement of the company must possess qualities like: relevance, reliability. Here relevance of financial statement can be ensured by considering predictive value, feedback value and timeliness. While in case of reliability the financial statement must be verifiable, neutrality and representational faithfulness. Relevance and reliability are considered as primary qualities of the financial statements. However the secondary qualities of financial statements are comparability and consistency (IFRS, 2009).
Relevance and faithful representation are considered as fundamental qualities for the financial statements. These elements are required for effective decision making in the organization. Here faithful representations are necessary in financial information so as to make the data presentable to the real world. It is necessary for the users as they don’t have time to search out the factual figures for the information provided. It also can be understood as to make a match between numbers and descriptions with actual facts and figures. For making the financial statements faithful, the quoted information must be neutral, complete and free of materialistic error. Here neutrality means the company should select information unbiased. As to benefit one group of user, over the burden on another group of user would affect the neutrality aspect of the financial statements. Hence to ensure neutrality financial reports of the company must be credible and unbiased (Baskerville, 2015).
Representation on qualititative criteria as faithful representations and neutrality
The information mentioned in the financial statements can be considered as reliable only if it is neutral. Neutrality means unbiased with the users who are potentially affected by the financial statements. According to Australian accounting standard board it is not easy for the companies to ensure neutrality in their financial statements. Besides this, it might possible that the standards issued by the Australian accounting standard board, favors one group of companies on the burden of other companies.
Faithful representation can only be ensured if the information in the financial statements is verifiable and neutral. For ensuring faithful representation, management has to ensure some factors indicating completeness, less error prone and neutrality. The second indicator of faithful representation is effective internal control system mechanism. The internal control system increases the confidence of public in financial statements. Besides this the opinion of auditor also plays a considerable role in ensuring the faithful representation of financial statements.
Reference to representational faithfulness within conceptual frameworks
Both international accounting standard board and financial accounting standard board has worked together to develop a statement of framework, which is called as conceptual framework. The conceptual framework develops a foundation for setting the future of accounting standard. It fulfills the goals of board that all the principles and policies are consistently followed. Faithful representations are required to fulfill the requirement of timeliness and understandability (Epstein, & Jermakowicz, 2010). According to the Australian accounting standard board, faithful representation in financial reporting is required so to ensure the completeness, neutrality and free from error (Rich, Jones, Mowen, & Hansen, 2012). Here completeness means that all the stated information is complete in all manners. There is no relevant information which is missed. Neutrality according to Australian accounting standard board means that all the information must be free from biasness to make the financial statement credible. It is required by the standard setters to make the public or general investors sure that all the mentioned information is credible and unbiased (Deloitte, 2013).
Historical cost accounting
Historical cost accounting is a measure to measure the assets and liabilities value. It is the method which helps the management in valuing the amount at which all the assets and liabilities are required to be quoted in the financial statements. Historical costs are known as original cost or nominal cost, this is the cost at which the asset or liability has been acquired by the company. This costing method was developed by GAAP (Generally Accepted Accounting Principle). According to this method, all the assets and liability has to be recorded at the amount on which the company has acquired them, which means that any changes in their respective market value would be ignored (Bakar and Said, 2007).
Financial statements which are prepared on historical cost accounting method, has certain limitations which are as follows:
In financial statements historical cost is preferred because accounting is done by keeping past events. Hence to bring consistency and comparability the accounting transactions are recorded in historical costs. Following are the key points which show the relevance of historical cost method in financial statements:
The alternatives of historical cost accounting are as: current cost, realizable value, present value, accrual basis, cash basis.
Measurement basis suggested by IASB and their impact on potential users
The measurement bases as referred by international accounting standard board are historical cost, fair value, and realizable value. Here potential users are existing and potential investors, lenders and other creditors for making decisions. There are different types of users of the financial statements. Every potential user has a different perspective regarding the valuation of assets and liabilities. For example potential investor would like to value the financial statements at their present value. While in case of lenders and creditors, they want to value the financial statements at realizable value. Hence it is said that every user has a different perspective regarding financial statements hence, financial statements cannot be made by following one accounting method as suggested by International accounting standard board (IFRS, 2012).
Fair value accounting and historical cost accounting are two methods that need to be adopted by the company, for valuing the assets and liabilities of the company. In fair value accounting the assets and liabilities are valued at their current price. While in historical cost method, the valuation is done on the basis of past prices. There is no method which can be said as more preferable to user. The reason behind this is, both the method provides some useful information in different contexts (Alexander, Britton, & Jorrison, 2007). If the management would be considering only one accounting method, it might be possible that financial statements start giving misleading results. Both fair value accounting method and historical costing method levies some risk. Besides this, different users have different perspective regarding the valuation methods adopted. Like in case of risky company it is preferable by the user to follow fair value accounting method in the company financial statements. While in case of stabilized company which has stable earning, the user has preferred historical cost method to be followed in the financial statements (ICAEW, 2011).
Conclusion
By analyzing the essay over accounting cost theories it is said that, choosing one accounting method is very complicated task for the management. The reason behind this is, each and every method of valuation of assets and liabilities in the financial statements has its advantages as well as disadvantages. If the organisation opts for historical cost method due to its simplicity, fair value method considers this as obsolete method. According to international accounting standard board, that accounting method should be adopted by the organization which provides best quality of its financial statements in terms of liquidity. In case of financial statements showing true and accurate picture, international accounting standard board has recommended for the use of fair value accounting method. Even if the organization has adopted for historical cost accounting, the company must use fair value accounting in showing some of the transaction in its disclosures. This is required to show the exact picture of the company in market for example in calculating ratios like market price per share, price earnings ratio etc. hence it is concluded that there is no specific method that can be referred to be followed by the company, while it is suggested that method should be opted depending upon the risk factors of the company and its potential users.
References
Alexander, D,. Britton, A & Jorrison, A,. (2007) International financial reporting and analysis, Cengage learning, London
Bakar, N, B, A and Said, J, M,. (2007) Historical cost versus current cost accounting. Retrieved on 15th March, 2017 from https://www.mia.org.my/at/at/200701/06.pdf
Baskerville, P,. (2015) Quora, What are the advantages of the historical cost model in accounting. Retrieved on 15th March, 2017 from https://www.quora.com/What-are-the-advantages-of-the-historical-cost-model-in-accounting
Bernstein, A,. (n.d.) Cost basis reporting overview. Retrieved on 15th March, 2017 from https://www.abglobal.com/cmsobjectabd/pdf/taxguides/cbr_webcontent.pdf
Brown, G,. (n.d.) eHow, The disadvantages of historical cost accounting. Retrieved on 15th March, 2017 from https://www.ehow.com/info_12022810_disadvantages-historical-cost-accounting.html
Deloitte,. (2013) Conceptual framework-measurements and elements of financial statements (IASB only). Retrieved on 15th March, 2017 from https://www.iasplus.com/en/meeting-notes/iasb/2013/march/cf
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