Faithful representation as per conceptual framework of the QC 12, Chapter 3 of AASB, for the financial reports reveals the economic position of any organization in numerical terms. The data to be relevant, the data involved in the financial report shall be included in faithful and relevant manner. The financial report must be free from error, complete and neutral from all aspects. The criteria shall me met with regard to the factor of perfection. The aim of the board of directors of any organization is to present the statement keeping in mind all these factors as far as achievable (Henderson et al., 2015).
Faithful representation is the neutral presentation states that the statement and data is free from any type of unfairness while presenting the statement. The fair presentation is free from manipulation and not slanted or emphasised. Faithful representation is achieved when the description is complete and assure about the validity of underlying transaction, circumstances and events (Burca, Mates & Puscas, 2015). A single phenomenon of accounting can be represented in various ways. The neutral representation states that the statement is free from bias that is intended to achieve a pre-established outcome or to persuade a significant behaviour. The financial data plays major role in forming the view of the users. They make their decisions based on the accuracy and fairness of the report and the financial report shall be true to protect the rights of the debtor, creditors and stakeholders and to maintain the business with good sense (Tan?Kantor, Abbott & Jubb, 2017). The fact of neutrality is a major objective to align the standards with the standard of AASB. It assures that reliability factor and relevance factor has been taken into consideration while the standards have been formulated and implemented. The financial report will not be considered as neutral if the information included in the financial statement is influenced by the decision or judgement of any interested person.
The setters for the standards desire to maintain the faithfulness and neutrality while preparing the financial statement due to the below mentioned reasons:
Primarily, it is maintained for preventing the favouring of any person. When the financial statements are prepared, it shall be free from any judgement or decision given by any interested person. For instance, as the shareholders of any organization are interested in the earning of the organization, the financial report must not be presented in a way to show the information more profitable that will influence the shareholders.
Secondly, it is maintained for achieving the Independent standard. The accountants while preparing the financial reports are expected to prepare it with regard to the practices and standards that are not influenced by any unfair means to present it ethically and accurately. The accountant further must take into account the AASB standards for preparing financial statements (Barth, 2015).
If the accountant who is preparing the financial reports has have strong willpower to maintain the neutrality then only the neutrality objective is attainable. The projection of cash flow is very crucial for the creditors, lenders and the stakeholders. This projection does not depend on the reliability factor only rather it involves the assumption and estimation of the accountant himself. However, it is a crucial fact to present the statements in a relevant and neutral way, so that the reports can be useful to the users whose decisions are affected by the financial statement representation. High level of standards must be taken into account as the allocation of capital and economical functions are highly dependent on the information included in the financial reports (Cohen et al., 2017).
In certain situations, maintaining the neutrality factor is a tough job, for example, if the preparer of the reports prepare it taking into consideration two or more sets of accounting standards, he may face difficulty in explaining the correctness of the data included in both the sets as there is a chance that that the financial arrangement, amount of cash flow and the profit from operation may vary significantly and there may be queries regarding the performance and profitability of the organization (da Silva, Rezende & Braunbeck, 2016).
It is concluded from the above facts that the fact of neutrality is associated with the accountant’s individuality. Owing to this factor, the accountants are counted as traditional, practical, pessimistic and careful. An accountant can prove himself as neutral through proper projection of obligations, expenses and profits. The loss shall be reflected at the maximum projected value and the profit must be reflected at the minimum projected value.
Historical cost values the assets included in the financial statement based on the nominal cost of the asset that was charged at the time of purchasing. It differentiates the asset’s actual value cost from its adjusted value, replacement value or present cost. The primary objective of historical cost is to report the asset at the value at which it was purchased inclusive of the cost incurred to prepare the asset to be used for the intended purpose of purchase. The historical cost of an asset can easily be identified through analysing the accounting and purchasing records of the particular asset. The historical cost of the assets are adjusted or updated over the time of use to align with the accounting standards (Collier, 2015).
Various weaknesses that are associated with the historical cost method are:
The main objective of publication and preparation of financial statement is control that is, to provide the information regarding the progress of the organization to ensure the stakeholders that the company has achieve its target and the management of the organization is utilizing the available resources of the company in efficient way. In the balance sheet in which the assets and the liabilities are recorded as per the historical cost, it fails to take into consideration various intangible assets like knowledge and skill of the staffs. Moreover, historical method of costing reveal the acquisition cost of the asset and does not state the present value of the assets. Therefore, it fails to deliver the actual success of the organization to the investors.
Secondly, the weakness associated is the consumption. As per the industrial evidence, dividends are paid based on the profit that is reported, however the maintenance of capital that is based on the historical method of cost is regarded to be risky, while the amount is measured for paying out through taxation or dividend. The decisions regarding the allocation must be made based on the requirement of consumption and the expected future opportunities for investments (Deegan, 2013).
Another weakness is taxation. As the charge for taxation of the organization is based on the accounting profit, the historical method of costing is not regarded as an appropriate method for measuring the tax obligation of any company. Historical cost method for calculation of tax charge during the period of price rising, the part of increase in the wealth of the company that is considered for taxation purpose may be higher as compared to the applied nominal tax rate (Drury, 2013).
Finally, another crucial weakness is the valuation. Knowing the organization’s historical value for the assets is not regarded as helpful while measuring the value of share and assets of an organization. Therefore, it is suggested to apply the current value approach for the valuation of the organization.
Though the historical method of costing is considered as a controversial approach, it has some advantages too, they are:
The advantage of historical cost method is objectivity. It is an objective system predominantly, as it accounts the cost at which the asset was value d at the time of purchasing it. Under this method the chances of manipulation of data is zero and the data is evidenced by the supporting documents like voucher receipt, invoice and counterfoil of cheque. Any other approach foe accounting the transaction will be of less objective as amounted is recorded based on the different views of the various people (Ginzburg, 2013).
Secondly, the historical method is cheaper and easier. As compared to other methods, this method is cheaper and easier for valuation. Further, the original cost of the asset cannot be altered, thus it is easy and simple to identify the cost. Moreover, the cost is easily verifiable as it is beyond the dispute.
Further, the advantage associated with this method is reliability. Reliability is a crucial factor for reporting the financial status by any organization. As the historical cost is the past value of the asset, it can be determined more reliably as compared to any other method of valuation and assure that the user will not be benefitted that is excess than actual (Jackson, Finn & Scheepers, 2014).
Various alternatives are there against the historical method. The 1st alternative is Replacement cost. This cost basis is used to replace the asset of any organization at equal or same value and the asset for replacement can be liens, investment securities, accounts receivable and building. Replacement cost can be altered base on the alterations in the market value and any other cost involved with the asset to prepare it for intended use. For instance, the depreciation expenses are allocated over the useful life of the asset (Liang & Riedl, 2013).
Another alternative is the Current cost approach. Under this approach, the alterations in the value of the asset are identified due to the alterations in the normal price level. This approach involves the procedure of interpreting and preparing the financial reports through significantly considering the alterations in price (Saunders & Cornett, 2014).
It can be concluded that though the historical method of costing have various disadvantages, it has some advantage too as the measurement of costing is simple and easy through accessing the original cost of the asset. Further, some costs like replacement cost and current cost can be used as an alternative to current cost approach.
As per the conceptual framework regarding the General purpose for financial reporting is a way of communicating the information regarding the financial information of the reporting organization that is reliable and relevant for the users. The information included in the reports is intended for the specific users like lenders, investors, debtors and creditors. The reporting organization has the control on the resources and manipulates the users through delivering the services and goods, charging prices, taxes and rates and investing the resources. The accountant while preparing the reports must assure that the external as well as internal users do not have any control on the information included in the reports and they are solely dependent on the reports provided by the organization (Picker et al., 2016). To prepare the statement with reliability it shall not be prepared by taking into consideration the view of the users of the financial reports like the investors or potential investors, creditors, lenders of finance or other users like competitors, employees, general public or government.
The financial statements are useful to the external as well as internal users in the following ways:
The stakeholders or investors analyse the return and risk factor of their invested amount through assessing the financial reports and take their investment related decisions on the basis of the evaluation. Moreover, the potential investors uses the reports to measure the viability of the organization and the risks involved with the financial viability of the organization are also assessed through the financial reports (Christensen & Nikolaev, 2013).
The creditors evaluate the credit worthiness of the organization and decide about whether it is viable to offer goods in credit or not. They assess the financial position to be sure of about payment of their dues. The credit terms are also fixed based on the financial viability of the organization (Nobes, 2014).
The lenders of finance like banks or financial institutions after assessing the financial statements of the organization take decision regarding whether to lend money to the business or not. They analyse the financial performance to get an idea about the chances of payment failure. The decision of lending are taken based on the liquidity position of the company and the asset base.
Apart from the above mentioned users, the financial information are also useful for the competitors, employees, governments and general public. These users go through the financial reports and assess the financial performance of the company to compare the performance of the company with the competitors, accurateness of declared tax and the economic environment of the organization (Sutton, Cordery & Zijl, 2015).
The fair value of any asset is the amount that is expected to be received after selling the asset or fulfilling the obligation. The fair value is measured on the basis of the market value. Through the fair value approach, the organizations analyse the worth of liabilities or assets based on the projected or actual fair value of the market. Alterations in the value of assets or liabilities over time create un realized losses or gains for the outstanding assets or liabilities which in turn, reduce or increase the equity as well as the net income of the organization (Henderson et al., 2015).
On the other hand, the historical value requires recording the liabilities or assets at their original cost or cost of acquiring the asset. It does not take into consideration the alteration in the values of liabilities and assets over the time. This approach is crucial as there is a frequent change in the market value that makes the accounting data, impair assessment and accounting unreliable. However, the historical method is not suitable for all kinds of valuation as in some instances, to assess the fair value of asset, it is important to use any method other than the historical method (Macve 2015).
It is concluded from the above discussion that there are various controversies regarding the selection of methods that which method will be appropriate among the historical method or the fair value method. As per the GAAP the historical method is preferred whereas the liabilities and assets of the organization are valued on the market value or cost, whichever lower. For some accountants, the historical method is preferred as the fluctuation in the market value are not required to be assessed regularly, while for others, the fair value method is preferred as it reveal the true value of the asset on a particular date.
References:
Barth, M. E. (2015). Financial accounting research, practice, and financial accountability. Abacus, 51(4), 499-510.
Burca, V., Mates, D., & Puscas, A. (2015). Standard-Setters Versus Big4 Opinion, Concerning Iasb Revision Project of the Conceptual Framework for Financial Reporting. the Case of Presentation and Disclosures Chapter. Studia Universitatis „Vasile Goldis” Arad–Economics Series, 25(2), 81-107.
Cohen, S., Cohen, S., Karatzimas, S., & Karatzimas, S. (2017). Accounting information quality and decision-usefulness of governmental financial reporting: Moving from cash to modified cash. Meditari Accountancy Research, 25(1), 95-113.
da Silva, J. M., Rezende, A. J., & Braunbeck, G. O. (2016). Judgment of the Relevance of Fair Value in Biological Assets: A Experimental Analysis on the Market Perception Versus the Academic Perception.
Henderson, S., Peirson, G., Herbohn, K., & Howieson, B. (2015). Issues in financial accounting. Pearson Higher Education AU.
Tan?Kantor, A., Abbott, M., & Jubb, C. (2017). Accounting Choice and Theory in Crisis: The Case of the Victorian Desalination Plant. Australian Accounting Review.
Christensen, H. B., & Nikolaev, V. V. (2013). Does fair value accounting for non-financial assets pass the market test?. Review of Accounting Studies, 18(3), 734-775.
Henderson, S., Peirson, G., Herbohn, K., & Howieson, B. (2015). Issues in financial accounting. Pearson Higher Education AU.
Macve, R. (2015). A Conceptual Framework for Financial Accounting and Reporting: Vision, Tool, Or Threat?. Routledge.
Nobes, C. (2014). International Classification of Financial Reporting 3e. Routledge.
Picker, R., Clark, K., Dunn, J., Kolitz, D., Livne, G., Loftus, J., & van der Tas, L. (2016). Applying international financial reporting standards. John Wiley & Sons.
Sutton, D. B., Cordery, C. J., & Zijl, T. (2015). The purpose of financial reporting: The case for coherence in the conceptual framework and standards. Abacus, 51(1), 116-141.
Collier, P. M. (2015). Accounting for managers: Interpreting accounting information for decision making. John Wiley & Sons.
Deegan, C. (2013). Financial accounting theory. McGraw-Hill Education Australia.
DRURY, C. M. (2013). Management and cost accounting. Springer.
Ginzburg, C. (2013). Clues, myths, and the historical method. JHU Press.
Jackson, S., Finn, M., & Scheepers, K. (2014). The use of replacement cost method to assess and manage the impacts of water resource development on Australian indigenous customary economies. Journal of environmental management, 135, 100-109.
Liang, L., & Riedl, E. J. (2013). The effect of fair value versus historical cost reporting model on analyst forecast accuracy. The Accounting Review, 89(3), 1151-1177.
Saunders, A., & Cornett, M. M. (2014). Financial institutions management. McGraw-Hill Education,.
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