Accounting practices - Essay Example

Analysis: Accounting Practices Ans Some of the issues plaguing the Profession The paper discusses accounting for business combinations. It highlights the differences between 'Pooling method' and 'Purchase method'. The issues plaguing the profession are highlighted by the Exposure Draft (ED) issued by the Financial Accounting Standard Board. Main issues are: i. The existing accounting practices are found to be providing information that is less useful in determining 'firm value' compared to that provided by the 'Purchase Method'. ii. The 'Pooling Method', used at present, imposes added costs to the users and prepares of the financial statements.

The allocation of resources is also adversely affected, for want of credible information. iii. The 'Pooling Method' is said to be based on a flawed conceptual base. iv. Pooling creates an uneven playing field within the national and international economic systems (i.e. this system is not in sync with the global accounting methods). v. Pooling method is not able to evaluate the current and subsequent performance of the investment, which is necessary for holding the management accountable for investments in business combinations. vi. Researchers have also found that the pooling method is prone to abuses.

Despite the original intent of mutual exchange of risks and benefits, it appeared that the primary motivation for the use of pooling was positive income effects and avoidance of recording of goodwill in the books. vii. Earnings and valuations computed under the two methods also differ. The Purchase Method restates acquired assets at their current values and expenses them at the revalued amounts. Pooling, in contrast, records and expenses assets at original costs. Such valuations play an important role at the time of mergers and acquisitions.

Basic objective of preparing financial reports is to provide credible information to investors, strategists and planners. Therefore the basic guiding concept in preparing financial reports should be 'whether financial statements enable decisions facilitating the achievement of certain goals.' To further strengthen its argument, the FASB study indicates that the accountability framework has to provide important insights and a strong basis for some key arguments in view of the inter-dependant nature of global business, which forms part of the information system.

This helps investors as well in making informed decisions. Ans. 2: Conflicts of Interest i. Williams (1987) elaborates that 'decision-usefulness' criterion is ends-oriented, and provides justification for accounting information that "facilitates" the achievement of desired goals. In contrast, accountability is means oriented and focuses on the obligations that arise and need to be recorded when transactions occur. Obligations are in the nature of "constraints" and create the potential for conflict between the persons involved.

The accountability-based framework warns that information should not be given to the concerned just because it is useful for him. It should flow from the accountor to the accountee only when such information is fair. ii. It is argued that research in the area has not adequately addressed the decision-usefulness issue in accounting for business combinations. Arguments are advanced that the regression analysis is desired for coming to conclusion. It is believed that operating cash flows, unlike earnings, are not affected by the accounting method.

Therefore, one school of thought advances the argument that operating cash flows may be more useful for mergers than accounting earnings because the factors affected by the accounting method used, namely, goodwill and asset values, do not affect the operating cash flows. iii. Vuong's Z test results indicate that overall the purchase method is superior to the pooling method using the "between-sample" approach; however, the evidence is limited in that the accounting accruals continue to provide information for decision making under both methods.

These results do not support the contention that cash flows are more useful than accounting earnings for pooling firms. iv. A key distinction between accountability and decision-usefulness is that accountability is means-focussed and decision-usefulness is ends or outcome-oriented. Some argue that pooling method provides information that is useful for accomplishing certain "public policy" goals. According to such proponents of pooling method, eliminating pooling would "impede desirable consolidation in certain industries, reduce the amount of capital flowing into those industries, slow the development of new technology and adversely affect entrepreneurial culture". v. There are conflicts between the goals of "public policy" perspective and those of investors and creditors.

Conflicts arose when the constituents have opposing goals that may require alternative accounting methodology.