Application of Various Accounting Theories - Essay Example

FINANCIAL ACCOUNTING Student’s Name Course Tutor Institution Date of Submission 1. ABC’s Interpretation and Recognition of Expenses The conceptual definition of expenses, as Weygandt (2005, 34) illustrated, is the losses or consumptions that are set in the future to benefit a firm by reducing the assets or increasing the entity’s liability that result in decreased equity in a reporting period. Enterprises engage in expenses in plans through which they seek to increase their capacity to meet certain productive demands or to increase their profitability within specified time-frames. This aspect is definitive of ABC’s interpretation of the term considering that they target to put up another factory to meet up the increasing demands. Ideally, their plan of increasing their liability for expansion within the illustrated five years illustrates that their interpretation of expenses qualifies for the conceptual definition of the term (Stickney 2010, 27). Besides, the recognition criteria for expenses also indicate that the ABC Company’s interpretation of expenses is ideal. The matching principle of the conceptual framework illustrates that expenses are recognized in the events that obligations are incurred and when they offset recognized revenues. In the sense, the company’s plan of dedicating $100,000 to the project for each of the five fiscal years will result into reduced benefits. Moreover, this loss of benefit can be quantified in monetary value, which is further proof that the company has met the recognition criteria for expenses. 2. ABC’s Dividend Shares as an Equity ABC’s plan with the released dividend shares is elaborate and lucid. In the instance, it plans to issue the 3% dividends and to back-pay for them within the two remaining years in the event that they do not prove as profitable to shareholders within the first year. Ideally, this aspect meets both the definition as well as the recognition criteria for liabilities. According to Porter and Norton (2009, 49), liabilities are the economic sacrifices that a company may make because of past transactions. To issue the shares than compensate the shareholders in the event that there is no profit meets this definition. Besides, considering that the company’s profitability may reduce in the future as it is investing in the expansion of its resources by putting another factory, it is likely that this mentioned sacrifice might be met. This, as Bragg (2013, 39) opined, is a measure that is used to recognize a liability. However, the second term for the issuance of the shareholders revert these projections and proves that these preference shares are equity to the company. Equity, according to Bragg (2013, 40), is the likely interest that the ABC Company may derive from the investment of the shares after the deduction of the liabilities. Notably, ABC demands that it will repurchase the dividend shares from the shareholders after the span of the three years at the original prices in which they issued them. When illustrating the same, Weygandt (2009, 20) elaborated that the economic value of shares appreciate, especially when a company’s financial position and performances are inclined to improve. Ideally, the investments that the company plans to make by putting up a new factory will improve its financial position and performance and is a factor that will lead to the increase of the value of the shares (Whittington & Delaney 2009, 96). To purchase the shares after three years at the same prices in which they were previously sold and a time in which they will have more value is profitable and can compensate for the sacrifices made in the previous years when they were not profitable. Ideally, this is the indication that the preference shares should be considered as equity (Weygandt 2005, 34). 3. IASB Fair Value Measurements: Principal Issues Summary Through the proposal, the IASB sought to improve the comparability and consistency for fair value measurements by implementing a measurement hierarchy that categorizes inputs into three levels (IASB 2015, 1). The first level defines the market’s active quoted prices for liabilities and assets within a measurement date. The second level is descriptive of the assets and liabilities that are not included in level 1 but that should be observed either directly or indirectly. Factors that are considered during the observation include credit spreads and implied volatilities. The third level defines the assets and liabilities that cannot be observed but that are used to measure fair value in a mechanism that makes the observable inputs unavailable. The proposal also restates that fair value measurement should be objectively created to help with the unbiased estimation of prices and the promotion of orderly transactions. To this effect, it issues a measurement guidance scheme through which it demands that the non-performance risks attached to the non-performance risks of the liabilities should be transferred on the measurements dates without cancellation or extinguishment. The other notable factor is the proposition that has been highlighted in the proposal that demands that the cost, market, and income approaches should be used as the techniques for the valuation of a measurement. To effectively address the subject of disclosure, the IASB also proposed that the objectives for a disclosure should be focused on the assessment of the value measurements of the unobservable inputs as well as the recurrence and non-recurrence basis of the liabilities fair value. However, there should not be a disclosure measured at a fair value and the assets whose fair value is a recoverable amount. Nonetheless, specific disclosures are required for: The non-recurring fair value of measurements The liabilities held at the measurement date Level 3 fair value measurements and the recurring values (IASB 2015, 1) Analysis The Conceptual Framework Preemption: The proposal, as Whittington and Delaney (2009, 29) explained, has preceded the significance of the measurement principles which should be a definitive part of the conceptual framework. In the instance, it only relates to the application of fair value as is required by the IFRS. Besides, it seeks to make changes in the application of the fair value by redefining its use. The IFRS definition reads as follows: “The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” (Whittington & Delaney 2009, 28) However, the proposal’s focus is on the valuation and disclosure principles that should guide a measurement (Weygandt 2009, 77; Fishman, Pratt & Morrison 2013, 162). That implies that the proposal should have expounded on the deliberations that should be derived from the definition. According to Flood (2015, 39) and Zyla (2013, 59), creating measures should be based on an understandable fulcrum, a factor that implies that the IASB should have expounded on the existing definition. Besides, the likely interpretation that the proposal has made for the definition of fair value is that that limits the fair value to price as opposed to being inclusive of amount. This is an interpretation that Stickney (2010, 51) also clarified to be only a consideration of fair value as an exit value as opposed to being an entry value as well. The Failure to Illustrate the Exit Value Choices The proposal does not justify its choice for an exit market. Bragg (2013, 85) opined that ideal markets should have a combination of exit and entry strategies. However, the proposal’s marking of fair value as the price that one gets for making a sale, a factor that Mard, Hitchner, and Hyden (2011, 34- 35) labeled as an exit strategy as well, does not meet the precepts outlined in definitive fair value models like the deprival value model. The IA definition for fair value is descriptive of a current market value. This definition is ideal, expansive, and accommodates the indications that are outlined in the deprival value model. Endeshaw (2013, 43) whose authorship the Auditing Fair Value Measurements and Disclosures lucidly elaborates the same, indicated that IA’s definition does not create market limitations as opposed to the IFRS definition that has been used by IASB. This projection is further supported by the UK Standard on Business Combinations that illustrates that fair value should also be definitive of replacement costs and recoverable amounts (Weygandt 2009, 80; Mard, Hitchner & Hyden 2011, 73)). However, the proposal’s preference for the exit values is based on the projection that exit values are futuristic and can stabilize the future cash flows as opposed to the deprival value model. Zyla (2013, 142) gave an illustration of an instance in which financial tools may be retained for sale. Nonetheless, consideration should have been given to the indication that was made by Flood (2015, 39), that entry strategies and values should not be ignored as they are may be more useful. For instance, owning fixed assets increases cash flow, as there are no constant purchases (Whittington & Delaney 2009, 29). Transaction Costs Considering that the proposal values the IFRS definition for fair value that only regards price as opposed to amount, it does not meet the measurement valuations that include transaction costs (Whittington & Delaney 2009, 60). Besides, this also spites the IASB’s projection in the IAS41 which demand that fair value should be consistent with the transaction costs. According to Endeshaw (2013, 71), the IAS41 states that fair value is based on lesser trading costs. Ideally, the transaction costs should have been addressed as part of the disclosure objectives as every transacting party should be acutely aware of the total costs to which they may be subjected. Flood (2015, 14) opined that even the prices defined in a fair value measurement should include all the expenditures. Notably, the actual cash flow that can be derived from an asset is defined in the collective value of the entry values and other realizable amounts like the acquisition costs (Zyla 2013, 96). The Valuation of the Portfolios of the both the Financial Liabilities and Assets IFRS 13 requires that fair value should get determined at the level of the unit of account. According to Bragg (2013, 72), this is one of the factors that have been adequately addressed in the proposal as a fair value measurement precept. That is because it takes into consideration factors like individual assets and liabilities which, as Weygandt (2005, 95) also supported, can be different from that of a portfolio. According to Whittington and Delaney (2009, 40), in the event that a portfolio includes items that have high market risks, then the portfolio’s fair value would be impacted without any effect on the individual assets’ fair value. This defined difference in the proposal is a factor that would help the transacting parties to evade the market risks (Fishman, Pratt & Morrison 2013, 45). However, despite its shortfalls, the proposal also has positive attributes that define how its use would be of significance (Fishman, Pratt & Morrison 2013, 162). For instance, it proposes a trident approach to evaluating fair value; the market, income, and cost approaches (Endeshaw 2013, 72). Through the market approach, it indicates that information pertaining prices and the value of goods in the mentioned prices should be considered, valuated, and compared to others (Fishman, Pratt & Morrison 2013, 63). The cost approach, on the other hand, stipulates that the replacement cost for an asset should be considered while the income approach should be targeted at creating a mold that satisfies the future income expectations of the enterprise (Bragg 2013, 85). Albeit the fact that these are not acutely defined as in the deprival value model that further equates an asset’s value to the loss that would be incurred in the event that the asset was lost, they encompass some of the same aspects that have been illustrated by the IA and the UK Standard for Business Combinations. That is because they consider the market value and the replacements involved in measurements (Bragg 2013, 88; Endeshaw 2013, 43). Besides, the proposal has issued an elaborate guidance on measurements (Weygandt 2009, 76). For instance, it requires that participants in a transaction should consider an asset’s condition before making the transaction and that the best and highest use of an asset should be considered as well (Whittington & Delaney 2009, 60). Besides, it stipulates that an optional exception should be applied for the financial assets and liabilities to avoid market and counterparty risks (Whittington & Delaney 2009, 28). These measures would ensure that all transactions meet their fair value, as there would be no losses or dupes. Recommendations In the instance, the IASB should consider improving the proposal’s aptitude (Endeshaw 2013, 42; Fishman, Pratt & Morrison 2013, 63). This would require that they integrate the concepts and interpretations that have been projected in other theories and organizational precepts. For instance, the IA and the UK Standard should consider the propositions that have been made for Business Combinations (Flood 2015, 14). This would ensure that the definitions and interpretations that are intended for the strengthening of the measurement of fair value in the proposal are broadened to cover other vital aspects (Mard, Hitchner & Hyden 2011, 90). For instance, the trident valuation approach that covers the market, income, and cost approaches should cover the recoverable amounts. This would help the transacting parties to comprehend fully the security that is offered in the fair value (Mard, Hitchner & Hyden 2011, 73). Besides, the disclosure involved in the measurement should address all other realizable amounts inclusive of the transaction costs (Porter & Norton 2009, 73). That is because that would create a podium on which the transacting parties can wholly comprehend the details of the transactions and the actual valuation of the fair value measurement. This would further eliminate the projection that the proposal’s definition of fair value focuses on price rather than amount. That is because inclusion of transaction costs would make the trajectory of the execution of the fair value measurement more elaborate and comprehensive (Mard, Hitchner & Hyden 2011, 90). Lastly, the proposal should enhance its projection that facilitates the differences between portfolios and individual assets. Endeshaw (2013, 56) and Flood (2015, 51) collectively opined that the IFRS 9 and the IAS 39 addressed this factor in a way that is better to compared to the proposition that has been indicated in the IFRS 13. The reports outlined that the mid-market prices should be used to value individual assets in marketing risks (Porter & Norton 2009, 72). Ideally, this increased the level of clarity in the measurements, as the transacting parties would be well aware of the measures that they would have to adhere to. Besides, there should be an exception that defines the approach that should be used in handling the portfolio, especially based on price (Fishman, Pratt & Morrison 2013, 45; Bragg 2013, 72). References WEYGANDT, J. J. (2005). Hospitality financial accounting. Hoboken (N.J.), J. Wiley. STICKNEY, C. P. (2010). Financial accounting: an introduction to concepts, methods, and uses. Mason, OH, South-Western/Cengage Learning. PORTER, G. A., & NORTON, C. L. (2009). Financial accounting: the impact on decision makers. Mason, OH, South-Western Cengage Learning. BRAGG, S. M. (2013). Wiley revenue recognition rules and scenarios. Hoboken, N.J., Wiley. WEYGANDT, J. J. (2009). Financial accounting. Hoboken, N.J., Wiley. WHITTINGTON, R., & DELANEY, P. R. (2009). Wiley CPA exam review 2009. Hoboken, NJ, John Wiley & Sons, Inc. ZYLA, M. L. (2013). Fair value measurement: practical guidance and implementation. Hoboken, N.J., Wiley. MARD, M. J., HITCHNER, J. R., & HYDEN, S. D. (2011). Valuation for financial reporting: fair value, business combinations, intangible assets, goodwill, and impairment analysis. Hoboken, NJ, Wiley. FLOOD, J. M. (2015). Wiley GAAP 2015 interpretation and application of generally accepted accounting principles. Chichester, U.K., Wiley. ENDESHAW, K. A. (2013). Auditing Fair Value Measurements and Disclosures. Saarbrücken, LAP LAMBERT Academic Publishing. FISHMAN, J. E., PRATT, S. P., & MORRISON, W. J. (2013). Standards of value: theory and applications. IASB (2015). IFRS Fair Value Measurement. http://www.iasplus.com/en/standards/ifrs/ifrs13 Read More