Different Valuation Methods for Financial Reporting - Coursework Example

DIFFERENT VALUATION METHODS FOR FINANCIAL REPORTING (Student Name) (Course No.) (Lecturer) (University) (Date) INTRODUCTION Financial Reporting counts as an important part of the accounting practice. It usually involves detailing the financial information in a more understandable manner for the interested users of such financial information. Every organization engages in either formal or information financial reporting system so as to make the financial procedures and activities more comprehensible to the users. In the modern days, several companies and business have come up with better ways to improve their financial reporting standards through adopting a number of valuation techniques. There are several theories and techniques which have been advanced in the financial world which have been beneficial in promoting better means of performing financial reporting. Scholars are however divided on which is the most suitable for all the valuation methods since they demonstrate varying levels of preferences to such standards. In essence, the need to improve and to bring much efficiency in the financial reporting standards has been the basic reason behind the promotion of several valuation techniques. This study seeks to focus on the reason for the existence of various valuation methods in the process of performing financial reporting. Some of the contemporary valuation methods which the study intends to review include Historical cost techniques, current cost techniques, fair value and market value techniques as well as deprival value method. The study will review these techniques through performing analysis of other scholars’ views on the various valuation techniques. The essay intends to attempt to determine why the financial reporters tend to have a multiple of varied valuation techniques to enable them to come up with the right reporting standards. The need for valuation of assets in the financial reports There are some valuation techniques which have been promoted so as to enable the accountant's report on the values of these assets at various dates. The essential reason behind the valuation of different assets in the statements is to enable the users of this information to understand the actual position of the business or the organization. The process of valuation is conducted so as to report on the worth of a particular assets or resource of the business (Chambers 1965). The information is taken among other components of the financial statements to report on the position of the business at a particular date. This has become an acceptable principle in finance since the users of the financial statements requires timely information and actual data on the exact worth of their undertakings or business. The various valuation methods The evolution and development of the financial reporting have seen the introduction and development of some valuation techniques. In the modern corporate world, various players such as business entities have adopted the use of a particular method to enable them to come up or ascertain the actual or reporting values of the property within the business (Watts 2003). Despite the presence of mixed preference for particular valuation techniques, the management or the financial players within this business normally merit the best method and further apply that in the process. The following is a review of some of the most common valuation techniques; A. HISTORICAL COSTS The historical cost relates to the prevailing cost at the time of the transaction. It is the cost which existed when the asset was acquired or when a transaction was completed. It’s also called the yesterday’s cost because it relates to the previous costs existed when the business entered into a transaction. In the final reporting system, it denotes the cost at which the assets are presented on the balance sheet being the value at which they were purchased by the business (McNeil et al. .2015). In other instances, this value is called the purchase cost because it’s the original cost at which the business transactions or the assets were purchased by the company. The historical costs pertain to both the assets purchased and the liabilities incurred. According to the existing Generally Accepted Accounting Principles (GAAP), the historical cost system reports on the assets at the balance sheet value when they were purchased. Besides, it represents the liabilities at the balance sheet value when they were incurred by the business. Therefore, the reporting date may be futuristic in nature, but the balance sheet dates may be historical represented transactions entered into yesterday by the business. Many scholars argue that this cost represents the true and fair value of the assets since it’s not affected by the current or present dynamics within the business or financial activities. Users of the financial information would be interested in receiving reports on the actual costs at which the assets or the liabilities were incurred so as to be able to perform comparisons and analysis (Chambers 1965). For example, several financial reviewers tend to prefer the reporting to be made on the previous or actual cost that prevailed when the activity was entered into by the business. This helps to compute the patterns of change and also analyze the existing trends within the organization. There has been a different school of thought castigating the relevance and the efficiency of historical cost method as a technique of valuation. The concern primarily concerns the need to factor in the current aspects which occur within the business world. Historical cost method is usually based on the past records and activities of the business. The costs which are reported in the statements relate to the original or past costs. However, this method has been open to any form of adjustments on the assets and liabilities such as depreciation and impairments. Despite this, it’s taken as non-cognizant of the changes which occur within the present business or financial world. Therefore, it has been perceived as devoid of relevance and accuracy. The users of the financial statements usually require having updated and current information on the assets and the liabilities of the business. In fact, several changes have commenced in the standard setting processes to seek to promote the reporting of assets and liabilities at their fair value as opposed to their historical value (Francis et al. 2005). Many businesses which subscribe to the use of this technique believe in the need to feature the assets and liabilities at their historical costs so as to present the actual values devoid of any current adjustment. For example, they believe that an asset which cost $10,000 ion 2016 ought to be reported at that amount so as to ascertain the exact value this year. However, this analogy is challenge by various scholars and users of financial information who believe that it’s right to factor in changes in the economy and business that influence the costs. Most of these scholars tend to argue that the historical cost estimation method lacks a sense of accuracy since it is based on past information. In this regard, it tends to leave out some of the vital information about the current development in the industry and the business. This, therefore, makes it an undesirable method in the valuation method (Hirst & Hopkins 1998). The cost principle or even the historical cost principle states that all assets and liabilities need to be reported on their original cost and all cost associated with getting the assets need to be included. This principle has buoyed the notion presented by many scholars who argue for the adoption of the use of historical cost method in the presentation of the financial statements. There is another valuation method which came up to seek to solve some of the shortcomings of this method. Some of the weaknesses identified include the need to inculcate some of the present activities within the economic and financial environment, need for relevance and also the need to report basing on the improvements done to the financial principles (Baxter 2003). The balance sheet reporting values are essential since they help in coming up with the financial position of the company or business as at any period. The developments have seen the introduction of other alternatives which are also used in the reporting of financial information. B. CURRENT COST The current cost relates to the cost that would be incurred to replace any asset in the current or present period. Every asset has a carrying cost or the historical cost at the time of purchase. However, there are several adjustments, risk instruments and management strategies which have the potential of rendering the historical costs obsolete. This causes a variation in the possible cost of replacing the asset and the cost at which it was purchased. In essence, there are a lot of adjustments which normally befall any asset at a particular date as compared to the time of purchase. Current cost method, therefore, factors in such adjustments and reports on the value of the assets and liabilities after taking care of all the necessary current adjustments (Raffournier 1995). The cost that an asset attracts today may be different from its purchase cost sometimes before the adjustments usually result from a current cost technique which makes the necessary adjustments so as to ascertain the true and actual value after all considerations have been made. Proponents of this valuation technique argue that it’s the best solution towards determining cost accuracy in the financial position. The balance sheet will make reports based on the calculated values after factoring in the dynamics and changes in the economy. In many cases, the current cost technique tends to rely on the information provided by other economic agencies which show the price dynamics in the market. However, much is calculated internally taking consideration of some of the activities which have occurred in the business (Hung & Subramanyam 2007). This has impacted negatively in much business which normally deals with the sale of assets, especially on a timely lane. Many investors, users of financial information and buyers have contested the use of other valuation methods based on their accuracy. They certainly believe that the correct and most accurate values are those which reflect the purchase price, plus or minus some of the changes or activities that have occurred from that date of purchase to the reporting date. Other antagonists to this technique have also contested on the need to adopt and use this method due to its inconsistency in valuing the industry and economic trends. For example, many argue that that the use of this method requires a lot of subjectivity since it’s difficult to ascertain some of the monetary effects on the financial activities. Therefore, the values which are adjusted and appear on the balance sheet as the current values are highly subjective and accurate as argued by the proponents (Damodaran 2012). The arguments about the accuracy rationale of the historical and current cost techniques have remained a herculean task which has seen the FASB seek to start making amendments on the historical method. There are proposals to carry out several changes to the historical method to make it include and integrate some of the modern aspects of the valuation process (Ball 2006). This includes adopting some concepts such as adjustments that are done under the current cost initiative. C. MARKET VALUE AND FAIR VALUE The market value denotes the price which an asset would attract when presented to the marketplace. It’s always the amount of money which would be associated with an asset when presented to the mark. Usually, it’s a term used by the publicly traded companies to denote the market capitalization cost. The problem, however, is to capitalize the illiquid assets such as the businesses or the real assets. In many cases, the market value may not be the actual purchase value. An asset may have a higher market value, but the buyer pays considerably less after some procedures such as negotiation with the seller of the particular asset (Ijiri &Jaedicke 1966). The market value technique, therefore, requires that transactions and assets are reported on the value at which they attract when presented in the market. Usually, the market dynamics have the abilities to set prices for certain property. The knowledge freely existing within such a market is that asset caries a particular value and therefore underestimating or overestimating would attract further investigations. Users of the financial statements such as the investors are usually keen in following the market value of various assets. For example, some of the assets which feature within the listing of assets are normally reported at their market values. These are the values which are known, mastered and prevail within the market. Proponents of this technique adopt the values in their statements based on what the market reads. For example, the value attaches to a particular real estate would be dependent on the established market value for such a property (Van Horne & Wachowicz 2008). The buyers would be interested in determining what the market reads as the value for such an asset and further seek to sell at such a value. On the other hand, the Fair Value denotes the sale price which is usually a product f agreement between the willing buyer of the product and willing seller being the owner. In the case of companies, it denotes the value of the subsidiary when the parent company consolidates its assets and liabilities. In many cases, this is the value agreed to assume the transaction has been done freely between the parties involved (Ijiri &Jaedicke 1966). One fundamental feature of the fair value is that in is subject to an agreement by the parties involved. It’s usually not set out and therefore the willing buyer, and the willing seller meets, agree on it and the final value attached is the value at which it was purchased. In many cases, the fair values are seen as slightly below the market value since it’s a product of negotiation between two parties willing to transact. The reporting values which are taken into the financial statements are the agreed to values after the buyer, and the seller agrees on the most suitable cost of the items. The proponents of this method of valuation agree that not every item is brought into the company at the market value. Therefore, they agree that some of the assets are products of a negotiated agreement between the seller and the buyer. In this case, the amount spent may be lower than the actual cost associated with purchasing such an item. Investors would be highly interested in the actual expenditure or associated costs pertaining o some of the property of the business (Andriessen 2004). Therefore, they usually insist in the accuracy of the values reported on these financial statements and not on the applicvati0on of theoretical concept which varies from the actual truth. D. DEPRIVAL VALUE The concept of deprival value has been deemed as an alternative to several contemporary valuation methods used in financial reporting. The concept usually tends to determine the kind of loss which a business would suffer in case its ‘deprived’ of such an asset. It, therefore, represents the degree to which a business gains or is better off holding a particular asset. It also denotes the relief value when a business suffers from a certain degree of liabilities. Every business has got certain kind of the extent of an asset that it values much. In much business, equally, have certain liabilities which they deem as of sufficient relief when they incur (Sterling & Radosevich 1969). The technique of performing this cost valuation tends to build on the value to the firm brought by a owning some asset or relief from incurring some liabilities. It has therefore been argued as absolute alternatives to some of the existing valuation methods in the financial reporting. The basis of building upon the deprival value regards the knowledge that every business or firm would suffer a certain loss when deprived of a particular asset. It’s therefore assumed as the replacement cost since the owner will use the value to replace the loss suffered from deprival of such property owned. The proponents of this methodology assert that it’s beneficial since its focuses on the particular benefits associated with the business property and not necessarily on the costs attached (Patton 1987). For example, they argue that every property or asset have a different value to a business despite its cost of acquisition. The value can only be manifested when the property is taken out of the business. In this case, the proponents argue that this should be taken as the actual value and used in the financial statements (Baxter 2003). Several critics to this valuation technique have argued that it is highly subjective and prone to changing values. They argue that it’s difficult to estimate loss or benefit since all these are subjective phenomena without much of quantitative values. According to many financial users, the proposed value of the loss from depriving a business of an asset depends much on what’s perceived and not what can be proved and measured (Ball 2006). Therefore, several critics argue that deprival value method is not ideal for estimating the value of assets and liabilities for any business. A lot of emphases has been put n the need to assign quantitative attributes to the values of the assets and liabilities so as to accurately describe them in the financial statements. This has been one of the ways through which the historical and the fair market value techniques have been used and developed by various businesses. Conclusion The presentation of information in the financial statements usually requires the use of a specific valuation technique. The valuation method is required to aid in presenting the values of various assets and liabilities within the financial statements. The users to the financial information normally keen at identifying what the financial position as reported in the statements clearly reflect. This explains why businesses have adopted the use of varied valuation techniques to seek to come up with the best values for various assets and liabilities. In many cases, there has been an increase in the use of alternative valuation methods due to the weaknesses and criticisms existing in the reporting of the information. Arguments have been intense on the most appropriate and desirable of all the valuation method. This review, therefore, sought to identify the views of scholars regarding these valuation techniques and described the different and contrasting information about the various valuation methods. References Andriessen, D. (2004). Making sense of intellectual capital: designing a method for the valuation of intangibles. Routledge. Ball, R. (2006). International Financial Reporting Standards (IFRS): pros and cons for investors. Accounting and business research, 36(sup1), 5-27. Baxter, W. (2003) The Case for Deprival Value, Institute of Chartered Accountants of Scotland. 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