Accounting: Prudence Concept

Fair value measurement has been argued to be one of the most controversial areas in accounting. Although not a new concept many accounting professionals have only in the past two decades warmed up to the theory as a means of replacing the long standing historical cost approach applied to reporting of financial statement. This deviates from centuries of traditional application of historical cost. It is maintained in literature that fair value accounting

For example, the business entity means that commercial expenses are kept separate from personal expenses and the monetary unit is generally the U.S. dollar. Next, there are four basic principles that cover historic costs, revenue recognition, matching and full disclosure. For instance, the historical cost principle mandates that companies report their asset and liability acquisition costs instead of reporting the fair market value. On the other hand, the revenue recognition principle states that companies must only record earned revenue, not received revenue. This forms the basis of accrual basis accounting. Finally, there are four basic constraints, which include objectivity, materiality, consistency and conservatism. To illustrate, the objectivity principle mandates that financial statements produced by the company’s accountants must be based on factual evidence. Conversely, the consistency principle means that the company must use the same accounting methodology for every accounting period. Overall, the GAAP provides structured consistency and transparency to all aspects of accounting and financial

Representations are faithful if there is a correspondence or agreement between the accounting measures or descriptions in the financial reports and the economic phenomena they purport to represent (FASB, 1980: 6; FASB, 2005: 3). The difference between reliability and a faithful representation is ambiguous. Since the attributes neutrality, completeness and substance of economic phenomena (substance over form) can be classified as qualities of faithful representation, reliability becomes redundant. Consequently, a point of attention is to discuss what exactly the notions reliability and faithful representation mean and what they do not mean (FASB, 2005: 2-3).In both frameworks neutrality is defined as free from bias. 'To that end, the common conceptual framework should not include conservatism or prudence among the desirable qualitative characteristics of accounting information. However the framework should note the continuing need to be careful in the face of uncertainty' (FASB, 2005: 3).

When talking about accounting, the first thing we should know is the history of its development. Traditionally, the development is from inductive to deductive. Inductive theory assume what is done by the majority is the most appropriate practice. However, It did not seek to evaluate the logic or merit of

The most controversial topic of today’s time in the world of accounting is fair value. However, one common point of confusion is the scale of businesses affected by fair value, and when fair value came onto the scene. According to Robert Herz and Linda MacDonald “...the use of fair value in financial reporting is not new. In fact, it has been in place for decades, principally for financial assets. But even then, fair value is not required for all assets.” (2008) The idea of using fair value measurements goes back at least to the 1930’s when Kenneth MacNeal wrote Truth in Accounting. It wasn’t until 1993, however, until the FASB released SFAS 115. SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. (FASB 1993) In 2006 the FASB released SFAS 157, which established a framework for measuring fair value. SFAS 157 also requires significantly more disclosures about fair value estimates than ever before. (FASB 2006) Finally the FASB issues SFAS 159, which permits entities to choose to measure many financial instruments and certain other items at fair value. (FASB 2007) These statements set the stage for the discussion of the advantages and disadvantages of fair value. Also discussed, will be the problems with implementation of a full fair value measurement system. That discussion will be followed by a brief summary.

Historically ,it is seen that there are numerous number of disputes in the field of financial reporting among different professionals, regulators and theoretitions .most of these disputes are related to the valuation of financial reporting components.the current curve in the progress of valuation is the push for and against the fair value approach.the purpose of this research is to examine the arguments on the use of fair value accounting and to identify the issues related to implementation of fair value accounting standards. Further, the results of literature related to role of fair value accounting within financial crisis are also investigated.

Accounting Information is the pearl of any organization. It is how a business provides its investors as well as other stakeholder parties’ direction towards a healthy economic decision in favor of the business. Regulation of these information and standardizing the process would lead to that organization solving the problem of ‘information asymmetry’. (Watts & Zimmerman, 1978)

Financial statements are often referred to as “reports”. As you scan the pages, you will find neat columns of precise numbers. Financial statements look objective. Looks can be deceiving. The questions that financial statements are intended to address do not have objectively true answers. Suppose a firm builds a factory, with custom-built machinery designed to specifically to produce the firm’s product. That factory would become an asset on the left-hand side of the balance sheet. How much is that asset worth?

In contrast, Historical Cost accounting is defined by recording assets or liabilities on its acquired cost. The nominal value that a company paid for an asset or recorded a liability. This measurement is based on a cost principal that states to record assets/liabilities at the acquisition value. In this approach, assets or liabilities are adjusted to its net realizable value in a systematic manner. For example, depreciation of fixed assets, amortization of intangible assets, and depletion of natural resources. These rational and systematics approaches to adjust assets’ value to bring these instruments to its carrying value, deviating from the recorded historical cost.

The main idea behind this principle is that when we face with two reasonable possibilities for recording a transaction you should err on the side of being conservative. This statement means recording uncertain losses while refraining from recording uncertain gains. Therefore, when you follow the conservatism principle you end up recording lower asset amounts on your balance sheet and lower net income on the income statement. Overall, adhering to the conservatism principle leads to lower profits being recorded on your statements.

There are different financial reporting approaches that companies can choose today. Companies measure and report the value of assets and liabilities on the basis of their actual or estimated fair market prices under fair value accounting. As with any accounting method, fair value accounting has its advocates as well as critics.

In accounting there are many perspectives on how fair value accounting is relevant and beneficial for financial users. In the eye of standard setters assessing the quality usefulness of fair value information is somewhat a common question for potential and current

The main purpose of financial reporting is to deliver transparent financial information regarding a company to the investors and general public. The financial crisis of 2008 had shown that absence of transparency in the financial statements may have an adverse effect on investor confidence. High quality accounting information is an essential criterion for well- functioning economy as investors rely on this information for investment purposes. Value relevance is thus one of the basic attributes of accounting quality. (Francis et al. 2004)

During the last 20/30 years there has been an increase in trade and communication. It is easier for people to do business across the world as the new technology allows this to be possible. The problem with this is that different countries have different ways of accounting standards, and therefore there is a problem on how to account standards. Hence, during the last years the debate on whether to use Fair presentation or the True and fair View is becoming a major concern. Fair presentation and the true and fair concept may seem as a similar concept, however, they do differ as well. While the former is the concept for

Both speakers have made credible arguments towards the contradictory nature of the International Accounting and Financial Reporting Standards. Accounting standards are a method of regulating the reporting of everyday transactions within the profession, alongside laws, regulations and codes of professional bodies (Guest Lecturer, 2014). Regulatory regimes are necessary as they aim to achieve a uniform objective that published accounts in the market are to show a true and fair view of the entity they purport to represent. However, the qualitative characteristic “true and fair” is very much subjective to the professional publishing the accounts. As it is open to interpretation, certain entities can use this vulnerability to their advantage