Ha3011 Advanced Financial Accounting Answers Assessment Answers
Many organisations elect not to measure their property, plant and equipment at fair value, but rather, prefer to use the ‘cost model’. This will provide lower total assets and lower measures, such as net asset backing per share.
You are required to answer the following questions:
(a)What might motivate directors not to revalue the property, plant and equipment?
(b)What are some of the effects the decision not to revalue might have on the firm’s financial statements?
(c)Would the decision not to revalue adversely affect the wealth of the shareholders?
Answer:
Conceptual Framework can be defined as a set of generally accepted accounting principles. Conceptual framework provides the frame for financial reporting to the organizations. It provides a theoretical measure for the determination of financial transactions. IFRS (International Financial Reporting Standards) is a revised set of accounting standards for reporting particular transactions in financial statements. IFRS standards are developed by International Accounting Standard Board with the objective to form a global standard for the preparation of financial statements.
Qualitative characteristics of Financial Reporting not satisfied by IFRS:
Easiness
The preparation of financial statement should be easy. They should not require lot of hard work and, it should have minimum calculations in order to report the financial statement on time. The statement should not be very large so that the user can understand the statements easily. The standards of IFRS are complex that makes it difficult to prepare and to understand by the user. The reports prepared with IFRS principles are result focused that makes it tough for the users to understand the true financial position of a company. The market valuation concepts are complex for the users.
Comparability
The financial statements are prepared with the objective to compare financial performance of a company either with its own financial performance in previous years or with financial performance of other companies. The reports to be compared with other companies require to be reported with same accounting principles. However, IFRS is not globally accepted and that makes it difficult to compare the financial statements of companies based in different nations.
Timeliness
The disclosure of financial statements of any organization should not be delayed. The companies would be required to train the staff about the IFRS standards or outsource the accountants, however, this will increase the cost of accounting processes and will lead to delay in financial reporting.
Public Interest Theory
The Public Interest Theory states that intervention of government in markets and regulatory activities leads to market imperfections. This theory argues that the regulation does not promote the welfare of stakeholders. The organizations are aware of the fact that the customers can be retained by indulging in the social environmental activities. The government should interfere to limited extend only. The companies are well aware about the impact of social and environmental development activities on the profitability of the organization.
Capture Theory
The capture theory states that the government intervention for the public interest in business operation works for the benefits of the industry instead. It states that the government regulatory body is captured by the industry. The members of this regulatory body are the employees of the industry. The government intervention should be limited to the training and public awareness programs like CSR (Corporate Social Responsibility) for the members of regulatory body and the organizations.
Economic Interest group theory of regulation
The economic interest group theory is based on the perspective of free market. It states that accounting information should also be treated like other goods and services. The market is driven by the demand and supply forces. The government intervention is not beneficial for the interest of public. The customer retention is based on the initiatives of the organization for the betterment of the society. The public welfare activities of the organization will lead to attract new customers and retain existing customers.
FASB Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets is based on the one accounting model for the financial reporting of long lived assets to be disposed of by sale. It improves the financial reporting by means of the improved presentation of discounted operations and disposal transactions. It broadens the presentation of disposal transactions. It resolves the implementation issues by making same rules for the similar events and transactions. It improves the reporting of financial statements by increasing the comparability feature of financial reporting. And the comparability among entities of financial statements improves the representational faithfulness of the financial reporting.
It improves the presentation of financial information by including the explanation of all entities of the financial information. It states that good will asset is not reported in financial statements if it is the part of lower level asset group. It effectively represents the profitability of an organization and includes the estimated future cash flows. It is based on the objective of calculation of long lived assets at fair value less than their recoverable amount. (Financial Accounting standards, 2010).
The managers are motivated towards not revaluating the property, plant and equipment due to the high cost associated with the revaluation process. The process of revaluation of fixed or long lived assets is a complex process as it includes various factors like depreciation and amortization. The fundamental issues in calculation of cost and value create problems to directors. The calculation of scrapping value and impairment of assets is a long and complex process. It includes the information about the takeovers that affects the public image of the organization.
Some of the negative effects of not revaluating the fixed assets are:
- It does not show the exact return on investment.
- A financial report does not depict the fair market value of assets.
- True asset and liability valuation is difficult.
- It manipulates the reporting of net income.
- Affects the borrowing capacity of the organization.
- Depreciation and impairment is not presented in financial reporting that affects the calculation of reliable value of long lived assets.
The decision of not revaluating the long lived assets negatively affects the wealth of shareholders. The proper revaluation of fixed assets helps the shareholders in determining the value of return on equity. The revaluation showing upward movement indicates the higher earnings per share. The asset revaluation affects the net worth of shareholders by impacting the net income of the organization. It helps the investors in decision making by providing information about changes in the prices of financial assets. The revaluation of fixed assets helps in calculating the accurate increase or decrease in shareholder’s wealth. It also the affect the issuing of new shares to existing shareholders.
References
ACCA Global (2018). “The Need For and an Understanding of a Conceptual Framework,” [Online]. https://www.accaglobal.com/in/en/student/exam-support-resources/fundamentals-exams-study-resources/f7/technical-articles/conceptual-framework-need.html. [2018 May].
AmosWEB (2018). “Capture Theory of Regulation” [Online]. https://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=capture+theory+of+regulation. [2018 May].
Bragg, S. (2018). “What is IFRS?” [Online]. https://www.accountingtools.com/articles/what-is-ifrs.html. [2018 May].
FASB (2018). “FASB Issues Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,” [Online] https://www.fasb.org/news/nr100301.shtml. [2018 May].
Mishra, S. (2018). “9 Characteristics of Ideal Financial Statements,” [Online]. https://www.yourarticlelibrary.com/accounting/financial-statements/9-characteristics-of-ideal-financial-statements-accounting/66764. [2018 May].
Regulation Body of Knowledge (2018). “Introduction,” [Online]. https://regulationbodyofknowledge.org/introduction/. [2018 May].
Seng, D. and Su, J. (2010). “Managerial Incentives behind Fixed Asset Revaluations: Evidence from New Zealand Firms,” [Online]. https://hdl.handle.net/10523/1606 [Accessed 22 May 2018].
Tay, I. (2009). “Fixed Asset Revaluation: Management Incentives and Market Reactions,” [Online]. https://researcharchive.lincoln.ac.nz/bitstream/handle/10182/1555/Tay_MCM.pdf?sequence=3&isAllowed=y. [2018 May].
Way, J. (2018). “Advantages or Disadvantages of Fair Value Accounting,” [Online]. https://smallbusiness.chron.com/advantages-disadvantages-fair-value-accounting-20577.html. [2018 May].
Winston, K. (2018). “Interest Group: Definition, Purpose, Theory & Examples - Video & Lesson Transcript,” [Online]. https://study.com/academy/lesson/interest-group-definition-purpose-theory-examples.html. [2018 May].
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