Accounting/ Accounting Standars term paper 17782

Accounting term papers
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Introducton

As you requested, I have researched the many possible methods used to account for long-term assets, and prepared a statement outlining my recommendations. The conclusions outlined herein are derived primarily from my interpretation of both the Conceptual Framework, and its intentions. Based on my findings, I believe the liability should be recognized when it is acquired. If new information arises allowing a better estimate to be made, the adjustment should be made and noted in the financial statements. Also, when attempting to measure the value of the liability for use in financial statements, the Present Value of the item should be used. The related expense must be recorded initially as a capitalized asset, and then expensed, in the form of depreciation, over its useful life. The following paragraphs will provide support for my conclusions as per the Conceptual Framework while also considering the opinions of representatives throughout the accounting field.

When to recognize the related liability

One of the central objectives of financial reporting is to provide information that is useful to both present, and potential, creditors, investors, and other users for decision-making purposes. To this end, in order to recognize a liability, a firm must first determine that the item in question represents a present obligation requiring probable future sacrifice of economic benefit. Also, this must come as a result of past transactions. In order enhance the usefulness of accounting information, it must be as relevant and reliable as possible. I believe that recognizing a liability at the point of acquisition, and depreciating the related cost over the useful life, is the method most consistent with the intentions of the Conceptual Framework.

By recognizing the liability in this manner, investors and creditors are aware of its existence as soon as it starts to impact the firm. Since the information distributed in this way is relatively current, it can help users to predict future events such as cash flows, or lack thereof. These revisions can also help to expediently confirm past decisions, giving the user confidence that no current changes are needed. If any estimates (length of useful life, estimated salvage value, etc.) are subject to change based on better information over the useful life of the asset, these changes should be reflected in the financial statements for users to see. Thus, users are always aware of any significant changes made by management.

In addition to increasing the relevance of accounting information, the method outlined above will ensure greater reliability. Since the liability is recognized as soon as it is acquired, users can check to make sure that it corresponds closely with the definition provided by the Conceptual Framework. Another benefit reaped by users is that verification is easily obtained. Since the value of the liability is constantly adjusted, and therefore current, its identity and value can be easily calculated across time, and subsequently verified. This constant re-evaluation also helps to ensure the nature and value of the liability reported by the firm is not biased toward a pre-determined result. In general, managers are less likely make an attempt at distorting a component of the financial statements if they know it will be subject to constant scrutiny.

How to measure the related liability

The method of measurement most beneficial to external users is that of Present Value. Though involving a certain degree of subjectivity, the timely nature of information provided by using this valuation far exceeds its drawbacks. Using Present Value allows investors and creditors to see the current value of a firm's liabilities, and therefore the effect they have on cash flows. Thus, users of financial accounting information have a relevant and reliable base on which to make their investment decisions. Since the Present Value is revised each period, users are well-equipped to re-assess or confirm their opinions of a company's financial situation.

How to record the related cost

One of the fundamental assumptions of financial accounting is that of the Matching Principle. Simply stated, this involves aligning expenses incurred by a firm with the revenues generated by these costs. This theme is central to my recommendation that the liability be capitalized as an asset, and be expensed, in the form of depreciation, over the estimated useful life. I believe this method helps to provide the most relevant and reliable information to users, and ultimately benefits all parties involved in the financial reporting process.

By recording the estimated cost of the liability first as a capitalized asset, and then depreciating it, users are able to reliably see the direct effect on the financial position of the firm. They are able to see that the company has generated revenues by incurring this liability, and view the specific time period over which these benefits were derived. In other words, they can see how the costs associated with the liability are matched against the revenues they help generate. This insight can be very useful to investors and creditors when determining where to allocate funds based on predictions about the future prospects of a company. Firms that generate higher revenues as a result of the incurrence of liabilities will be more attractive to suppliers of capital, and will receive a lower interest rate on their future borrowings. Investors and creditors, in return, will enjoy the decreased risk that the higher returns generated by the company provide.

Opinions of Interested Parties

There are numerous groups of people that may be interested and/or affected by the recommendation I am laying forth. For purposes of simplicity I have lumped them into three categories: Users, Preparers, and Auditors. Users of financial information consist primarily of creditors and investors who provide loanable funds and start-up capital to firms. Preparers are made up of members of a firm, usually managers, who are involved in the generation of the financial statements. Auditors consist of independent accounting professionals hired by companies to review their financial statements and issue their opinion of the information presented. The general areas of concern to each group in relation to the three above topics are as follows.

Users

The primary concerns of the users focus on the usefulness of information disseminated by corporations. Investors, and creditors commonly use financial statements in their decision-making process when evaluating investment decisions. More specifically, the goal is to predict future cash flows of firms. In order to enhance the accuracy of these predictions, users wish to maximize the relevance and reliability of the information they receive. Thus, if an item meets the definition of a liability, they want it to be recognized as such (as opposed to a loss, etc.). If the liability can be traced to revenues generated during specific periods, users want to see it matched against these inflows.

Preparers

With their position representing a near polar opposite of the users, preparers generally wish to minimize disclosure while maximizing personal benefit. Given that many executive compensation packages are now heavily weighted with stock options, preparers are motivated to boost share prices. However, they strive to accomplish this by disclosing as little as possible, and often employing highly questionable accounting tactics. The goal is simple, minimize the negative impact of events on the financial statements, user decisions, and stock price. However, preparers are conscious that their financial statements must be viewed credibly by investors, creditors, and others, in order to secure additional capital at low cost ad avoid class action suits by shareholders. In effect, preparers attempt to make the incredible appear to be credible.

Auditors

As a group, auditors are placed in a thankless position by the financial community. On one hand, they must ensure that accounting information meets the disclosure needs of lawsuit-happy users. Often extremely costly, these circumstances often arise when uses believe auditors have allowed a firm to get away with inconsistencies in their financial statements, or have misrepresented the true financial position of the company. On the other, auditors are pressured by senior members of their own firm to please clients. With future employment status often hinging on the satisfaction of the preparers, auditors are forced to represent the best interests of two opposing factions. Thus their concerns revolve around making sure the financial statements satisfy user needs, while disclosing as little information as possible. Thus, if an item meets the definition of a liability, auditors want it to be disclosed, but are relatively flexible as to when and how.

Conclusion

In response to your inquiry, I initially recommended that obligations associated with the retirement of long-lived assets be treated in the following manner:

1. Record the liability at the point of acquisition and make adjustments in estimates over time as more relevant/reliable information becomes available.

2. Measure the liability at its Present Value (of future cash flows).

3. Record the associated cost as a capitalized asset, and depreciate (according to the matching principle).

The above recommendation was based on the premise that the relevance and reliability of financial accounting information delivered to users would be maximized. However, after considering the viewpoints of the constituent groups, I believe that my recommendation should be taken with a grain of salt. As you know, when making a decision, the effect of constraints such as Cost/Benefit, Materiality, and Conservatism must be considered. While the idea of providing users with the most information possible may seem utopian, we must also take into account the effects of this increased disclosure on firms. Will vital business secrets be revealed, leading to a competitive disadvantage? What are the marginal costs associated with this disclosure? How will users react? For these reasons, in addition to those outlined previously above, I am recommending that auditors be given some discretion as to the implementation of my initial recommendation. As trained professionals, auditors have the ability to clarify many of the questions associated with the employment of accounting methods. By the very nature of their jobs, auditors are constantly forced to balance the needs and wants of both users and preparers. We have faith in auditors to certify the validity of corporate financial statements for users, and we must also trust their judgment in applying accounting rules appropriately to individual firms.

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