Comparing Two Approaches To Financial Reporting

Superior Essays
For recent decades, controversy between balance sheet and income statement approaches to financial reporting has been debated. In order to critically evaluate these two approaches to financial reporting, it is important to understand the purpose of general financial reporting, which is to provide users with decision useful information to reduce information asymmetry caused by the separation control between shareholder and managements. In addition, it is essential to find and focus on the differences between these two approaches. Obviously, balance sheet approach and income statement approach bases on two different measurements, fair value accounting and historical cost accounting, respectively. Because financial reports aim to provide financial …show more content…
Under income statement approach, financial reports shows that profit from operation, which provides useful information to shareholder about how effective managements has do them duties. Income statement bases on historical cost accounting, which is based on actual transactions. Therefore, the amounts are reliable and verifiable. Since balance sheet amounts show that what has been paid and received, reports are free from management bias. Historical cost accounting is objective and also easy to use (Daines, 1929). Moreover, historical cost accounting provides relevant information for managers to forecast future costs, which is based on historical costs is the basis (Ijiri,1975). However, Solomons (1961) argues that values at historical cost will be irrelevant when in a high inflation. Moreover, Penman (2007) says that when investors use information provided at historical cost accounting to consider the current and future financial positions, information is irrelevant because historical price cannot reflects timely information. Historical cost accounting can cause misleading as well. Take cases of McKesson and Robbins in 1938 as examples, figures at historical cost misleads investors and creditors. Dichev (2008) states that income statement approach can better represent the operation of companies. However, there are some limitations of historical cost accounting. First, it …show more content…
The balance sheet approach measured by fair value accounting can provide more relevant and reality information to users while the income statement approach cannot provide irrelevant information for decision making. Though historical cost accounting can provides more reliable and verifiable information for users based on actual transactions, Fair value accounting is based on current market and reflects value changes in the market and this provides information for investors to predict future and to make decisions. Moreover, transparency increased by reflecting current market. The limitations of historical cost accounting, including allocated problem and conservatism, reduce the usefulness of information to users. Historical cost accounting provide information about how well or badly managements do their duty to shareholders. Among the comparisons between fair value accounting and historical cost accounting before, the advantages of fair value accounting is more than those of historical cost accounting. In my view, I prefer balance sheet approach at fair value. Fair value accounting has many advantages which are discusses above and also is a trend under regulation. The main weakness in fair value accounting is that when market is not perfect, how to get fair value from market. However, I think this problem can be solved easier than the limitations of Historical cost accounting. Regulators could

Related Documents

  • Improved Essays

    The Sarbanes-Oxley Act

    • 884 Words
    • 4 Pages

    It is the most contentious aspect of the bill, where it requires management and the external auditor to report on the adequacy of the company’s internal control on financial reporting (Wang, 2008). One of the issues Chowdhury (2007) raised, about the cost-effectiveness of the bill, is posed in this section as this is the most costly aspect of the legislation for companies to implement. To help ease the high costs of compliance, practice and guidance have evolved to accommodate some of the expensive costs of the Act. The Public Company Accounting Oversight Board approved a couple standards for public accounting firms in the year 2007 to help alleviate these problems. Some of the things that the two standards together would require management to do is to assess both the design and operating effectiveness of selected internal control related to significant accounts and relevant assertions, perform a fraud risk assessment, scale the assessment based on the size and complexity of the company, as well as other steps in this process to conclude on the adequacy of internal control over financial reporting (Virag,…

    • 884 Words
    • 4 Pages
    Improved Essays
  • Decent Essays

    LaShundra, I agree with you when you look at a company’s balance sheets and income statements it can give either internal or external users a picture of how the company currently is doing during a certain period of time. With this information either party internal or external can make decisions that can affect the company as a whole by either investing in its future or expanding the latest production line.…

    • 70 Words
    • 1 Pages
    Decent Essays
  • Improved Essays

    The Financial Accounting Standards Board (FASB) has been the assigned organization in a private sector for establishing standards. These standards are important to be useful because it allows investors to make informed decisions. Financial information must be reliable, consistent and transparent. Transparency refers to high-quality financial statements that are clear and easy to understand. Being transparent in financial reporting allows investors, creditors and the market to properly evaluate business entity.…

    • 1619 Words
    • 7 Pages
    Improved Essays
  • Improved Essays

    Sarbanes-Oxley Act

    • 833 Words
    • 4 Pages

    Organizations also have to focus on the corporate social responsibility to serve different stakeholders, for example, clients, employees, suppliers, groups, and ecological and human rights advocates, whose interests are attached to the organization's execution. A corporate social responsibility is a business practice that involve the organizations making decisions that concern society benefit. Companies should provide customers with safe and high quality products that are fairly priced and easy to use information system for shopping and tracking orders. Organizations become more nimble, relevant, and responsive to internal and external customers (Walker, 2008, sec.10).…

    • 833 Words
    • 4 Pages
    Improved Essays
  • Improved Essays

    Cost accounting is very important in the healthcare system, but may be considered difficult and resource intensive. Applications such as the Electronic Medical Records (EMR) have been the primary focus of many organizations. There is a lot of pressure from all stakeholders to lower healthcare cost. Cost accounting analyzes the cost structure of an organization by gathering information about the costs incurred by the organization and assigned cost to products and services rendered in order to evaluate the proficiency of cost usage and controlling cost. Cost accounting in healthcare is concerned with developing an understanding of loses and profit and provide strategies to generate future earnings.…

    • 265 Words
    • 2 Pages
    Improved Essays
  • Improved Essays

    Financial statements are indispensable analytical tools for any business regardless of size. There are four primary statements (balance sheet, cash flow statement, retained earnings, and income statement) that are reviewed and analyzed on a regular basis that display an organization economic wealth and health. • Balance Sheet – will permit the viewer to determine the net worth of an organization via seeing: o Total assets, debt, and owner/stockholder’s equity • Income Statement – one will ascertain the both current and past performance of a company via displaying: o Gross income o Adjusted gross income (gross income – cost of goods sold) o Operating income (direct and indirect) o Income before and after taxes • Cash Flow Statement – is…

    • 811 Words
    • 4 Pages
    Improved Essays
  • Great Essays

    Friedlob Annual Reports

    • 1162 Words
    • 5 Pages

    The step involves analyzing how the particular company manages the assets, liabilities and the equity in its possession. Asset = Liability+ Equity is the core equation of a balance sheet The second step in ensuring the validity of the financial statements is to analyze the report of the income statement and comprehend the overall performance, the profits and losses of the particular business in a specified time (Gibson). This analysis consists of revenue, expenses, earnings before tax, the revenues and the profits after tax. Putting into consideration arguments such as the income alone does not equate to profitability ensures more accurate financial…

    • 1162 Words
    • 5 Pages
    Great Essays
  • Improved Essays

    The rich industrialists of the 19th century pioneered the business practices of the time, and set the foundations for the success of US corporations for decades to come. One such business practice was cost accounting. In the 1880s, industrialist Andrew Carnegie was “the first in the railroad industry to apply cost accounting, or breaking out the product cost for each step.” (Skrabec, 73). Keeping track of costs for each step in the production process was a major improvement from the disorganized methods used by Carnegie’s competitors and by most industrialists at the time.…

    • 331 Words
    • 2 Pages
    Improved Essays
  • Improved Essays

    By one using this type of accounting one is able to determine how to better improve the overall state of the company. It will help improve long and short term goals, monitor progress, follow trends, and assist with the control of decisions. While all of these are important managers need to assure accounting ethics are being followed to accurately determine the success of the company. Financial and managerial accountings are both ways to track data of an organization and they have similarities and differences. The biggest difference between financial and managerial accounting is, financial accounting is to inform outside parties of the company’s economic state, and managerial accounting to provide information to the organization.…

    • 822 Words
    • 4 Pages
    Improved Essays
  • Improved Essays

    It 's important to realize that the financial statements and the ratios are decision-making tools used both internal and external. The financial statements, especially the balance sheet is typically asked for by lenders prior to extending a loan to a company, and the financial statements are the statements of record if there is ever a tax audit done on the company (Bluest, 2015). References Averkamp, H. (2015). Cash Flow Statement Explanation. Retrieved December 5, 2015 from http://www.accountingcoach.com/cash-flow-statement/explanation…

    • 839 Words
    • 4 Pages
    Improved Essays
  • Improved Essays

    Introduction 1. Zara’s financial statement analysis The financial statement is recognized as an efficient method of communicating the company’s financial status and statistics to its shareholders (CILT, 2014a, p. 17). In addition, it aims is to provide a detailed description of where the company stands from a financial perspective along with its performance in a specified period. Hence, an organization can plan and set their future economic decisions based on their performance reflected in the financial statements (CILT, 2014b, p. 18).…

    • 775 Words
    • 4 Pages
    Improved Essays
  • Improved Essays

    With this accounting equation, it is presented to give you an idea of a double entry accounting. And when a company borrows from the bank, a company 's cash account can increase and its liability account loans payable will increase. If the company pays for advertisement their cash flow will decrease but the account advertisements expenses can increase. Connections between an income statement and Balance sheet Each of the financial statements is on separate sheets for the annual financial report, here is a quick explanation how they working from the top to the bottom.…

    • 1042 Words
    • 5 Pages
    Improved Essays
  • Superior Essays

    Publicly owned companies are required to periodically publish general-purpose financial statements that include a balance sheet, an income statement, and a statement of cash flow. Understanding the financial side of a business can often times be challenging and complicated. Understanding a company’s accounting system and financial statements can be just as hard. “Four statements are normally prepared by profit-making organizations for use by investors, creditors, and other decision makers. I.e.: balance sheet, income statement, statement of stockholders’ equity, and statement of cash flows (Bethel, 2017).” These reports do not have a period as to when they are to be completed.…

    • 1663 Words
    • 7 Pages
    Superior Essays
  • Superior Essays

    Upon the completion of this course I have come across topics that have interested me and increased my knowledge especially in the financial and accounting aspect. This course has introduced me to understanding the relationship between financial and accounting in making an effective strategic decision. In as much they sound alike they are different and used in different purposes, both accounts are important to the business but are used for different purposes. Financial statements are requirement for any organisation and are published at the end of a financial period for its stakeholder, shareholder and customers to see, they show reports of performance on a historic basis and what has been achieved over the years. At the time the statement is…

    • 1536 Words
    • 7 Pages
    Superior Essays
  • Improved Essays

    Cost Accounting Essay

    • 1292 Words
    • 6 Pages

    The use of accounting in the business field to measure an entity in many aspects regarding financial information is crucial in modern day. Tracking how a business obtain, spends, and invest their financial assets are key indicators for not only external users such as investors and creditors, but internal users such as management departments. To plan for future endeavors, one must understand their present capabilities. Through extensive research, we can establish why cost accounting is important to the success of the firm, various methods of cost accounting, and how they are used.…

    • 1292 Words
    • 6 Pages
    Improved Essays