Comparing Two Approaches To Financial Reporting

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