Financial Accounting Theory
QUESTION 1
a. Outline the objective and the principles of a theory that prescribes fair value accounting.
Fair value accounting is to measure selected assets at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The objective of fair value accounting is linked with the objective of ‘decision usefulness’ of general purpose financial reporting. That is, to provide relevant information that is representationally faithful for users.
IASB’s (and FASB’s) accounting standard on fair value measurement establishes a ‘fair value hierarchy’ in which the highest attainable level of inputs must be used to establish the fair value of an asset or liability. Levels 1 and 2 in the hierarchy can be referred to as mark-to-market situations. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are mark-to-model situations where observable inputs are not available and risk-adjusted valuation models need to be used instead. Fair value accounting emphases assets and liabilities and includes change in asset values in revenue. The primary statement is balance sheet.
b. Outline the objective and principles of a theory that prescribes historical cost accounting.
Under historical cost accounting, assets are recorded at the amount of cash or as equivalents paid, or the fair value of the consideration given, to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances, at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.
The objective of
a. Outline the objective and the principles of a theory that prescribes fair value accounting.
Fair value accounting is to measure selected assets at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The objective of fair value accounting is linked with the objective of ‘decision usefulness’ of general purpose financial reporting. That is, to provide relevant information that is representationally faithful for users.
IASB’s (and FASB’s) accounting standard on fair value measurement establishes a ‘fair value hierarchy’ in which the highest attainable level of inputs must be used to establish the fair value of an asset or liability. Levels 1 and 2 in the hierarchy can be referred to as mark-to-market situations. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are mark-to-model situations where observable inputs are not available and risk-adjusted valuation models need to be used instead. Fair value accounting emphases assets and liabilities and includes change in asset values in revenue. The primary statement is balance sheet.
b. Outline the objective and principles of a theory that prescribes historical cost accounting.
Under historical cost accounting, assets are recorded at the amount of cash or as equivalents paid, or the fair value of the consideration given, to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances, at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.
The objective of