Question

Please briefly discuss the following:

A. What are general types of values used for external accounting.

B. Discuss the reasons why use historical cost accounting for some accounts while use fair value measure for other accounts.

Answer 1

PART A

The accounting process provides financial data for a broad range of individuals whose objectives in studying the data vary widely. Three primary users of accounting information were previously identified, Internal users, External users, and Government/ IRS. Each group uses accounting information differently, and requires the information to be presented differently.

Internal Users

Accounting supplies managers and owners with significant financial data that is useful for decision making. This type of accounting in generally referred to as managerial accounting.

Some of the ways internal users employ accounting information include the following:

• Assessing how management has discharged its responsibility for protecting and managing the company’s resources
• Shaping decisions about when to borrow or invest company resources
• Shaping decisions about expansion or downsizing

External Users

Typically called financial accounting, the record of a business’ financial history for use by external entities is used for many purposes. The external users of accounting information fall into six groups; each has different interests in the company and wants answers to unique questions. The groups and some of their possible questions are:

• Owners and prospective owners. Has the company earned satisfactory income on its total investment? Should an investment be made in this company?
• Creditors and lenders. Should a loan be granted to the company? Will the company be able to pay its debts as they become due?
• Employees and their unions. Does the company have the ability to pay increased wages? Is the company financially able to provide long-term employment for its workforce?
• Customers. Does the company offer useful products at fair prices? Will the company survive long enough to honor its product warranties?
• General public. Is the company providing useful products and gainful employment for citizens without causing serious environmental problems?

Some of the ways external users employ accounting information include the following:

• Stockholders have the right to know how a company is managing its investments
• Banks or lending institutions may use accounting information to guide decisions such as whether to lend or how much to lend a business
• Investors will also use accounting information to guide investment decisions

General-purpose financial statements provide much of the information needed by external users of financial accounting. These financial statements are formal reports providing information on a company’s financial position, cash inflows and outflows, and the results of operations.

Government / IRS

Government agencies that track and use taxes are interested in the financial story of a business. They want to know whether the business is paying taxes according to current tax laws. . Tax preparation will be outside the scope of this course.

There are three major areas of finance that business owners and managers usually have to be knowledgeable of. There are three major areas of accounting as well:

Financial accounting is the area of accounting concerned with external parties interested in the business firm. Financial statements, for example, are produced for the benefit of the external investors. Investors need to be able to review financial statements such as the income statement, the balance sheet, and the statement of cash flows in order to determine whether or not to invest in the business firm or remain invested in the company.

Financial statements are also of interest to another group of external individuals and those are the creditors of the firm. .

Financial accounting, according to the Financial Accounting Standards Board (FASB), provides important financial collecting and reporting functions for business firms.

Managerial accounting is the area of accounting associated with gathering and preparing financial information for those inside business organizations such as managers and staff. It can be compared to financial accounting which is concerned with information for external individuals. Managerial accounting is the field where the gathering and preparation of financial information are for the insiders of the firm.

Managers use financial information to make better business decisions in their managerial and control roles. Much of this information is private since it is for insiders of the firm instead of public.

Some business professionals include cost accounting as a part of managerial accounting and some think that cost accounting is a different functional area of accounting. Whatever the case, cost accounting and managerial accounting surely overlap.

Cost accounting looks at the costs of production for a business firm by looking at the fixed costs of the products they sell and their input costs.Cost elements often used are indirect costs or overhead, raw materials, and labor. Managers often use the information from cost accounting to set up cost control programs for the business firm.

PART B

Fair value is the estimated value of all assets and liabilities of an acquired company.Historical cost is based off of the original monetary value of an item.fair value accounting say that it is more relevant because it captures market trends, depreciation, etc. This measurement of change seemingly makes the value points more current. On the other side, historical cost accounting is typically looked at as more conservative, which can also be perceived as reliable.

Fair value accounting was widely used in the 19th and early 20th centuries. most accountants preferred to use historical cost accounting for it’s reliability and accuracy.

Unfortunately, it’s not that simple. In most countries, primary financial statements are prepared on the historical cost basis of accounting without regard either to changes in the general level of prices or to increases in specific prices of assets held. Ignoring price changes also leads to discrepancies on a financial statement such as:

If inflation occurs historical cost accounting does not factor in the loss of value to monetary assets.

Opportunity costs of older properties that may be on more or less valuable land is not calculated.
No current values of assets are taken into consideration.

The historical cost principle accounts for the assets on a company's balance sheet based on the amount of capital spent to buy them. This method is based on a company's past transactions and is conservative, easier to calculate and reliable. However, the historical cost of an asset may not be relevant. For example, if a company purchased a building several decades ago, the contemporary market value of the building could be worth a lot more than the balance sheet indicates.

fair value accounting, a financial-accounting approach that companies use to report their assets and liabilities at the estimated prices they would receive if they were to sell the assets or be alleviated of their liabilities. By using contemporary measurements, mark-to-market accounting aims to make financial accounting information more accurate and relevant.