Question

Accounting Theory

1. In terms of theoretical foundations, how do you compare accounting to other disciplines such as economics, physics, mathematics, etc.?

2. Discuss three major challenges facing fair value accounting practices and their implications to the future fair value accounting.

3. Assuming the above challenges to fair value accounting were solved, why would you prefer fair value accounting over historical cost accounting?

4. Explain why we would not need an income statement if everything was accounted for under the fair market value system.

Answer 1

Answer 1-

Accounting vs. Economics

An Overview

Accounting and economics both involve plenty of number-crunching. But accounting is a profession devoted to recording, analyzing, and reporting income and expenses, while economics is a branch of the social sciences that is concerned with the production, consumption, and transfer of resources.

Key Differences

Both accountants and economists help businesses, industries, and governments to strategize and plan, make sound financial decisions, and set fiscal policies. Professionals in both fields base their analyses and projections on real-life markets, conditions, and events.

Accounting is the nuts-and-bolts field that tracks the inflow and outflow of money, while economists are typically more concerned with the big-picture trends that drive money.

Accounting vs. Physics

Despite physics being incredibly more complex (especially when entering the realm of quantum mechanics, general relativity and similar areas), and also dynamic (in terms of explaining or demonstrating cause and effect), the key similarity is the need for both sides of the “balance sheet” to balance.

For example, in simple mechanics, the net force on an object is the vector sum of all the forces. If these are non-zero, an acceleration (change) will ensure. However, both the net energy and net momentum of the system will remain unchanged (i.e. the balance sheet (if you will) will remain balanced).

Similarly, conservation of charge (creation or annihilation of positive and negative) requires that the balance sheet balance (anything added or subtracted from one side, is added or subtracted from the other side in an equal amount). The same thing is true with respect to mass converting to energy - as complex as we perceive the process to be, it can be considered (from an accounting perspective) to simply be moving something (crediting or debiting) from one account to another.

Accounting vs. Mathematics

Comparison 1- Mathematics is a limitless calculation of numbers where different type of topics are calculated. This is mainly based on your mental capacity and strength.With the help of mathematics one can calculate the answer of the question in many different ways(The answer have to be same). You just need practice after practice and a clear concept of numbers. Mathematics cover some important chapters like Geometry, Trigonometry, Arithmetic, Algebra and Modern maths. Whereas Accountancy is a subject which teaches you how to keep a book of account. The root of this subject is the Golden rule where 3 accounts are partly separated and each have an individual rule .

Comparison 2- Mathematics is a practice of numbers where one can calculate answer with help of different formulas of different topics whereas Accountacy is a practice of keeping the book of account in a right way with right journals of every transaction

Answer 2-

Three major challenges facing fair value accounting practices:

1) Value Reversal-Fair value accounting can also present challenges to companies and users of reported financial information. Conditions of the markets in which certain assets and liabilities are traded may fluctuate often and even become volatile at times

2) Market Effects-The use of fair value accounting may further affect a down market adversely. For example, after an asset has been revalued downward because of drops in the current market trading prices, the lower value of the asset could trigger greater selling of the asset at a potentially even more depressed price

3) It loses historical perspective -Although current accounting is important to measure, there must also be a general sense of what has happened historically for accuracy in tracking results. Because assets may have a down year and reduce net profits, it can artificially lower the successes that a business may have had.

Answer 3-

Preference of fair value accounting over historical cost accounting -

The fair value accounting method relative to historical cost accounting. Although both methods are widely used by entities in computing their income and financial positions, there is controversy over superiority. Historical cost accounting reports assets and liabilities at the initial price they were exchanged for at the time of the transaction. Conversely, fair value accounting quotes the prevailing price in the market. Nevertheless, while both methods of accounting affect financial statements, the impact of fair value accounting on the balance sheet and income statement is extreme due to the potential volatility of the method. Fair value accounting is deemed superior when compared to historical cost accounting because it reflects the current situation in the market whereas the later is based on the past. In addition, in relative terms, fair value accounting provides users with more current financial information and visibility.

Answer 4-

We would not need an income statement if everything was accounted for under the fair market value system because, we can easily determine profit by using fair market value system which can be easily available