Question

Please Answer in Detail

Question 01: Qualitative characteristics of accounting information relates to the second level of conceptual framework. Discuss in detail, the primary qualitative characteristics relating to the content and presentation of information with particular emphasis to their importance.

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Question 02: Financial statements prepared under historical cost convention do not have regard for changes in price levels and therefore do not reflect financial realities. Discuss six limitations that statements prepared by historical cost accounting possess that reduce their utility to the users.

Answer 1

Financial Statement prepared under historical cost convention do not have regard for changes in price level, therefore, have the following limitations:

1. Depreciation under historical cost convention is charged on the original value of the asset. The mechanism is created to replace the fixed assets when it becomes economically or technically obsolete. The future cost of an asset mostly if not always exceeds the price at which these are acquired. Therefore, under this mechanism most of the times depreciation reserve falls short of acquisition cost and put pressure on the existing working capital of an entity.

2. Under the inflationary conditions price of a currency is never stable and accounts under historical cost convention are prepared on the assumption that the underlying currency is stable. Therefore, this assumption states a number of distortions in the financial statements.

3. The additions to the fixed assets are clubbed together not taking into the account currency valuation at the time of acquisition of the fixed asset. For example a building was constructed 10 years back for USD 1-Million costs USD 1.5 Million 10-years later. Although there is no difference in structure and quality, however, the accounts shows an increase in valuation by 1.5 times.

4. In the balance sheet monetary assets like debtors, creditors etc. are shown at their monetary value on the balance sheet date and non-monetary assets like fixed assets, inventories are shown at their historical cost. Thus, non-monetary assets are over or under stated depending on the inflation and is correct to say that balance sheet do not represent a true picture.

5. The matching figures are not restated according to the value of currency at the time preparation of accounts. Therefore, matching figures are really not meaningful.

6. There is no distinction in the historical accounts for actual growth. The sales figures in highly inflationary period may be misleading as there are no adjustments made for inflation in the accounts.