Arguments about approaches compile FS in accounting

The research about historical cost and intangible assets focuses on three main objectives, which are determining approaches to calculate the value of an asset, identifying the pros and cons of historical cost and fair value approach, and finally adjusting what intangible assets are not recognized on balance sheet and how it understates the true value of a company. However, due to the limit of time and human resources, the study still has limitations in the output. The research mostly concentrates on analysis of historical cost and fair value, as well as intangible assets which are not recognized on balance sheet. The paper then cannot include analysis of other approaches in compiling a companys financial position. It is recommended that later researches should focus on providing further knowledge about remained approaches in particular dimensions.

Table of content I/ Introduction.

1 Accounting/ methods to measure

1.1 Accounting

1.1.1 Present value approach

1.1.2 Fair value approach

1.1.3 Current cost approach

1.1.4 Historical cost - historical amortized cost approach

2 Intangible assets

II/ Main Body

1 Historical cost

1.1 Formula

1.2 Arguments about historical cost

2 Fair value

2.1 Formula

2.2 Arguments about fair value

3 Intangible assets

3.1 Importance of intangible assets

3.2 Kinds of intangible assets

3.3 Issues about intangible assets

3.3.1 Reasons

3.3.2 Consequences

III/ Conclusion

IV/ Reference

I/ Introduction

In nowadays worldwide market, accounting plays a significant role in a company's future It is believed that the production and transmission of information about an enterprise are include in that enterprise's financial statements which can be compiled by several approaches to determine values of assets on balance sheet These approaches include historical cost, current cost, fair value and present value approach Each of these approaches has its own advantages and disadvantages in describing a company's real financial position However, some recent arguments believe that the method of using historical cost approach could not give the correct financial position of a company The argument may be true in some case, but it is undeniable that this approach also has advantages for accountants to use Therefore, this paper will discuss effects of historical cost approach in compiling a company's financial statement in order to decide whether historical cost approach is an appropriate method to pinpoint the financial position of a business or not Moreover, argument of some certain intangible assets are not recognized on balance sheet will seriously understate true value of that entity will also be discussed

The research about historical cost and intangible assets focuses on three main objectives, which are determining approaches to calculate the value of an asset, identifying the pros and cons of historical cost and fair value approach, and finally adjusting what intangible assets are not recognized on balance sheet and how it understates the true value of a company However, due to the limit of time and human resources, the study still has limitations in the output The research mostly concentrates on analysis of historical cost and fair value, as well as intangible assets which are not recognized on balance sheet The paper then cannot include analysis of other approaches in compiling a company's financial position It is recommended that later researches should focus on providing further knowledge about remained approaches in particular dimensions

1 Accounting/ methods to measure

1.1 Accounting

Accounting is an important factor of any business in worldwide market nowadays It is significant that an organization could not accomplish its strategy without accounting information In accordance with the development of international

economy, importance of accounting information has become greater leading to various understandings of accounting Accounting was defined by The American Institute of Certified Public Accountants (AICPA) in 1953 as follows

" Accounting is the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part, at least, of a financial character, and interpreting the results thereof." (Cited in Naseem Ahmed, 2008, p.3)

Rechard Wittsiepe (2008, p.7) cites the definition of Accounting by the American Accounting Association (AAA) as "the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information" Accounting can be also understood as a service activity, which provides useful information about entities in making economic decisions among courses of action ( AICPA definition in Jack Quarter, Laurie Mook, Betty Jane Richmond, 2003, p.42)

Accounting, therefore provides useful information to decision makers It is clearly that accounting provides quantitative financial information that the users in making better business decisions In addition, through measurement, classification and classification the mass of data of a company, accounting helps describing, analyzing and compiling that data into financial reports and statements that identifies the financial condition and results of operations of the company The information system produces and transmits information about an enterprise to a wide variety of interested parties The needs of users to whom accounting is addressed are very diverse, so financial statements in the public domain should be able to satisfy most needs

Measuring accounting is an important step which can affect the future of a company The financial statement, then can be compiled by several methods including present value, fair value, current cost, and historical cost to determine the value of an asset Each method has its own characteristics, disadvantages and advantages which will be discussed as followings

1.1.1 Present value approach

Present value is the current value of a future amount of money This approach has advantages in showing a cash flow at a certain time in the future and calculating

the cash flow's present value Calculating the present value assumes that the investor knows both the future amount and the applicable interest rate or rate of return However, there still be questions remained in whether information collected through present value is reliable or not, since it mainly focuses on evaluating the value of future amount of money in current position without considering the previous figures and facts

1.1.2 Fair value approach

IFRS 13 defined Fair value as the amount for which an asset could be exchanged between knowledgeable and willing parties in an arm's length transaction The definition is nor significantly different from other definition by FASB in 2006 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.(John Dorchester Jr, 2011) The advantages of fair value includes the accuracy of value of assets and liabilities since they are traded in an arm's length transaction It is also claimed to provide users with more relevant information since fair value utilizes specific information in current market conditions However, disadvantages of fair value approach is also clear One of the disadvantages of fair value is its pricing deviation which is vagueness of the measuring process of financial statement Other major disadvantage of fair value is the limited reliability which makes the value turn out to be inappropriately optimistic since the information provided in financial statement is reliable and relevant only for a short period (Miroslav Škoda and Peter Bilka, 2012)

1.1.3 Current cost approach

Current cost is defined as the price must be paid for an asset or its usage at the date of the balance sheet (Henrdicksen and Breda, 1992, p 426) It is the cost based

on the prevailing price paid for assets, stock, raw materials etc as opposed to their historical cost Current cost method is said to have advantage in providing a better measure of efficiency and supporting in decision making Despite the advantages of current cost method, it is also received some criticism Current cost is claimed to be very subjective (Edward et al.,1981, cited in Bakar N B Abu, 2007) It is also concluded that information in financial statement compiled by current cost approach

is only relevant for short-term decision

1.1.4 Historical cost - historical amortized cost approach

Among four methods to measure accounting, historical cost could be determined as the most common one Historical cost is defined as a measure of value used in accounting in which the price of an asset on the balance sheet is based on its original cost when acquired by the company (Bessong P Kekung and Charles Effiongaicpa, 2012) Historical cost has advantage in the relevance for making economic decisions, and it is useful for control purpose This method is favored of its reliability because the information in financial statement held at historical cost is based on transactions that have already occurred which are verifiable and free from management bias In contrast, financial statements using historical cost method is criticized to be misleading since it cannot ensure the quality of justice and honesty within such information It is clear that this kind of method is commonly used by the accountants, however, there are many arguments about the effectiveness of this methods Questions about whether this method is still helpful or not are raised among accountants, and that could be further discussed in next part of this paper

2 Intangible asset

Intangible assets are studied in a large numbers of researches during the last two decades Intangible assets are assets without physical or financial embodiment involving in many processes as well as areas of economy They are described as non-financial assets without physical substance using for production of goods or services, rental to others, or administrative purpose (Epstein and Mirza, 2005) Evidence from the development of numbers of countries suggests that intangible assets are so important to companies that they encourage investment grow faster than tangible assets It is because intangible assets can easily be converted into tangible assets to create revenue They are also of considerable interests to investors For the benefits

of intangible assets, it is understandable that

II/ Main Body

1 Historical cost

As previously mention, historical cost is the traditional method of recording assets at the original cost It means that when an enterprise purchases a product, it is written in the enterprise's balance sheet as its historical cost Historical cost method is considered as a good basement for any cost approach procedure, and it measures the

actual costs occurred during the development of intangible assets (Céline Lagrost, Donald Martin, Cyrille Dubois, Serge Quazzotti, 2010) Historical cost have both advantages as well as disadvantages

1.1 Formula

The formula to compute the estimated historical cost of an asset using the CPI

is as follows:

Estimated Current x Index Rate for Estimated ÷ Index Rate for = Estimated Historical Cost Year of Acquisition Current Year Cost

Example: The estimated or actual year of acquisition of an asset is 1950 The purchase price of the same asset in 2002 is $90, 000 The estimated historical cost of the asset in 1950 would be computed as follows:

$90,000 × 72.1 ÷ 538.8 = $12,043

The very important thing when focus on this kind of method is that it relates to

a large area of finance Property, plan and equipment, salary and compensation, or most significantly intangible assets can be examples of fields in which this kind of method is used to measure Through it, accountants realize the significance of such fields in the development of an enterprise However, it is undeniable that this method brings negative effects to the company Accountants realizes the advantages and disadvantages of historical cost in nowadays financial world

1.2 Arguments about historical cost.

Some arguments accept this kind of method believe that it has lots of positive effects on the measurement of financial area of a company The very first argument believes that historical cost play an important part in making economic decision as well as giving experience in the establishment of a financial statement The reason for the importance of historical cost in economic decision making is related to three manners Historical cost relates to the evaluation and selection of decisions in the past The results of these past decisions will determine which rules current economic decisions should follow Furthermore, an economic decision would not be made if there were no forecast for future prices Historical cost is then considered as the basis knowledge to make the forecast of the prices of assets in future Finally, through historical cost, accountants could have a precious lesson from errors in decisions made previously Another argument shows that historical cost keeps accounting

measurement objective and verifiable (Anao, 1989, p 14-23) Accounting is seen as involving stewardship function of management Historical cost which bases on actual transactions gives managers records of all the assets and liabilities at the exactly price This help managers to avoid the manipulation in using figures for accounting Historical cost is also considered as manner to evaluate the effectiveness of what managers have accomplished, and at which levels they have met their responsibility Finally, this kind of approach is easy to establish since it mainly focus on the transactions made in the past, which bring the convenience for users to utilize such approach

Although historical cost has been used for decades, some people argues that historical cost is no longer suitable for a successful company This method is criticized mainly from proponents of current cost accounting Historical cost's first disadvantage is the irrelevance to decision making This disadvantage point seem to confused with its advantage Although accounting bases on the stewardship function

of management, it is understandable that accounting also bases on other factor, for example, the increases and decreases in the value of accounting investment Transactions in the past is not enough, but current position and assets in financial area of the company are also necessary Historical cost is also criticized to be misleading The value of intangible assets in balance sheet are unrealistic since it follows historical cost approach The historical cost cannot guarantee whether information written in balance sheet is justified and honest or not In result, the misleading of historical cost leads to over payment of taxes, dividends and wages during up-ward change in price In addition, historical cost cannot evaluate the inflation in nowadays economy Effects of inflation are not the same for all the companies in the market, and historical cost accounting become almost unhelpful in the comparisons of enterprises' performance In the 1980s, many blamed historical cost accounting for not being able to report potential losses from innovative financial instruments in a timely manner.(Yi-Ping Liao, 2013) Finally, historical cost no longer reflects economic reality As said before, historical cost bases on transactions

in the past, which is not the only factor in nowadays financial industry Historical cost does not recognize current market value It ignores the possibilities that current market value of assets may be higher or lower than suggested

2 Fair value

Fair value is defined before as the price that would be received to sell an asset

or paid to transfer a liability in an orderly transaction between market participants at the measurement date Although fair value is an appropriate approach for accountants

to utilize in balance sheet, this method has not become the main method of accounting in some countries and it is questionable whether it will be used in some days Following evaluation of advantages and disadvantages of fair value method supports in answering that issue

2.1 Formula

The calculation of fair value is relatively simple as long as you have access to the necessary underlying data The formula most often used is:

Fair value = Cash × (1 + r × x) ÷ 360 – Dividends

While Cash is the closing index value, r is the current interest rate, and x is the time remaining until the contract expires, in days

For example, the fair value calculation for the Stock market index of 100 UK market companies (FTSE) where the closing price is 1157 points with a cash index of

1146, the interest rate is 0.57%, with 78 days before expiry of the contract, and a dividend value of 3.47 points, would be calculated as follows:

Fair value = 1146 × (1 + 0.0057 × 78) ÷ 360 – 3.47

This calculation gives a fair value of 1156.68 points If the FTSE is trading at

1157 then the difference between the two figures is 0.32 At this time, the stock is trading below fair value

2.2 Argument about fair value.

The most advantage of fair value is the accuracy of value of assets and liabilities Fair value is thought to be reliable and verifiable Since assets and liabilities in a company are traded in an arm's length transaction if follows fair value, accountants can check information about both current and past market prices Financial Accounting Standards Board (FASB, 2000, p 8) has stated that its long-term goal is to have all financial assets and liabilities recognized at fair values The second argument for fair value accounting is that it provides more information on balance sheet that historical value Beside the figures and facts of financial position

of a company in the past, fair value also requires extensive information about risks

and opportunities, methodology and assumption of the financial statement of the company It enhances the company's financial statement in order to bring more overall view of that firm financial position than historical cost Fair value is also claimed to provide users with more relevant information since it utilizes specific information in current market conditions The value of this approach in giving information for a firm evaluating the results of financial activities is also taken into considerations of accountants Further, fair value accounting reduces the risks of being manipulated in the financial facts of a company Using fair value accounting, the increase or decrease of net income in a company is reported in exactly timeline when it occurs

Finally, from a long-term point of view, the approach affords a means of evaluating the firm as a going concern

Although fair value has lots of advantages in compiling financial statement of

an enterprise, it also faces criticisms Here are the disadvantages of this kind of approach One argues that fair value's pricing deviation which is vagueness of the measuring process of financial statement The next argument against fair value is that

it also gives misleading information The method only reports the achievements and losses when they occur, which bring the question about the ability to forecast future situation of worldwide market So the market change which can be affected by other factors of the financial industry may be inefficient, and not reflect in its estimates Despite the positive effect of fair value in helping avoiding manipulation, there still

be a risk in adopting a fair value estimates because in financial market, trading by firms can have an effect on both traded and suggested prices Other major argument against fair value is the limited reliability which makes the value turn out to be inappropriately optimistic since the information provided in financial statement is reliable and relevant only for a short period (Miroslav Škoda and Peter Bilka, 2012) This is the common disadvantage of both historical and fair value approach The financial statement conduct in fair value approach would be appropriate for a short period of time, while market environment change every day The change; therefore, causes confusion of whether previous financial statement is suitable for applying in current situation or not The writer believes that both fair value and historical cost have some similarities in their advantages and disadvantages Through a set of

advantages and disadvantages of these two approaches, in the author’s observation, overall fair value accounting benefits investors more compared to accounting based

on alternative measurement attributes, including historical cost accounting

3 Intangible assets

3.1 Importance of intangible assets

In nowadays market, assets and liabilities of a company are considered as key factors to the company's success in the area of finance Especially, the intangible asset is proved to be a special driving force to the future of that company So what is

an intangible asset? Intangible assets are described as “non-physical sources of expected benefits” (Zambon, 2003) Intangible assets come in the form of intellectual property, skills, knowledge and attitude of staff in a company According

to Phil Preston (2011), intangible assets account for up to 80% of stock market valuations in developed countries The instance of intangible assets of Coca-Cola is given to clear the importance of this kind of assets According to Stock Analysis on Net (2013), intangible assets of Coca Cola can be divided into three categories includes intangible assets with definite lives subject to amortization, intangible assets with indefinite lives not subject to amortization and goodwill After considering figures and facts combining with the history of intangible assets, the company realizes that its intangible assets is a significant part of the company Intangible assets is determined by Coca Cola can be amortized, primarily on a straight-line basis through their lifetime and they varies from 1 to 20 years The company, understanding the importance of these assets, is taking the matter of recognizing the value of these assets into consideration

3.2 Kinds of intangible assets

Intangible assets are divided into three categories: Intangible assets with legal rights, Goodwill or Non-separable Intangible Assets, and separately identifiable Intangible assets Warfield, Terry D and Weygandt, Jerry J (2001) shows the basic knowledge about intangible assets: