Reporting recorded assets and liabilities
The purpose of this webpage is to examine further the logic and the methodology which underlie the traditional manner in which assets and liabilities are recorded and depicted on the balance sheet. First, we discuss the conventional historical cost valuation of assets and the implications of this method of valuation for balance sheet purposes. Second, we discuss the adjustments to historical cost values which are made at the stage of preparing the balance sheet. Third, we review the implications of the variety of different results obtained from traditional accounting practices. In this webpage, therefore, the concern is with historical cost valuation. The discussion of current cost accounting is deferred.
The financial accounting conventions may be said to have their origin in the concept of stewardship accounting. A number of these conventions have a determining influence on valuation for financial reporting purposes, and reflect the stewardship concept of financial reporting as regards the manner in which boards of directors should communicate information to shareholders about the way in which their funds have been handled. For example, when a transaction occurs, it is said that both parties to the transaction are agreed as to the exchange value of the asset involved: that value may be verified at that point, that is, it is an objective measure of value for accounting purposes. It follows, therefore, that the cost of acquiring assets has traditionally been thought to provide the best method of valuing assets for financial reporting purposes on the assumption that the objective of financial reporting is to explain to shareholders how their funds have been handled.
Since the stewardship concept of financial reporting has its roots also in the prevention of frauds, it is interesting to note that one of the major arguments in favour of historical cost valuation is the prevention of fraud. Accountants feel that to depart from this basis of valuation would open the way to fraudulent practices since other measures of value are essentially in the nature of opinions.
We shall note that the convention of conservatism leads to a modification of the cost convention in certain cases, and to reporting to shareholders the lowest likely value. If the realizable value of stocks, for example, is lower than its historical cost value, the convention of conservatism requires that the realizable value be adopted.
The convention of consistency requires that once a basis of valuation has been adopted, it should not be changed except for valid reasons.
Finally, it should be noted that Company Law stipulates the manner in which values should be reported. In the United Kingdom, the law generally reflects the conventions of accounting, and in this respect, we may say that in developing legal rules for financial reporting, the law has followed its tradition of codifying conventions existing among practitioners.
This Section of the website has been concerned with the accounting procedures for preparing and presenting the two main financial reports, namely, the income statement and the balance sheet.
The extraction of the trial balance at the close of the accounting period marks the first stage in the preparation of these reports. Earlier webpages have examined the adjustments required for the purposes of periodic measurement. These include accurals, depreciation and adjustments in respect of bad and doubtful debts. All these adjustments are effected informally on working sheets, and once they have... see: Losses in Asset Values Summary