Principles for Financial Reporting

Question: Discuss about the Principles for Financial Reporting. Answer: Introduction: The financial position of any company is revealed through its statement of financial position also known as the balance sheet of a company. It clearly states the various assets that the company owns, the amount of liabilities it has to pay and the shareholders equity fund. The net result is that the assets are always equivalent to the liabilities of a company. The balance sheet discloses the various assets and liabilities by dividing the same into various groups or heads. This makes it easier for the reader to comprehend the financial position of a concern as on a particular date. It is very important to understand that the financial position is revealed not for a period of time but as on a particular date. Measurement of the various assets and liabilities shown in the balance sheet is done using three main measurement approaches namely the entry value, exit value or the value in use. These approaches are further divided into six bases of measurement. The entry value uses cost of acquisition method or the replaceable cost method. The exit value uses the net realisable value method (NRV) or the fair value method and the value in use approach uses the discounting of the future cash flows to present value i.e. the NPV method or the undiscounted recoverable amount (Crane, 2012). Depending upon the entities requirements the base of the measurement approaches are determined. The most common is the historical cost method used for valuing an asset and disclosing the same in the balance sheet. This is basically used for the valuation of fixed assets such as goodwill (intangible asset), plant and machinery (Tangible asset) and furniture and fixtures. From the asset side of the financial statement it is the cost incurred for the acquisition of the asset usually monetary in nature and the other direct expenses incurred in getting the asset to its workable condition. And for the liability the measurement is the cash acquired for incurring a liability. The said method is very much in use by the manufacturing concerns. This method determines the actual cash or cash equivalents outflow in case of an asset or the cash received in assumption of a liability. Further the sanctity of the actual cost can easily be verified. However the said method has its own weakness. This t ype of valuation is not suited for the valuation of current assets (Cooper, 2015). The entry value also uses the measurement basis the replacement cost. This is considered to be the most effective way in which the investment of the stakeholders of an enterprise can be measured. However the said method has lot of issues attached to it which makes it less popular amongst the entities. Most of the time the asset which is being valued using this method is difficult to find the replacement value if a similar or identical asset is not available. Thus the crux of valuation gets defeated (Intermediate Accounting, 2007). The next two bases of measurement i.e. the NRV method and the fair value method which is used in determining the value of the assets and liabilities using the exit value method is also not full proof in nature. The same also has its own strengths and weaknesses, thus depending upon the kind of asset and liability to be valued, the same is applied. These two are the most common methods used by most of the companies. The Net Realisable Value of an asset is basically the estimated price that will be fetched on selling a product in the ordinary course of business after deducting the sale proceeds with the cost of production and other selling and distribution expenses (Accounting Standards Board. 1999). This method ensures that revenue is recognized only when the process of conversion of an event to asset is assured and on the verge of completion. The strength of the NRV method is that it enables recoding of the assets and liabilities on actual basis instead of any valuation methods. The most important factor in this method is the time of occurrence. Valuation of inventories generally take place using the NRV method only (Bank, E. 2015). The fair value method is another exit value approach which uses the method of determining the exit price of an asset or a liability at a particular date from the viewpoint of the holder of the asset or the liability owner. This method though seems to be simple, is actually a complex one with regards to assets and liabilities whose fair value is not easy to determine. This valuation method is based on three main components, knowledgeable parties, willing to enter into a transaction and arms length transaction. Valuation of all assets and liabilities do not fulfil all these criterions. Thus making the method complex. The biggest strength that this method portrays is to the investors of an entity. They are able to measure the value of the firm basis the fair value that is prevalent at that particular point of time (Way, 2015). Lastly is the value in use approach which also uses two bases namely the discounting of the future cash flows to the present value, NPV method and the undiscounted recoverable amount. The NPV method is not very useful in valuing the liabilities of a firm. It is more useful in measuring the investments of a firm. A rupee earned tomorrow will e of lesser value than a rupee earned today. Following this concept the said method discounts the future cash flows from an investment in todays term so that the actual worth of the investment can be analyzed by the shareholders and the investors of the entity (Kinney Raiborn , 2012). The biggest strength of this method is that it enables one to understand whether the investments made by the company is worth or not. It takes into account the various risk factors associated with an investment. The biggest weakness that entails in this method is too much assumption. Further it fails to compare projects of varying size. Further it can be applied to very limited asset class of an entity (Zizlavsky, 2014). Our balance sheets have a class of assets and liabilities that are subject to periodic impairments such as discontinuing operations. The method of recovery of these assets are undiscounted as it is not recoverable in the ordinary course of business. This method is not suitable for the major portion of the financial statements. It has a very limited application(accountingtools.com. 2015). I have chosen GP Batteries International Limited, a company who is into the manufacturing and distribution of batteries and battery related products. It is listed in the main board of the Singapore Stock Exchange. It is one of the primary suppliers of the main as well as rechargeable batteries across the globe to various manufacturers of equipments. The company also caters to the retail segment. The company has factories located in Singapore, China, Taiwan, Hong Kong and Malaysia. The company finalized its annual report for the year ended 31st March 2016 on 27th of May 2016 (Gpbatteries.com, 2016). On analyzing the financial report of the group as a whole the companys non-current asset class are many. However I chose to discuss upon the Investment properties and the Property, Plant and Equipment. The study of the investment properties reveal that there has not been any disposal or fresh entry of any investments in the year vis a vis the last year wherein there was a significant amount of disposal of investment property. The company measures the same by using the fair value method. An independent appraiser is appointed by the company with commendable professional qualifications with adequate experience in the location in which the property is stated. The company uses this method as it enables them to determine the current value of the property based on the recent market value that the same would fetch if sold immediately. Thus it looks into the fact that how much would a similar property fetch in the same location. This method will enable to give a clearer view to the stakeholde rs of the company about the value of the investments made in property by the concern. But the biggest disadvantage that lies is finding a competent valuer in the location where the property is located. Further if there do not exist any similar property in the vicinity then valuation becomes cumbersome and is also not reliable (Isda.org. 2002). The next category in the non-current assets are the property , plant and equipment which are indispensable part for any concern. It is very difficult for any organization to work without the basic property and the equipments. The company is observed in using the value in use method for the measurement of the said category of the non-current asset. A review of some of the plant and equipment and the property is done with regards the recoverable amount and the impairment loss was recognized so as to ensure that the present carrying amount of the said assets become equivalent to the actual expected recoverable amount. Te company uses a discount rate of 10.4% for discounting the future cash flows expected from the use of the existing property, plant and equipment. The same is advantageous to the company as they come to know whether a particular asset needs replacement and helps to analyze the cost and benefit in depth. This makes the decision to replace or not easy. The only disadvantage that is felt in this kind of a valuation though realistic and most apt for the said class is the discount rate assumption. This is a complex task and a small mistake in determining the same may lead to misappropriation of the cost of property, plant and equipment. Similar to the non-current assets, for any company its current assets are also of utmost importance as it enables one to understand the amount that can be fetched from the sale of immediate asset. The two classes which I would be considering here are the bank balance, deposits and cash and the receivables and prepayments. The bank balance, deposits and cash comprises of two sections one is the bank and cash balance which is captured on actual basis without the application of any measurement base as the amount in hand is what should be written. The fixed deposits are however measured at fair values. These are very short term deposits which are easily convertible to cash as the maturity period is three or less than three months. Thus measuring the said asset class using the exit value method is the best as these are most liquid in nature. The second current asset class in discussion is the receivables and prepayments. These are also known as sundry debtors and the prepaid accounts. Every trade whether retail or wholesale is conducted on credit. It is no possible to conduct a business purely on cash basis. Thus trade receivables are receivables which do not carry any interest component until and unless the due date for payment has crossed. They are recognized in the financial statement basis the actual amount receivable until and unless the collection seems to be doubtful in nature. In such a scenario a provision is made and impairment is done. The provision for bad debts is basically the difference between the carrying amount and the actual expected realization amount. The company does not seem to make any allowance for bad debts for the year 2015-2016 as it considers all its debtors to be good and thus they are being recorded at the fair value (Gp-industries.com .2016). Thus it is well understood that the most prevalent method used by various companies are the fair value method. This enables to give a very true picture of the asset liability position of an organization. Howsoever the fact cannot be denied that each measurement approach has its own pros and cons due to which no company can use a single type of an approach. Depending upon the asset class the approach is applied. But it is to be ensured that the same should be applied on a consistent basis year on year so that comparability becomes easy. References: Accountingtools.com. (2015). Value-based Pricing. Retrieved from https://www.accountingtools.com/value-based-pricin Accounting Standards Board. (1999). Statement of Principles for Financial Reporting. Retrieved from https://www.frc.org.uk/Our-Work/Publications/ASB/Statement-Statement-of-Principles-for-Financial-Re.pdf Bank, E. (2015). The Net Realisable Value Method of Accounting. Retrieved from https://smallbusiness.chron.com/net-realizable-value-method-accounting-65552.html Cooper, S. (2015). Taking a measured approach . Retrieved from https://www.ifrs.org/Investor-resources/Investor-perspectives-2/Documents/Investor-Perspectives_Taking-a-measured-approach.pdf Crane, L.M. (2012). Measuring Financial Performance: A critical key to Managing Risk. Retrieved from https://msu.edu/user/steind/financial_measures.pdf Gp-industries.com, (2016). GP Industries Limited Annual Report 2015-2016. Retrieved from https://www.gp-industries.com/IR/data/_uploaded/file/Annual%20Report/2015-2016/GP_Ind_2015-2016_Annual_Report.pdf Gpbatteries.com, (2016). Corporate Information. Retrieved from https://uk.gpbatteries.com/uk_en/corporate-information Isda.org. (2002). Explanation and Benefits of Fair Value Accounting. Prepared by The Bond Market Association, International Swaps and Derivatives Association and Securities Industry Association. Retrieved from https://www.isda.org/speeches/pdf/FV101_2.pdf Intermediate Accounting, (2007). Recognition and Measurement Concepts. Retrieved from https://highered.mheducation.com/sites/0072994029/student_view0/ebook/chapter1/chbody1/recognition_and_measurement_concepts.html Kinney, M.R., Raiborn , C.A. (2012). Cost Accounting- Foundations and Evolutions. South Western Cengage Learning : USA Way, J., (2015). Advantages and Disadvantages of Fair Value Accounting. Retrieved from https://smallbusiness.chron.com/advantages-disadvantages-fair-value-accounting-20577.html Zizlavsky, O., (2014), Net Present Value Approach : Method for Economic Assessment of Innovation Projects, Procedia- Social and Behavioural Sciences, 156, 506-512