Standard Setters Case Study
a) In your opinion, why do standard setters require measurement methods other than traditional historical cost accounting?
At the beginning, traditional historical cost accounting practice were designed to allocate financial results across reporting periods and record the outcome of transactions. Under this approach, revenue is recorded when it is realized while expenses are matched in the same reporting period as revenue. However, in 1980s accounting standard setters began to shift away from this approach because the combination of historical cost and loss recognition impacted financial results to be separated from economic reality. Other than that, standard setters prefer measurement methods due to the fact that historical cost accounting
allow managers to earn greater profits using excess reserves and selective sales of securities and it is also considered as a poor measurement approach in inflationary markets. In addition, derivatives and structured investments hardly to be measured in a proper way using traditional historical cost accounting approaches. Thus, Financial Accounting Standards Board (FASB) started to introduce the application of fair value measurement in accounting standards. Accounting standard setters analysed that measurement method lead towards a more principles based, objectives-oriented approach and it was argued that measurement method tend to reduce the complexity of accounting rules and increase transparency in the preparation of financial statements. Furthermore, measurement method is capable in minimizing chances for financial engineering whereas technical compliance is achieved but evaded in terms of standard. Other than that, standard setters move towards measurement method as it properly anchors the standard setting process by ensuring the robust conceptual planning to the underlying economic reality. In addition, since valuation is the primary driver of accounting results, standard setters move towards measurement method as it serves as the anchor for the asset/liability approach because historical cost accounting is considered irrelevant. Thus, most accounting standard setters determined that measurement method offers timely, transparent and accurate information to investors when compared to traditional historical cost accounting method in the preparation of financial instruments.
At the beginning, traditional historical cost accounting practice were designed to allocate financial results across reporting periods and record the outcome of transactions. Under this approach, revenue is recorded when it is realized while expenses are matched in the same reporting period as revenue. However, in 1980s accounting standard setters began to shift away from this approach because the combination of historical cost and loss recognition impacted financial results to be separated from economic reality. Other than that, standard setters prefer measurement methods due to the fact that historical cost accounting
allow managers to earn greater profits using excess reserves and selective sales of securities and it is also considered as a poor measurement approach in inflationary markets. In addition, derivatives and structured investments hardly to be measured in a proper way using traditional historical cost accounting approaches. Thus, Financial Accounting Standards Board (FASB) started to introduce the application of fair value measurement in accounting standards. Accounting standard setters analysed that measurement method lead towards a more principles based, objectives-oriented approach and it was argued that measurement method tend to reduce the complexity of accounting rules and increase transparency in the preparation of financial statements. Furthermore, measurement method is capable in minimizing chances for financial engineering whereas technical compliance is achieved but evaded in terms of standard. Other than that, standard setters move towards measurement method as it properly anchors the standard setting process by ensuring the robust conceptual planning to the underlying economic reality. In addition, since valuation is the primary driver of accounting results, standard setters move towards measurement method as it serves as the anchor for the asset/liability approach because historical cost accounting is considered irrelevant. Thus, most accounting standard setters determined that measurement method offers timely, transparent and accurate information to investors when compared to traditional historical cost accounting method in the preparation of financial instruments.