Valuation and Measurement
Valuation is used by investors to know how much the company are worth, so regularly have to publish the value of their assets and liabilities.
Valuation is deciding how much something is worth.
Measurement is determining how big something is.
Measurement is used to calculate their profits or losses their managers need this information and so do shareholders, bondholders and the tax authorities.
Accounting policies are their way of doing their accounts.
Range of methods of valuation that are accepted by law or by official accounting standards.
- In USA use GAAP (generally accepted accounting principles).
- In most of the rest of the world use IFRS (international financial reporting standards), set by the internasional accounting standards board.
Technical rules or conventions are accepted ways of doing things that are not written down in a law.
Businesses can choose among different accounting policies, the have to be consistent using the same methods every year is called consistency principle.
The policies also have to be disclosed or revealed to the shareholders.
The annual report will contain a ‘statement of accounting policies’ that mentions any charges that have been made that enables shareholders to compare profits and values with those of previous years.
Depreciation is reducing the value of assets in the company’s accounts.
Provisions are amounts of money deducted from profits.
Areas in which the choice of policies can make a big difference to the final profit figure include
- the valuation of stock or inventory.
- the making of provisions for future pension payments.
Historical Cost and Inflation Accounting
The aim of accounting standards is to provide shareholders with the information that will allow them to make financial decisions.
The reason countries accounting follows the historical cost principle :
- companies record the original purchase price of assets and not their estimated current selling price or replacement cost.
- more objective.
- the current value is not important if the business is a going concern as its assets aren’t going to be sold or don’t currently need to be replaced. Going concern is a successful company that will continue to do business.
Some countries with regular high inflation like south America use inflation accounting system that take account of changing prices.
One system used is replacement cost accounting, which values all assets at their current replacement cost.
Replacement cost is the amount that would have to be paid to replace them now.