Conventional ing 3n6k4p

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CONVENTIONAL ING BASIC CONCEPTS Objective of ing A large enterprise has caused a separation between owners and managers. That is, the firm has an identity of its own, separate and distinct from owners, creditors, and all other interested parties. According to the stewardship function of managers must be the focus of attention of ants in reporting to external parties. Owners and creditors are primarily concerned about what management has done with the funds entrusted to them. ing theory therefore should explain the concepts of revenue and expense in of enterprise asset-changes rather than as increases or decreases in stockholders’ equity. Income From the traditional point of views, revenues indicate the accomplishments of the firm for the given period, expenses represent the effort expended, and income is correlated with the effectiveness of the firm as an operating unit. Income is a measure of the performance of the managers in handling the resources entrusted to their care and use. The income statement reveals the result of the operations of the enterprise. Cost Attach Traditional ants believe that it is justifiable to use historical cost and to allocate its amount, even if the replacement cost has risen. Therefore, the “cost attach” has been formulated. There are two types of cost: displacement and embodied. Displacement cost denotes what has been given up and sacrified, synonymous with opportunity cost. Embodied cost or absorption cost, relates to the factors of production and has to do with what goes into something. To determine the cost of one product, one simply needs to add up all the attached cost to that particular product. The total of all those attached costs represents the effort expended to produce it, not the value of the product. Therefore the costs attach theory is fundamental in cost ing. But, economists do not accept this theory. They believe there is only one kind of cost, a sacrifice. Flow of Cost The ant’s job is to keep track of the flow of cost, trace the movement of those costs as they flow through the business to achieve the objective of the firm, which is to make a profit. The ant must decide which costs have expired and to be matched against revenues on the income statement. They also determine the unexpired costs which are to be placed on the balance sheet as assets.

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The matching principle is critical point which guides the ant to decide which costs are to be considered as expenses. DEFENSE OF HISTORICAL COST 1. Historical cost is relevant in making economic decisions. As managers make decisions concerning future commitments, they need data on past transactions. They must be able to review their past efforts, and the measure of those efforts is historical cost. a. Historical cost affects the evaluation and selection of decision rules because it directly related to past decision. It also serves as a basic for forecasting the future prices. b. It provides input to the “satisficing” notion. c. It is imposed on the decision maker by his environment. 2. Historical cost is based on actual, not merely possible, transactions. A recording of the actual transaction is made and therefore there is a ing record on the financial statement. Records 3. 4. 5. 6.

of the past transactions are necessary for ability. Financial statements based on historical cost have been found to be useful. The concept of profit is the excess of selling price over historical cost. Historical cost is less subject to manipulation than current cost or selling price. If the price of an asset at the end of the year is lower than it was during the year, this encourages critism of management by stockholders for not having disposed of the asset earlier. Thee are

important reasons for holding an asset other than realizing an immediate profit. 7. Historical cost does not differ materially from current cost. 8. Insufficient evidence to justify rejection of historical cost ing. CRITISMS OF CONVENTIONAL ING 1. Stewardship is narrowly constructed. People want ing information for decision-making purposes. They wish to make predictions about the company’s future cash flows. The more current the information, the more relevant it is. Therefore, using historical cost is not a logical consequence of the objective of ing. 2. The assertion that historical cost attach to goods and services is based on fiction. 3. The task of deciding which costs have expired and which have not is basically arbitrary, because making such judgment is virtually impossible. It is inconsistent also to argue that costs move through the company and gradually expire, whereas revenues suddenly appear, usually on the date the output is sold. 4. Most people believe that conventional ing financial statements are sufficient, although some additional data could be included.