ACT5401: ACCOUNTING THEORY

COURSE CONTENTS:

1. Introduction
2. Methodology of Accounting Theory
3. Conceptual Framework of Financial Accounting
4. The Equity Theory
5. The concept of Income and Income Measurement
6. Methods of Assets Valuation
7. Accounting Standards
8. Alternative to Historical Cost Accounting Method
9. Historical Development of the Accounting Profession in Nigeria

LESSON 1

GENERAL INTRODUCTION:

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What is a theory?

The word theory means different things to different people; this arises because
explanations are made at different levels.

At one extreme theories or theory are generalizations which serve to organize masses of
data in order to establish significant relationship from that data. Data constitute the
facts and significant relationships developed through reasoning (Glautier, Underdown
and Morris, 2011). Belkaoui (2004) a theory, therefore, includes propositions linking
concepts in the form of hypotheses to be tested. The elements included in a theory are
concepts propositions and hypotheses, linked in a systematic structure to allowed
explanation and prediction.

The construction of theory requires a process of reasoning about the problems implicit
in the data under observation, as means of distinguishing the basic relationships. Thus,
theory construction is a process of simplification, which requires assumptions that
permit the representation of reality by a generalization that is easily understood
(Glautier, and Underdown, 2001). Therefore, a theory is a formal set of ideas that is
intended to explain why something happens or exists. It comprises of the principles on
which a particular subject is based. Thus, theories are concerned with explanations
which, relates to a set of observations in a theoretical construction of reality which fits
those observations. If no theoretical scheme that does this reasonably well is available,
the desire for explanation leads to the creation of a scheme of ideas which provides a
definition of the problem observed; as well as an understanding of it; in the form of
explanation. In both cases, relating observations to existing theory, and constructing
theory to fit observations, have the objective of providing an explanation of those
observations (Glautier and Underdown, 2001).

Hawking (1995) a theory is a good theory if it satisfies two requirements (1) it must
accurately describe a large class of observations on the basis of a model that contains
only a few arbitrary elements. (2) It must make definite predictions about the results of
the future observations.

Theory Construction process

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The following represent the general steps in formulation of a theory

World of facts

Recognition of a problem

Collection and organization of data

Formulation of proposition and definitions

Development of hypotheses

Testing hypotheses

Theory verification, modification or rejection

Theory acceptance

ACCOUNTING THEORY

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Definition; Accounting Theory is an organized body of knowledge which deals with
order, reasons, relationships, objectives and methods involved in the practice of
accounting. In the words of Watts and Zimmerman (1986) accounting theory seeks to
explain and predict accounting practice. They see accounting as positivist theory but
even though it study situation and discover problem, it seldom suggest remedy to these
problem.

Hendrisen and Van Breda (2001) define accounting theory as a coherent set of
hypothetical, conceptual, and pragmatic principles forming a general frame of
reference for inquiring into the nature of accounting. Wolk et al on their site view
accounting theory as the basic assumptions, definitions, principles and concepts and
how we derive them and the reporting of accounting and financial information.
Moreover, Hamid (2009). See Accounting Theory as the summation of accounting
literature, postulates, principles assumptions, statues, standards etc, which guides the
production and reporting of accounting information.

THE ROOTS OF ACCOUNTING THEORY

The roots of accounting theory are located in decision theory, measurement theory
and information theory.
1. DECISION THEORY:
Traditionally, the focus of attention among accountants has been the measurement of
profits (income). But in last 2 to 3 decades, the changing social attitudes, the
developments in information technology, quantitative techniques and the behavioral
sciences have all combined to shift the focus of attention in accounting away from
income theory alone towards decision theory.
Decision theory as noted by Glautier and Underdown (1978) is said to be partly
descriptive and partly normative. It is descriptive in the sense that, it attempt to
explain how decisions are made, it is normative in that, it attempts to throw light on
how decisions ought to be made i.e. it is concerned with establishing standards for the
best, or optimal, decision.
The decision theory is based on the, premise that a proper understanding of
accounting may be obtained only by seeing its essential purpose as providing
information for decision making.

2. Measurement Theory:
Measurement has been defined as the assignment of numbers to the attributes or
properties of objects being measured. It should be clear that we do not measure
objects themselves but rather something that might be termed the Naira, dollar, pound
“numerosity” or “how – much ness” that relates to a particular attribute of the object.

Types of Measurements

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The relationship between the measuring systems itself and the attributes of the objects
being measured determines the type of measurement. The most widely used types of
measurements available include the following:
 Nominal Scale: A nominal scale is nothing more than a simple classification
system, a system of names. An instance is to assume that all the B.Sc
(Accounting), UDUS come from three states i.e. Kano, Lagos and Enugu. Under
the nominal scale, if one wishes to classify the students by state, a 1(one) might
be assigned to Kano, a 2 (two) to those from Lagos and a 3 (three) to Enugu
students. In this example the numbering system serves no other purpose than
to classify by state. In accounting however, a chart of accounts provides a good
instance of nominal classification.
 Ordinal Scale: The next in the measurement rigor is the ordinal scale.
Numerals assigned in ordinal rankings indicate an order of preference.
However, the degree of preference among ranks need is not necessarily the
same. Assume that Four candidate are running for NUASA’s presidency. A
voter’s ranking might be Abdul first, John second, Hassan third, and Jacob
fourth. However, the voter may see a virtual toss – up between Abdul, John and
Hassan, either of whom is vastly prepared to Jacob. In accounting, however,
ordinal measurement is used to determine liquidity in the balance sheet.
 Interval Scale: In the interval scales, unlike ordinal rankings, the change in the
attribute measured among assigned numbers must be equal. An instance is a
Fahrenheit temperature scale, the increase in warmth from 5o to 6o is the same
as that from 15o to 16o or any other increase in temperature of 1o
 Ratio Scale: Like the interval scale, the ratio scale assigns equal value to the
intervals between assigned numbers, but it also has additional feature.

Information Theory;
The purpose of information as it is argued, is to enable an organization to reach its
objectives, through proper and efficient utilization of its other resources such as
human, machine, materials, and other assets and funds (money).
Given the fact that information is also a resource, the information theory concentrates
or considers the problems of its utilization. These problems are costs associated with
the collecting and processing data and disseminating information as out put to users.
The total cost of producing information increase directly with the volume of
information disseminated; because extending disclosure of information may require
more staff and beyond certain extent, or point, installing expensive data processing
equipments and gadgets and hence the MC (Marginal Cost) of producing information
tends to increase at increasing rate with volume.
The relationship between marginal cost of information and its marginal value could be
expressed as: As the volume of information increases the marginal cost increases at a
faster rate and as such the additional benefit or marginal utility of the information
decreases.

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 HISTORICAL DEVELOPMENT OF ACCOUNTING

The Pre-Christian Era

Excavations conducted by archaeologists invariably discover evidence that accounting

was a feature of early civilizations? There are respectable hypotheses that both writing
and arithmetic originated in the need to keep accounts, and that this first took place at
the time of man’s transition from hunter to cultivator. The origins of capital, in the form
of a store of food, are also the origins of accounting.

Many of the early records which are recognizable accounts, or the raw materials of
counts, lack those systematic attributes of form and content with which we associate
accounting today. They consist mostly of inventories, lists of commodities used as
payments, contracts of sale or loan, and, more rarely, simple journal entries.
Nevertheless, ancient accounts were both used and useful; a modern archaeologists,
studying the records which were kept by the Chaldean merchant Ea-Nasir nearly five
thousand years ago, was able to assert that he was trading at a loss.

The force which provided the necessary impetus for the development of modern
accounting was the introduction of money as a means of exchange as with so many
other discoveries it appears that the Chinese were the originators of this practice and
that they used coined money some two thousand years before it appeared in Europe.
Although Western knowledge of Chinese accounting in ancient times is very limited,
we do know that sophisticated forms of government accounting, including both
historical accounting and budgetary control, existed in China as early as 2000 B.C.,
accompanied by an audit function performed by a high and independent public official.

The coinage of money having a uniform value, therefore, suitable for use as a medium
of exchange, first took place in Europe in the seventh century B.C. Greek civilization,
based on the secularization of an economy previously controlled by the priests,
possessed a sophisticated system of public administration with accounting and auditing
functions, of which details have survived. Banking and other commercial activities were
conducted in ancient Greece, and accounting played an important role in them.

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No doubt the Goths and Visigoths did their part by destroying all remaining physical
records. Tantalizing glimpses of Roman accounting occur in the legal codes of Gaius
and Justinian, in the orations of Cicero, and in other literary sources. From these it has
been surmised that the Romans used the bilateral account form and even that the
double-entry system was known fifteen hundred years before Pacioli.

We do know that large-scale commercial and industrial operations were a characteristic

of the Greek and Roman civilizations, and that they operated complex organizations
such as banking, shipping, and insurance. From the Zen on papyri and other records we
know that basic principles of accounting, planning and control such as budgeting, the
journal entry, financial reporting, and auditing were used by the Greeks, and therefore
probably by the Romans. We are on more certain grounds when we view the modern
history of accounting.

The Rise of the Double-Entry System

The destruction of the Roman and Byzantine civilizations was followed by a period of
European history known as the Dark Ages. The feudal system of political organization
rescued Europe from chaos and provided the stability necessary for the creation of
economic surpluses. These surpluses represented the capital base on which the
economic development of the middle Ages was built. The conversion of a subsistence
economy into a money economy was effected by the Norman adventurer-kings. The
medieval period, therefore, saw the existence of conditions favorable for the
development of accounting.

This development took place as several levels : government, business and the medieval
manor. Apart from banking, the conduct of business was largely a function of small
traders and artisans who kept accounting records of a crude memorandum nature,
sufficient for their restricted information needs. Large-scale business operations were
carried on by the banks and the church, the latter through the manorial system, and we
find the banks using financial accounting based on principles which eventually became
double-entry bookkeeping, and the manors using management accounting, based ones
sentially statistical models.

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We have mentioned the use of the bilateral account form long before this period. The
integration of this form into a system of double-entry accounts appears to have evolved
during the twelfth or thirteenth centuries A.D. It may or may not have been an
invention of the Italians who at that time dominated banking, trade, and what little
manufacturing there was. Largely as a result of the Liber Abacciof Leonardo of Pisa, the
Italians adopted Arabic in place of Roman numerals, which was an additional factor
favoring the expansion of the concept underlying accounting.

Although it is believed that the idea of double-entry was originated by banks, the oldest
surviving record which incorporates double-entry principles is the Giovanni Farolfi
branch ledger (Salon, France) for the year 1299-1300. More familiar are the double-entry
trading accounts of Donald Soranzo and Brothers, merchants of Venice, from the first
quarter of the fifteenth century. The method of Venice became the model for the
celebrated exposition of double-entry bookkeeping published by Pacioli in 1494. The
first professional organization of accountants was founded in Venice in 1581. The
method of Venice then spread throughout the world, partly through translations and
plagiarisms, partly through being transplanted to other countries by Ventian traders
and clerks.

Giovanni Farolfi and Company was a firm of Florentine merchants, and it is noteworthy
that the banking and manufacturing center of Florence experienced a parallel
development of double-entry bookkeeping during the same period as Venice. In fact,
Florentine accounting appears to have been more sophisticated than the method of
Venice and more comparable with modern accounting systems. Datini (1335-1410)
conducted a large-scale international business what is today being called a multi-
national corporation using a full double-entry system of accounts for the control of
foreign as well as domestic operations. The Medicis not only kept complex accounts for
their banking operations, but also integrated cost accounting records for textile
manufacturing. In these latter records we find the first examples of accounting for
depreciation, interest on capital, and cost of production.

The Industrial Revolution and the English Companies Acts

The industrial revolution, which is conventionally regarded as beginning in the 1760s

with the invention of power machinery, had several consequences of far-reaching
importance to the history of accounting. One was the growth of the large-scale
enterprise, beyond anything previously known, requiring quantities of capital greater
than could be provided by one man or one family.

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The demand for capital involved increasing numbers of savers in investment situations,
either directly or through financial intermediaries such as banks and insurance
companies. The corporation proved to be the most satisfactory form of business
organization from this point of view. As more and more individuals and institutions
were involved as stock holders, in this situation the owners of the business were no
longer able to inform themselves by keeping accounts for its operations, because they
took no part in the management of the enterprise. To afford these outside investors a
measure of protection, the British government introduced a succession of Companies
Act. These laws placed certain obligations on the promoters and managers of
corporations as part of the price they had to pay for the privilege of incorporation. The
1844 Act required the directors of a company to supply the stockholders with audited
balance sheets annually, and the 1865 Act provided a model form of balance sheet for
this purpose. This legislation has been progressively supplemented and refined to the
present day. It is aimed at providing investors and other financiers with audited
information in the form of accounts on which to base their investment and
disinvestment decisions and from which to judge the manner in which the directors of
the corporation have managed the business.

The lengthening of the time period of production had two principal effects. These were
the development of business credit, as distinct from investment, and the gradual
transfer of attention from the balance sheet to the profit and loss account.

Business credit, by its nature short-term and revolving, required decisions for which
short-term information about financial position and results was necessary. The need to
prepare more frequent financial statements which would reveal profitability and
liquidity gave considerable impetus to the development of accounting. In the
preparation of financial statements, the analysis of changes in capital became necessary
for a variety of operating decisions. This led to the establishment of rules for income
statement preparation in particular, for calculating depreciation, the valuation of
inventories, revenue recognition, and provision for future expenditures arising out of
past activities.

Evaluation of Management Accounting

Management accounting was used in business, as we know from the Zenon papyri.
These rolls represent the records of the Egyptian estates of Appolonius, finance minister
to the Greek ruler Ptolemy Philadelphus II, which were managed by one Zenon. t is
clear from them that techniques of accounting control, which we associate with the
modern corporate form of business enterprise, were known and understood over two
thousand years ago. No accounting records have survived the fall of the Roman
civilization, which extended from about 700 B.C. to 400 A.D. This has been attributed to

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the fact that the Romans kept their accounts on wax tablets, which turned out to be a
most perishable material.

The industrial revolution led to the growth and refinement of management accounting.
The use of accounting and other quantitative data for purposes of management
planning and control has been noted in Ancient Greece, in the medievalmanors, and by
the traders of the age of stagnation. Some cost accounting was done, varying in
sophistication from the ad hoc calculations of individuals to the integrated systems of
the Medici factories and the French Royal Wallpaper Manufactory.

The complex manufacturing processes and large-scale organization which appeared

during and after the industrial revolution required more detailed and systematic
analyses of costs of production. Thus, the subject of cost accounting, encompassing the
accounts necessary to plan, control, and analyze costs, acquired a separate existence
during the second half of the nineteenth century. This separation of cost from financial
accounting has persisted to the present, in spite of practical and theoretical efforts to
integrate them. For this reason, there appear to be two separate theories of accounting
and reporting, an unsatisfactory state of affairs in that it should be possible to present
one unified theory of accounting.

The Development of accounting standards

For accounting to qualify as a profession, just like any other profession, it needs
standards or a kind of benchmarks to regulate its practice. Glautier & Underdown
(1986) opine that the need for standards arose as a result of the lack of uniformity
existing as to the manner in which periodic profit was measured and the financial
position of the enterprise represented. It is this idea that informed the formation of
bodies charged with the responsibilities of producing accounting standards by several
countries of the world.

McCuller& Schroeder (1982) report that the AICPA established several committees and
boards like the committee on Accounting procedure (CAP) in 1938, Accounting
Principles Board (APB) in 19559, and the financial Accounting Standards Board (FASB)
in 1973 to deal with the need for development of accounting principles or standards.

The establishment of FASB led to the abolition of APB. Similarly, U.K established the
Accounting Standards Committee in 1970, while Nigeria established the NASB in 1982,
all with similar objectives. Thus accounting bodies all over the world engage in the
review of their conventions and standards in order to obtain qualitative practice;
achieve high degree of uniformity and consistency as well as protect the interests of the
stakeholders in the provision of accounting information.

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Question

1. Define accounting theory

2. In note less than 200 words account for the historical development of accounting
under the following periods:

LESSON 2

THE ROOTS OF ACCOUNTING THEORY

The development in accounting theory has been influenced by the technological
changes and advances in knowledge in many other related disciplines. The major
disciplines which have influenced such development are: The decision theory,
measurement theory and information theory.
Decision theory: Traditionally, the focus of attention among accountants has been the
measurement of profits (income). But in last 20 years, the changing social attitudes, the
developments in information technology, quantitative techniques and the behavioral
sciences have all combined to shift the focus of attention in accounting away from
income theory towards decision theory.
The essence of this theory is that decision-making is not an intuitive process but a
conscious evaluation of the possible alternatives that leads to best result or optimizes
the goal. It is a logical sequence that involves the following stages:
(i) Recognition of a problem that needs decision,
(ii) Defining all the possible alternative solutions,
(iii) Compiling all the information relevant to these solutions,
(iv) Assessing and ranking the merits of the alternative solution,
(v) Assessing the best alternative solution by selecting that one which is most highly
ranked and,
(vi) Valuing the decision by means of information feedback.

Decision theory is both descriptive and normative. As a descriptive process it attempts

to explain how decisions are made, while as a normative process it suggests which
decision is to be made. The significance of decision theory as a central construct of
modern accounting theory becomes apparent from the FASB objectives and qualities of
accounting information and the True Blood Committee Report that came down heavily
in favors of decision usefulness of accounting information. But much earlier in 1966, A

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Statement of Basic Accounting Theory by the AAA foresaw the role of accounting
information for such decision usefulness to the managers, creditors and the investors.

With decision theory accounting cannot be viewed as a discipline with practically no

interaction with other operating functions of the business. In fact, accounting functions
are intertwined with managerial analysis because, as an information system it provides
significant meaningful information about the firm both for internal management use
and external financial reporting.

Measurement theory: There is a clear relationship between accounting and

measurement theory. Such relationship has been subjected to extensive analysis by the
eminent writers like Chambers, Ijiri and Mattessich. Accordingly, accounting has been
defined as a measurement discipline that pertains to the quantitative description and
projection of income circulation and of wealth aggregates in explicit monetary terms.

Measurement has been defined as the assignment of numbers to the attributes or

properties of objects being measured. It should be clear that we do not measure objects
themselves but rather something that might be termed the Naira, dollar, pound
“numerosity” or “how – much ness” that relates to a particular attribute of the object.

Measurement can be categorized into:

(a) Direct and Indirect measurement; and (b) Assessment and prediction measures.

(a) Direct and Indirect measurement:

The direct measurement, is a situation where by the number assigned to an object is an
actual measurement of the desired property for e.g. the replacement cost of an
inventory (that is commonly traded) could be determine by multiplying the current
whole sale price by the number of quantity in the store and adding them to determine
the current replacement of the inventory in the store. This is a direct measure. While
when the price is determined through round about means, it is an indirect measure. For
example, trying to determine the current replacement price of an item, that is no longer
commonly traded, as a result of change in fashion or technology.

(b) Assessment and prediction measures

The Assessment measure is concerned with particular attributes of objects. An instance
of assessment measure is valuing marketable security at market price. The
measurement assesses how much cash would be realized if the securities were sold.
While the prediction measure, on the other hand, is concerned with factors that may be
indicative of conditions in the future, for e.g. income of the current year or period might
be used as a predictor of dividend for the following period.

The Measurement Process:

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  The object itself in measurement we do not measure objects themselves but
rather something that might be termed the Naira amount. For e.g. in valuing a
motor vehicle, we measure the value or the Naira amount of the vehicle.
 Attributes being measured – These are particular characteristics that we measure
for e.g. the length, height, weight, how “muchness” of a clothing material the
capacity, durability of an assets.
 The Measurer: This is the person performing the measurement. The measurers
might have different qualification. The level of knowledge and commitment of
the measurer my affect the measurement task.
 Counting or Enumerating – This may vary from simple Arithmetic in a cash
count to statistical sampling in inventory valuation.
 The Instrument available for the measurement task. This may range from a large
computer to calculator to pencil and paper.
 The Constraints affecting the Measurer: The obvious constraint is time

Types of Measurements
The relationship between the measuring system its self and the attributes of the objects
being measured determines the type of measurement. The most widely used types of
measurements available include the following:
 Nominal Scale: A nominal scale is nothing more than a simple classification
system, a system of names. An instance is to assume that all the M.Sc
(Accounting), UDUS come from three states i.e. Kano, Lagos and Enugu. Under
the nominal scale, if one wishes to classify the students by state, a 1(one) might
be assigned to Kano, a 2 (two) to those from Lagos and a 3 (three) to Enugu
students. In this example the numbering system serves no other purpose than to
classify by state. In accounting however, a chart of accounts provides a good
instance of nominal classification.
 Ordinal Scale: The next in the measurement rigor is the ordinal scale.
Numerals assigned in ordinal rankings indicate an order of preference. However,
2the degree of preference among ranks need is not necessarily the same. Assume
that Four candidate are running for NUASA’s presidency. A voter’s ranking
might be Abdul first, John second, Hassan third, and Jacob fourth. However, the
voter may see a virtual toss – up between Abdul, John and Hassan, either of
whom is vastly prepared to Jacob. In accounting, however, ordinal measurement
is used to determine liquidity in the balance sheet.
 Interval Scale: In the interval scales, unlike ordinal rankings, the change in the
attribute measured among assigned numbers must be equal. An instance is a
Fahrenheit temperature scale, the increase in warmth from 5o to 6o is the same as
that from 15o to 16o or any other increase in temperature of 1o
 Ratio Scale: Like the interval scale, the ratio scale assigns equal value to the
intervals between assigned numbers, but it also has additional feature.

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Information theory: The dominant nature of accounting lies in an information
communication system. More precisely, accounting is an application of the general
theory of information to the efficient economic operations. The significance of
information theory to accounting lies in the fact that it is a part of the decision-making
process that reduces uncertainty and thereby provides a means to improve the quality
of decision. Information theory in particular can help accounting to resolve certain
important issuessuch as: What is information? What is the relationship between
information and data? What should be accounting information and what should be the
system orsystems by which to communicate the information?

The term information however, is not easy to define in view of the

psychologicalovertone or personal attitude implied in the term. But accounting being a
Measurementdiscipline as well as an information communication system, we can define
informationas a data that adds to the receivers knowledge, reduces uncertainly, and
communicates a message to influence the users behavior in his decision-making
process. In short,when the receiver of a data reacts to it, it is said to carry information. A
data is thusdistinguished from information. According to Bedford, however, a data
becomesaccounting information only when it is measured and is bounded by the
criteria ofrelevance, verifiability, freedom from bias and quantifiability. The terms,
relevance,verifiability, freedom from bias and quantifiability may be regarded as the
attributes thatprovide internal boundary of the accounting information. Under this
theory, informationis regarded as a resource, the collection, processing and
transmission of which involvea cost. Such costs accelerate with the increase in the
volume of information.

DIRECTIONS IN ACCOUNTING RESEARCH

In words of Abubakar (2015), accounting research is research on the effects of economic

events on the process of accounting, and the effects of reported information on
economic events. It encompasses a broad range of research areas including financial
accounting, management accounting, auditing and taxation.

Accounting research is hard to define because it has shifted over time. As a rough
overview, early accounting research (pre-1960s) was mostly normative (i.e., arguing for

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the “correct” accounting treatment, or what should be). With the advent of the Journal
of Accounting Research, advances in finance such as the efficient market hypothesis,
creation of large data sets and the statistical abilities to analyze them (i.e., computers),
and the publication of Ball and Brown’s seminal work in 1968, accounting research
moved into positive research (i.e., examining what is rather than what should be).
Although this change has had its critics, it has resulted in a significant increase in
research output (and many new journals).

The advent of the Journal of Accounting Research, advancement in finance such as the
efficient market hypothesis, creation of large data sets and the statistical abilities to
analyze them (i.e., computers), and the publication of Ball and Brown’s seminal work in
1968, accounting research moved into positive research (i.e., examining what is rather
than what should be). Although this change has had its critics, it has resulted in a
significant increase in research output (and many new journals).

The following approaches represent particular orientations or directions of accounting

research. They represent a significant change over the purely normative research of
generations ago.

1. The Decision – Model Approach

The decision – model asks what information is useful for particular decisions rather
than what information the users want. From this viewpoint, financial statements based
on entry values, exist value and discounted cash flow qualify as useful possibilities.
Thus the orientation of this approach is normative and deductive. A major premise
underlying this research is that decision makers may need to be taught how to use this
information if they are unfamiliar with it.

The focus of this approach is to provide a valuation system that is useful for making
decisions. The exit - value approach is said to be important and hence, useful because
selling price of assets is relevant to the decision of keeping or disposing the assets. Also
aggregated value of all assets provides a measure of total liquidity available to the
enterprise.

2. Capital Markets Research

The capital market research relies heavily on the postulation of the Efficient Market
Hypothesis (EMH). A significant amount of empirical research shows that prices of
publicity traded securities react rapidly and in an unbiased manner to new information,
hence market prices are assumed to reflect fully all publicly available information. This
proposition has some potential significant implications for accounting. The postulations

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of efficient market hypothesis are that the returns of a security are based on its risk. The
capital market research attempts:

a. To determine or assess the relationship between accounting based measure of

risk (financial statement ratios, for example) and market based risk measures.

b. The effects of accounting policy choice on security price.

3. Behavioural Research

The main concern of the behavioral research is (a) how users of accounting information
make decisions. (b) What information they want. The behavioral research attempts to
find out how accounting information is selected and processed.

4. Agency Theories or Contracting Theory

Agency theory is concerned with the various costs of monitoring and enforcing
relations among various groups, such as management, owners and government. It main
assumptions include: (a) individual acts in their own best self-interests, with managers
trying to maximize their gains such as bonuses; and (b) the enterprise is the locus or
intersection point for much contractual type relationship that exists among
management owners and government. One of the postulations of Agency theory is that
management attempt to maximize their welfare by maximizing the various agency costs
arising from monitoring the contract.

5. Information Economics

This theory stems from the fact that accountants are becoming increasingly conscious of
the cost/and benefits/of producing accounting information. See discussions on
information theory.

6. Critical Accounting: The critical accounting, views accounting as having a

pivotal role in adjudicating conflicts between the corporation and social
constituencies such as labour, consumers, and the general public. Critical
accounting emerges from the amalgamation of two other areas of accounting
developed in the 60s, the public interest accounting and social accounting. Public
interest accounting was concerned with doing Pro bono (free) work of tax and
financial advisory nature for individuals, groups and small business unable to
pay for these services. Social accounting on the other hand is an attempt to
measure and bring into the corporate statements the effects of externalities
(pollution). The critical accounting attempts at solving broad social problem

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LESSON 2
METHODOLOGY OF ACCOUNTING THEORY

The term “methodology” is defined as a body of methods, rules and postulates

employed by a discipline, a particular procedure or set of procedures (John, 1968) the
methodology of accounting theory is discussed within the context of classifications and
approaches to accounting theory. These points are explained below.

A. Classification of accounting theory

Hendriksen and Breda (2001) identified three ways of classifying accounting theory,
thus:

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Theory as language: Accounting is often called the language of business. This
classification relies on the notion that accounting is a language. Theories suggest that
there are three questions that should be asked about a language, the words and phrases
that make up that language: (a) what effects will the words have on listeners? (2) What
meaning if any, do the words have? And (3) do the words make logical sense?

Answers to each of these questions form part of the study of a language. Pragmatics is
the study of the effect of language: Semantics is the study of the meaning of language;
and syntactic is the study of the logic or grammar of language.

Although it’s fair to say that almost all correct research into accounting is pragmatic in
its orientation, semantics and syntactic are also important in accounting theory.
Semantics is important because ideally financial information has economic or physical
content that is agreed to by both the producers and the users of the information.
Syntactic is important in accounting because ideally one piece of financial information
relates logically to another.

Accounting numbers and classifications vary with respect to the degree of

interpretation that can be inferred by the reader of accounting reports. For example, the
item cash in the statement of financial condition is fairly understood to mean what
accountants intend it to mean. On the other hand, the classification deferred charges has
no specific interpretation apart from the structural processes that gave rise to it. The role
of theories that emphasize semantics is to find ways to improve the interpretation of
accounting information in terms of human observations and experience. The FASB in
particular, is working steadily to rid the balance sheet of items lacking in semantic
content.

Theory as Reasoning: The second means of classifying the form of the theoretical
debate is to ask whether they flow from specifics to generalizations (inductive
reasoning). In accounting, the generalizations are often termed postulates. From these,
accountants hope to deduce accounting principles that will provide a basis for concrete
or practical applications. With the deductive method, practical applications and rules
are deduced from the postulates and not from observing practice. With the inductive
method, principles are induced from best current practice.

Theory as Script: Both inductive and deductive theories may be descriptive (positive)
or prescriptive (normative). Descriptive theories attempt to prescribe what data ought
to be communicated and how they ought to be presented: that is they attempt to explain
what should be rather than what is. Inductive theories, by their nature, are usually
positive: but it does not follow that deductive theories are necessarily normative. One
can begin with generalizations about how the world is perceived to be and draw from

18
those specific deductions that are intended to be wholly descriptive. Accounting
theorists are interested in answers to both kinds of questions: the normative that
attempts to discover the best way of accounting for a transaction, and the positive one
that attempts to discover how management and others decide what the best way is for
them. The answers to these sorts of questions, together with the attempt to find these
answers, constitute the subject of accounting theory.

Theory Verification: Verification may be defined as establishing the acceptability, or

the truth of a theory. All theories should be logically sound, but beyond that, the nature
of verification will depend on the nature of the theory being verified: Normative
theories are judged one way: positive theories another Normative, theories including
the theory of verification itself are judged by the reasonableness of their assumptions.
Ideally, the assumptions on which a normative theory is based, and the ground on
which they might be judge acceptable, are stated clearly in the theory. Others may then
reject the normative conclusions, by refusing to accept the assumptions, but the basis
disagreement is then well defined.

B. Approaches to Accounting Theory

There are numerous approaches that are used in solving problems and in taking
decision in accounting. Some of these approaches include, tax approach, legal approach,
ethical approach, economic approach, behavioral approach, and structural approach.

Each of these approaches is relevant, and can be used individually or in conjunction

with another approach, in taking a decision to solve an accounting problem.

1. The Tax Approach: Although tax accounting has different objectives from
financial accounting, various income tax Acts have had a major impact on
accounting practice in many areas. They were important in bringing the average
accounting practices up to the required standard. Even firms that do not produce
financial statements are usually motivated to do so, so as to conform to the
requirements of the tax authorities. This created an improvement in general
accounting practices and in maintaining consistency.
Businesses are assessed a variety of taxes (including company income tax, excise
duties, Value Added Tax (VAT) and capital gains tax) all of which require the
preparation of periodic financial reports to tax agencies (FIRS and SBIR).
Although financial reports prepared by businesses are general purpose in nature,
they are adjusted for income tax purposes, using the tax approach. This is done
by reflecting the provisions of the tax laws on the general purpose statements so
as to conform to the requirements of the tax authorities.

19
 The Legal Approach: The usual question asks here is what is the position of the
law or decisions of judges regarding an item or its treatment in the account. In
establishing a conceptual framework for accounting, the FASB (FASB
Memorandum, 1976), (investigated the use of law to establish accounting
principles Hendriksen and Van Breda, 2001). They noted that, in many situations
there are economic as well as legal issues. For example companies listed on the
Nigerian Stock Exchange, would have to consider the laws relating to the
standards for financial reports established by the Exchange, in addition to the
relevant provisions of Companies and Allied Matters Act (CAMA) 1990, Banks
and Other Financial Institutions Act (BOFIA) 1991, Central Bank of Nigeria
(CBN) circulars, General Accepted Accounting Principles (GAAP) etc in their
reports.

In practice, this approach is applied by businesses. Although, there may be

instances where there is conflict between the legal form and financial reality of a
transaction. In such situations, the financial reality takes precedence over the
legal form, in compliance with the concept of substance over form. For example
in hire purchase transaction, the hire purchaser would have to bring the assets
into his books and depreciates it, as if it belongs to him, even the property in the
good still lies with the vendor, until the hire purchaser pays the last installment,
and exercise the option to buy the asset.

From the above discussion, it can be said that in practice the legal provisions
(CAMA 1990, BOFIA 1991 etc) have greatly enhanced the quality of financial
statements by ensuring the disclosure of minimum information, which is
considered necessary in taking informed decisions by various user groups.

2. The Ethical Approach: A third approach to accounting thought asks the question
whether there is an ethical solution to an accounting problem. Is there something
management ought to be doing? Is this something more than following a set of
International Financial Reporting Standards (IFRS)? In asking these questions, it
does not imply that other approaches have no ethical content, nor does ist imply
that ethical theories necessarily ignore all other concepts. As James (1965) points
out, ethical questions are at the heart of all modern theory.
The ethical approach to accounting theory places emphasis on the concepts of
justice, truth, and fairness of decisions relating to the treatment of items in the
account and its presentation to various users. Information should not be bias or
coloured to influence behaviour in a particular direction. Rather, information
presented should show a true and fair view of the state of affairs of the business.

20
 For example, the recognition of a gain at the time of sale of an asset is reporting
of “true” condition, whereas reporting an appraisal increase in the value of an
asset, prior to sale as income, lacks truthfulness.

3. Structural Approach: Most reasoning in this approach is by analogy

(comparison), which attempts to treat like with like. Using this approach,
accountants attempt to classify similar transactions or, more formally, to seek
consistency in recording and reporting transactions. It is only when they
encounter a transaction which does not fit into a previous mold that they are
forced back to more basic principles (McDonald, 1967; Sterling and Raymond,
1969; Larson, 1996). For example, treatment of payment for patent right,
contingent liabilities, deferred advertisement expenditure, import duties on raw
materials, charges for delivery of items purchase on the internet, etc. can all be
made using this approach. This process of classifying like data with like, and
summarizing them in specific groupings (accounts and ledgers) and further
summarizing the groupings into reports and statements has been called
“compacting” (i.e. compilation of accounting information) (Hendriksen and Van
Breda, 2001).

4. The Economic Approach: Accountants have long attempted to interpret

accounting concepts in terms of economics. In recent years, there have been
veritable explorations of research investigating the correspondence between
economic interpretations and accounting data. Hendriksen and Van Breda
(2001), highlight the three avenues in adopting an economic approach to
accounting. These are the macroeconomic approach, the microeconomic
approach, and corporate social accounting approach.
a. Macroeconomics: A macroeconomic approach attempts to explain the
effect of alternative reporting procedures on economic measurements and
economic activities at a level broader than the firm, such as an industry or
national economy. This is done on the argument that one of the objectives
of accounting is to direct the behaviour of firms and individuals towards
the implementation of specific national economic policies. As such,
national economic objectives require accounting reports that will permit
and even encourage higher dividend and larger capital investments
during periods of inflation. Hendriksen and Van Breda (2001), report that
some countries, notably Sweden, attempt to base accounting concepts and
practices on macroeconomic goals. One of the objectives of this approach
is to report stable earnings from year to year to legitimize the use of
reserve and flexible depreciation policies. The most important question to
ask is how ethical is this approach? Where it is unethical, accountants
should never indulge in it.
b. Microeconomics: A microeconomic approach to accounting theory
attempts to explain the effect of alternative reporting procedures on
economic measurements and economic activities at the level of the

21
 enterprise and the firm. Modern accounting theory, which is founded in
microeconomics, focuses attention on the enterprise as an economic entity
with its main activities affecting the economy through its operations in the
markets. As reported by Wolket al (2001), this view is also adopted by the
FASB in its fundamental premise that financial information has inevitable
economic consequences.
c. Corporate Social Accounting: The microeconomics view of accounting
does not necessarily encompass all the effects companies have on society.
The costs of environmental pollution, unhealthy working conditions and
other social problems are not normally reported by firms. Proponents of
stakeholder analysis argue, with some justification, that traditional
accounting with its emphasis on shareholders is really a subset of a social
accounting with its emphasis on the broader group of stakeholders. The
enterprise theory considers the corporation as a social institution operated
for the benefit of many interest groups (Hendriksen and Van Breda, 2001).
The FASB formally recognized in its conceptual framework that there are
many parties other than present owners interested in financial
information. In the broadest form these groups include, in addition to the
stockholders and creditors, the employees, customers, the government as
a taxing authority, the regulatory agencies, and the general public. From
an accounting point of view, this means that the responsibility of
corporate reporting extends not only to stockholders and creditors, but
also to many other groups and to the general public. Corporations can no
longer operate solely in the interest of stockholders, and it cannot be
assumed that the forces of competition will necessarily protect the
interests of other groups. From a study of thirty firms quoted on the
Nigerian Stock exchange (NSE), Mamman (2004) found that 83% of the
firms present corporate social responsibility performance information on
their financial statements in different formats, but that does not result in a
systematic measurement of externalities (social costs and benefits). This
has reaffirmed what Idoko (1998) found some years ago. In practice in
Nigeria, only big firms see themselves as socially responsible to the
society in which they operate, but small firms and business enterprises do
not see themselves as such. This is in view of the fact that there are in
adequate laws which ensure that all business outfits are environmentally
friendly and socially responsible. This is evident from the level of
environmental pollution through reckless dumping of waste, pure water
polythene bags, and other refuse by business firms throughout the
Country.

5. Behavioural Approach: This approach relies on the insights of psychology and

sociology in the development of accounting theories. The focus in this approach
is on the relevance of information being communicated to decision makers and
the behaviour of different individuals or groups as a result of the presentation of

22
 accounting information (Ijiri and Robert, 1966).Behavioural theories take into
consideration the effect of the actions of accountants and auditors on the
behaviour, reactions and decisions of users of the accounting information. The
most important outside users of accounting information include stockholders,
investors, creditors and government authorities. Thus, behavioural theories
attempt to measure and evaluate the economic, psychological, and sociological
effects of accounting information on the various users of such information. Thus,
where auditors or reporting accountants (in case of public offer of shares), give
their professional opinion on the financial statements, the behaviour and
decision of users is influenced.

THE CONCEPT OF INCOME AND INCOME MEASUREMENT

Introduction:

Despite the wide use of the income concept, there is, however, a general lack of
agreement between accountants, and between accountants and economists as to the
proper definition of income. This disagreement is most noticeable when the prevailing
definitions used in the disciplines of economics and accounting are analyzed.
Although, there is a general consensus that economics and accounting are related
sciences, and that both are concerned with the activities of business firms and deal with
similar variables, there is however, a lack of agreement as to the proper timing and
measurement of income.

Definition of Income

In accounting, business income is generally conceived as the residual from matching

revenue realized against costs consumed. It is also defined as the flow of benefits from
wealth during a given period of time. Borrowing from the field of economics, especially
the definition of a man’s income given by Hicks (1946) (as the maximum value which a
man can consume during a week and still be as well off at the end of the week as he was

23
at the beginning). This, approach of “well off ness” at the end of period as was at the
beginning has been used to determine the business income. From the business point of
view, the economist define business income as, the amount of wealth that can be
distributed to the owner during the period without diminishing the entity’s future
prospects below those that prevailed at the start of the period.

Uses/Objectives of Income

The emergence of income reporting as the primary source for individual decision
making has been well documented, in the accounting literature. Income reporting
serves to aid our economic society, in variety of ways. For example the study group on
Business income documented the need for the income concept in society, Alexander
(1950) noted the following uses of income:

a. Income as a measure of efficiency: Income is used as a measure of efficiency in

two senses: (a) the overall efficiency of a business is assessed in terms of the
income it generates during a particular period. Thus income has become the
yard stick or tends to provide the basic standard by which success is measured;
and (b) Shareholders assess the efficiency of their Investments by making
reference to reported income. Hence, the allocation of investment funds, the
selection of portfolio and the operations of the financial system depend upon
income as a standard by which decisions are taken.

b. Income as a guide to future investment: The selection of investment project is

made on the basis of estimates of future cash flows, after discounting or
incorporating the effects of risk and uncertainty in the decision making process.
In a more general way, however, current income acts to influence expectations
about the future. And, thus investors rely heavily on financial reports to decide
whether to invest, re-invest or divest their interest in any company.

c. Income as indicator of managerial efficiency: Management effectiveness both as

decision makers and as stewards of resources is judged by reference to reported
income. It is in this respect that auditors play a key role in ensuring that the
statement placed before shareholders reflect a True and fair view of the financial
results.

d. Income as a Tax Base: Income of companies and individuals has been used by
government or tax authorities as the base from which to work out taxable
income.

24
 e. Income as a guide to credit worthiness: The firm’s ability to obtain credit
finance depends on its financial status and its current and future prospects. For
this reasons banks and other credit institutions require assurance of a firm’s
ability to repay loans out of future income by broking upon current income
levels a guide post.
f. Income as a guide to Socio-Economic Decisions: A wide range of decisions take
into account the level of corporate income: for example wage bargaining procedures
and price increases are usually justified in terms of income levels Government
economic policies also are guided by level of corporate income as one of the key
social indicators.
g. Income as a guide to Dividend Policy: Despite the fact that there are other
consideration is deciding dividend payment, but reported income has become the
most important factor considered by companies in deciding what should be paid
out as dividend and what should be retained for future investment.

Problems of Measuring Business Income among Accountants

Despite the importance or uses of the income concept, there are multitudes of problems
surrounding its measurement. These are now discussed below:-

a. Definitional Problems: There is generally a lack of agreement as to the proper

definition of the income concept in the accounting literature. This problem is
more pronounced when comparison is made between the definition of income as
used in the disciplines of economics and accounting. The economist measures
income in real terms (with a view to maintaining the capital of a business intact).
The accountant measured income in historic terms, in observance of the
objectivity principle.
b. Another problem associated with the definition is that of the nature of income
itself. Bed ford has identified three: (a) Psychic implies satisfaction of human
want (b) Money income refers to increase in the monetary valuation of resources.
While (c) Real Income – refers to increase in economic wealth.
c. Instability of the Measuring Unit: The monetary measurement unit keeps on
changing year in year out as a result of inflation. The effect of inflation is to
reduce the measured income in real terms. Taking sales revenue as an example,
the accounting measurement of sales revenue will undoubtedly differ each year
even if exactly the same number of units were sold. Much of these changes will
be as a result of changes in the value of the Naira. In contrast, consider a
classroom, if we were to measure its width in feet and inches today, next week,
next year accurate measurement would give the same result each time.

25
 d. Another factor that complicates accounting measurement is that arbitrary
decisions must be made for periodic reporting purposes. For instance,
depreciation, depletion and amortization are allowed in order to measure
income; all these are example of arbitrary and inexact measurement techniques
that complicate the accounting process.
e. The accounting concepts and conventions: Realization: (refers to the formal
recognition of revenue in the computation of income). There has been a great
deal of confusion in accounting literature over the precise meaning of the term
realization and secondly, arguments over the proper timing of income
recognition. In accounting, the use of realization convention results in revenue
being recognized at point of sale and, the timing of recognition usually deferred
depending on the situation or event, for e.g. Revenue is recognized: (i) during the
production process; (ii) at the completion of product; (iii) as services are
performed; (iv) as cash is received; (v) upon the occurrence of event – for
instance, where door to door sales contracts exist. In some developed Countries
rights to cancels or voids contracts exist within certain period of time,
recognition is usually delayed to that up to the expiration and period.
f. The Problem is that, there is no specific criterion by which the accountants can
make judgments as to the most appropriate moments of recognition. Even
though there are various precedents and conventions that provided support for
the recognition of revenues; organization or businesses some time use their
discretions to determine the appropriate timing.

ACCOUNTING VS ECONOMIC CONCEPT OF INCOME

1. Definition:
Accountants defined income as the residual from matching of revenue realized against
cost consumed. Another definition is that, Income is the flow of benefits from wealth
through a period of time.

Economist: The definition of income could be ascribe to (the definition of a man’s

income) ticks, who defines man’s income as the maximum value which a man can
consumer during a week and still expects to be as well off at the end of the week as he
was at the beginning. Borrowing from this definition of “well- off-ness” the economist
defined a business income as, the maximum amount of wealth that can be distributed to
the owners during the period without diminishing the entity’s future prospects below
those that prevailed at the start of the period. The economist definition is concerned
with the concept of capital maintenance.

2. Determination of Networth: The accountant: in his determination of net worth

does not consider price level change or holding gains, resulting from the appreciation of
fixed Assets. The economist considers inflation and holdings gains of fixed Assets.

26
3. The Underlying Assumption of the Income Concepts:

The going concern concept: Accountants have accepted the presumption that, in the
absence of evidence to the contrary, the productive life of the enterprise may be deemed
to be indefinitely long.

a. Cost Expenses:
Accountant: As a result of this postulate the accountant,

 Defers all costs of the enterprise until such time as they have been
consumed by revenue or production process or have expired because of
passage of time.
 Records fixed Assets value at the cost which generally represent market
price at the time of acquisition.
 Ignores later changes in market values of Assets except in the case of
appreciation.
This line of reasoning is justified by the accountant, on the assumption that the
life of the entity is indefinitely long and the cost of the asset will eventually be
completely written off.

Economist – rejects the assumption of the going concern as a basis for

determination of income, for the reason that he values the firm annually. Since
he must first determine the net worth to compute net income, then each year’s
balance sheet is equivalent to terminal determination, except for no provision to
liquidate.

h. Accounts Receivable:
Accountant: - from an accounting point of view, the valuation of accounts
receivable at any given time are valued at the full expected amount to be
collected in the future periods. This is on the presumptions that on a going
concern basis, there is no need to decrease the asset to its present value.

Economist: The economist in order to arrive at his current net worth would
consider accounts receivable at the discounted presented value.

i. Objectivity:
The accountant: because of his intension to utilize accuracy in accounting
procedure, has come to regard objectivity as a major guide post. Thus, the
accountant makes his measurement on the basis of verifiable evidence.
Therefore, changes in assets, liabilities and related effects (if any) on revenue,
expenses and retained earnings are not given formal recognition earlier than the
point at which they can be measured in objective terms.

27
 Economist: The economists, however, does not adhere to the principle of
objectivity in developing his concept of income. There is heavy reliance on
subjectivity and individual judgment in the determination of income. Because
the economist before he can arrive at current net income, he determines the
ability of the firm to earn future income; determine what the total future income
might be (by computing its discounted value); and then arrived at the current net
worth of the enterprise.

j. Realization of Revenue:
Accountant: The accountant takes a conservative view in determining the point
at which income should be recognized. It has become stand practice for
accountants to record income at the point of realization (i.e. point of sale).

Economist: The economist believes that the enterprise at any given time can
recognize income. This is done by making an estimate of the value of such future
income, and capitalizing it as goodwill. The economist believed that if the
estimates are correct, then all the income of an enterprise could be recognized at
the time of its inception, since it represent the difference between future and
present values of its income.

In addition, the economist recognizes income representing holding gains (ie the
current market values of assets) and monetary fluctuations. But the accountant
would not recognize holding gains on Assets until it is realized.

k. Stable Monetary Unit:

Accountant: The accountant adheres to the concept of the stable monetary unit,
and hence, fluctuations in value of monetary unit are ignored.

Economist: The economist is diametrically opposed to this presumption and

takes an adamant position that all changes in price levels must be reflected in
income during the period of such changes. Thus, the economist adjusts for
changes in monetary values from one period to another in order to maintain real
monetary value.

Conclusion:

- The economist and accountant have different objectives in the determination of

income, as well as different concepts of income.
- The accountant measures income independently, and the balance sheet, in effect,
is a residue of prepaid and deferred items.
- The economist maintains successive balance sheets in real terms or values.
- The accountant on the whole, is interested in what is or what has been.

28
 - While the economist is interested in what might be.
- Income of the enterprise from the accountants’ point of view must be realized
and objectively quantified.
- While the economists view point is that income can accrue only after provision
has been made to keep the capital intact. This is done by capitalizing all future
gains or net receipts as goodwill. The economic income is the summation of the
future net receipt plus interest earned on capital plus other unexpected gains
such as appreciation of fixed assets and monetary fluctuations. The economist
therefore deals with certainties and uncertainties.
- The underlying assumption on which economic concepts of income are based
bear heavily on subjective judgment, while the accounting assumptions are
objective in nature.

ASSET VALUATION
Asset Valuation
Valuation is the process of estimating the market value of a financial asset or liability.
Glauteir and Underdown (2001) defined valuation as the process of attaching money
measurements to accounting events and items. Valuation is feasible in both tangible and
non-tangible assets. For instance we can value building, machineries, stocks etc as well
as goodwill, trademarks, patent rights etc. Asset can be valued using either the
historical cost model or alternatives valuation models. The latter models have many
branches amongst which are present value, current purchasing power, current
replacement cost, net realizable value and current value accounting. However, it is ideal
to explain certain terms used in assets valuation, amongst which includes;

 Intrinsic value: is an assets true value regardless of the market price

 Fair market value: this is the cash price an item would sell for between a willing
buyer and willing seller assuming both have perfect knowledge about the
market and the instruments therein and they are not under any compulsion.

Historical cost model

This is a system of valuation where assets are shown or valued on the monetary value
given or received at the data of the transaction (i.e. invoiced price) and the trend would
be maintained throughout the life of the asset. This method is an old system which is
still been practiced by very many accountants and firms. It is the most commonly
applied method. Assets are valued at their original cost after deducting an amount
equal to the usage such as asset put to the organization (Wood and Sangster, 2002).

Nonetheless, there are a lot of criticisms against the validity and the efficiency of the
historical cost system. In an attempt to substitute the historical cost deficiencies, the
antagonists of the system came with various valuation approaches. Scholars who are
supporting the historical cost system have also criticizes the alternatives.

Methodology of Historical Cost Accounting

29
Under the historical cost accounting, cost is the basis for initial accounting recognition
of all assets acquisition, services rendered, creditors and owners interest (Ola, 2001).
Historical cost accounting operates based on two principal assumptions:
Firstly, it assumes that assets purchased many years ago, still cost the same amount
today.
Secondly, it assumes that inventories have a constant price irrespective of the time
when they are to be replaced in the store.
The two principal assumptions have generated a lot of criticisms against the historical
cost accounting basis in recent times. The greatest limitations of the historical cost
accounting concepts have stemmed from its inability to reflect the effects of changing
price levels. But before delving into the details of those limitations, let us first consider
the advantages of historical cost accounting.

Advantages of Historical Cost Accounting

The advantages of historical cost accounting include, among others, the following:

a. Safeguard the Integrity of Accounting Data: Historical cost accounting system

enables both accountants and management to guard the integrity of their data
against internal modifications. The idea of using current cost or exit price as
advocated under the other systems open room for manipulation of these
numbers by management. The integrity of the data is always maintained because
of the fact that the data is supported by evidence such as invoices, receipts, etc,
This can only be achieved under the historical cost accounting system.

b. Provides Significant Range of Alternatives for Measuring Accounting Data:

The historical cost accounting system provides reporting accountants and
managers, with a significant range of alternatives methods in recognizing,
reporting and measuring accounting data. The various methods, for instance, for
the valuation of stock or for the calculation of annual depreciation, all provide
the reporting accountant a wide range of alternatives to choose from, under such
a situation, all that the reporting accountant need to bear at the back of his/her
mind is to be consistent with the alternative adopted. And where there is a need
to change the alternative, adequate explanations should be provided for.

c. Basic cost data provide the basis to forecast future operational costs: Historical
cost accounting system assists managers to plan and forecast future operational
costs. The ability of a manager to make authentic forecast is often based on
previous experience and past actual cost data. Records based on historical cost
accounting system enable accountants and management to set standards and
prepare budgets which consequently promote efficiency in the management of
the company's resources.
d. The basic function of historical cost accounting is to tell an accounting
information user "the cost of a thing". Without knowing the original costs future
projects might be hampered.

30
 e. Provides Reliable And Verifiable Data: Historical cost accounting plays an
important role here by providing reliable accounting information. Since its
principles are based on recording original or actual costs, it therefore does not
only provide a record of actual transactions but also figures that are objective,
reliable, verifiable and most often credible.

f. General Usefulness and Acceptability of Financial Statements: Financial

statements based on historical cost accounting system have over time gain wide
recognition and acceptability. Empirical evidence indicates that various interest
groups, for instance, government, lenders, etc find the conventional financial
statements more useful than those prepared under the dreamt modern
accounting systems. The general acceptability may not be unconnected with the
fact that in all the various accounting systems - conventional and non-
conventional, it is only the historical cost accounting system that is guarded by
legal rules, concepts and conventions (within the framework of generally
accepted accounting practice)

Limitations of Historical Cost Accounting

Despite the advantages of historical cost accounting system as discussed in section three
of this paper, critics have identified flaws in its operation. The flaws identified as
limitations include, among others, the following:

a. Fixed Asset values are Unrealistic: Historical cost accounting system, over a
period of time has been subject to many criticisms, especially as it considers the
acquisition cost of assets and does not recognize the current market value.
Historical cost accounting is only interested in cost allocations and not in the
value of asset. While it tells the user the acquisition cost of an asset and its
depreciation, it ignores possibility that the current market value of that asset may
be higher or lower than it suggests. The assumption that assets purchased many
years ago, still cost the same amount today is hardly a reflection of reality. For
instance, while capital items are valued at historical cost, items related to the year
in which the accounts are prepared such as raw materials, wages and salaries are
valued at current prices. Thus the matching of historical costs such as
depreciation of fixed assets with current revenue (in current prices) may result in
inflated profits which might be paid out in form of dividends. The balance sheet
value of the assets especially fixed assets are understated in relation to their
current market value. Thus return on capital employed may be overstated hence
the performance of the company is exaggerated (Ola, 2001).

b. Depreciation is inadequate to Finance the Replacement of Fixed Assets: This

criterion is generally well understood and, you well appreciated, that what is
important is not the replacement of one asset by an identical new one (something

31
 that rarely happens) but the replacement of the operating capability represented
by the old asset.
c. Another critism of historic cost depreciation is that it does not fully reflect the
value of the asset consumed during the accounting year. The understated
depreciation, overheads and cost of sales result into overstated profits. The
notional profits could then be distributed as dividends, which may eventually
lead to capital erosion.

d. Holding Gains on Stocks are included in Profit: During a period of high

inflation the monetary value of stocks held may increase significantly while they
are being processed. The conventions of historical cost accounting lead to the
realized part of this holding gain (known as stock appreciation) being included
in the profit of the year. It is estimated that in recent years nearly half the
declared profits of companies were due to stock appreciation. Consequently,
since the reported profit includes this holding gain, the tax that the company will
eventually pay to the government may be in excess of what it should have paid.

e. Profits (or Losses) on Holdings of Net Monetary Items are not Shown: In
periods of inflation the purchasing power, and thus the value, of money falls. It
follows therefore, that an investment in money will have a lower real value at the
end of a period of time than it did at the beginning. Indeed a loss has been made.
Similarly, the real value of a monetary liability will reduce over a period of time
and again will be made. Under the historical cost accounting system neither the
losses nor the gains on these items are shown in the financial statements.

f. The True effect of Inflation on Capital Maintenance is not shown: To a large

extent this follows from the points already mentioned. It is a widely held
principle that distributable profits should only be recognized after full allowance
has been made for any erosion in the capital value of a business. In historical cost
accounts, although capital is maintained in nominal money terms, it may not be
in real terms. In other words, profits may be distributed to the detriment of the
long term viability of the business. This criticism may be made by those who
advocate capital maintenance in physical terms and those who prefer money
capital maintenance as measure by naira of current purchasing power.

g. Comparisons over Time are Unrealistic: Historical cost accounting information

tends to create an exaggeration of growth over time. For example, if a company's
profit in 1981 is N2, 000,000 and in 2001 N5, 000,000, a shareholder's initial
reaction might be that the company had done rather well. If however, it was then
revealed that with N2, 000,000 in 1981 he could buy exactly the same goods as
with N5, 000,000 in 2001, the apparent growth would seem less impressive.

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ALTERNATIVES TO HISTORICAL COST ACCOUNTING

Nonetheless, there are a lot of criticisms against the validity and the efficiency of the
historical cost system. In an attempt to substitute the historical cost deficiencies, the
antagonists of the system came with various valuation approaches. Scholars who are
supporting the historical cost system have also criticizes the alternatives.

Current Purchasing Power (CPP)

CPP evolved in the 1980s as result of high inflation rate in UK. According to Wood and
Sangater (2002) CPP is the adjustment of historical costing which uses Retail Price Index
(RPI) in order to arrive at the real capital maintenance. It is a valuation model which
suggests the conversion of historical cost of assets to represent the actual – present cost
of the asset so that they depict the real value of such assets during the time under
review. Pandy (2006) sees CPP as the amount an organization could realize if it sold its
business as an operating business. The conversion can be made using Retail Price Index
where CPP is applied with high degree of objectivity needed, the price level could be
traced easily using the RPI which makes it verifiable. Wolk et al (2001) said there are
two types of valuation method under this method of valuation i.e. exist value - a
valuation approach were assets are valued at the net realizable value if it were to be
sold under normal circumstances rather than on valuation process.

It is ideal if quantitative analysis is used in presenting the CPP for more understanding.
Example, using the CPP valuation approach determines what would be the actual
worth of the two assets which were bought at different times. The first was purchased 2
years back at the cost of N300,000 when the presumed price index was 80 the machine
have 5 years estimated life span. Similar asset was purchased at the cost of N450, 000
and as at the time the price index was 150. It is the policy of the company to depreciate
this category of machines using straight line method.

Replacement Cost Accounting (RCA)

Firms are expected to live a longer life and consequently their resources would be
subjected to replacement time after time. The axiom under this model is that the cost

33
consuming such assets in realizing profit should be equal to their replacement cost
(Glautier and Underdown, 2001). Wolk et al (2001) replacement cost is applicable where
market values for similar assets are available. Pandy (2006), Wood and Sangster (2002)
opined that Replacement cost is an estimated amount that would have to be paid to
replace the asset in a prevailing situation at valuation date. Entry value on the other
hand is the price charge or received when buying an asset or replacing an old one.
Relative value model determines the value of an asset based on the current market
prices of similar assets either on the basis of input or output value i.e. replacement or
net realizable respectively. Absolute value model determines the value of an asset by
estimating the expected future earnings from possessing the asset discounted to their
present value.

Liquidation Value Model:

Under this valuation approach, assets are valued at a price of wind up organization.
Trehan (2007) viewed liquidation model into two units i.e. progressive sale of assets – a
situation where a company is considered to have the ability to progressively sell it
assets and terminate operation in the future. The assets are valued at liquidation value.
A forced liquidation of the company- this method provides for the include liquidation
at the book value, but the liabilities are adjusted to include liquidation related
obligation.

Shortcomings of the Models

Furious debates had in the past occurred both in the international and national level
and are still on. Those who are against the historical cost said it is not wise to use the
cost at which an asset was purchased to represent the value/cost after subjecting it to
business use, for years, particularly during inflation period. The depreciation to be
charged may 10% why the 10%, why not something beyond 10% or less? Why do we
use straight line method of depreciation and not reducing balance method? They
further argued that where a current asset particularly stock is valued using either LIFO,
FIFO WACC etc and in the end the cost of closing stock normally differ, why?
According to the antagonists of the historical cost its doesn’t make sense to add the cost
of same fixed assets bought at different time in one balance sheet as presenting it as if it
were been bought at the same time. Example, machine “A” was bought 5 years back for
N1,500,000 and same type this year at the cost of N3,500,000, making the total asset to
be N5,000,000. This N5,000,000 is what the balance sheet will reflect, which is an
indication that the time value of money is not put into consideration. In other words,
what N100 bought 5 years back is what it will still buy today and even tomorrow. This
according to them is crude and defective, for it doesn’t portray the real financial picture
of the organization.

Those who are not supporting CPP valuation method have this as part of their
argument. Since the main principle underlying the CPP method is the Relative Price

34
Index, what bases are used in selecting an index in a given period of time? Prices in
developing countries fluctuate like no man business, in this regard, how do we
determine the index? Don’t forget the fact that data bank in such countries is nothing to
write home about. The higher the rate of change in price the more inaccurate figure
obtains using the CPP. Worst still, the CPP is using Exposure Draft No. 8 (ED 8) of 1973
which says firms using the CPP must present another separate financial statement apart
from the conventional one indicating the changes. One wonders how costly would the
financial statement be! A lot of individual and in fact even government is not in support
of this approach and that was why Current Cost Accounting (CCA) approach was
created to replace the CPP.

The Replacement approach didn’t go free; there are accusations and criticism against it.
The first is that are we sure that we would get the same asset when we are looking for
one? Are we not subjecting ourselves to the problem of trade by barter? There bound to
be ample negotiation before a conclusion would be reached.

The various valuation methods provide various profits/values if used. And since the
aim of an organized firm is wealth maximization through transparent and accountable
means. High level of prudence and/or conservatism should be applied in valuing any
asset. The following key issues in determining appropriate method are relevance and
reliability.

Relevance: To be relevant, information about an item must have feedback value and/or
predictive value for users and must be timely. Information in relevant if it has the
capacity to make a difference in the decision of owners, investors, creditors or other
interested parties.

Reliability: To be reliable, information about an item must be an item to be

representationally faithful, verifiable and neutral. Information is reliable if it is
sufficiently consistent in its representation of the underlying resource, obligation, or
effect of events, and sufficiently free from error and bias to be useful to the owners,
investors, creditors and others in making decisions. If two methods are equally relevant
and reliable, then a method with lowest cost to the prepared would probably be chosen.

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LESSON 6

HUMAN RESOURCE ACCOUNTING

What is Human Resource Accounting?

American Accounting Association’s Committee on Human Resource accounting (1973)
has defined Human Resource Accounting as “the process of identifying and measuring

36
data about human resources and communicating this information to interested parties”.
HRA, thus, not only involves measurement of all the costs / investments associated
with the recruitment, placement, training and development of employees, but also the
quantification of the economic value of the people in an organization1.

Flamholtz (1971) too has offered a similar definition for HRA. They define HRA as “the
measurement and reporting of the cost and value of people in organizational resources”
Therefore, HRA can be defined as the process of identifying, recording, measuring
human resources and communicated related financial information associated with the
human resource to the interested users.

Human Resource (HR) is though one of the valuable assets of the organization but there
is no statutory regulation to report it in the organization’s annual report. But sometimes
HR value of an organization can exceeds its’ tangible assets value but traditional
accounting systems provide little chance to record and recognize these values of HR.
For instance - a few years back when the Bill Gates declared to retired from the
Microsoft Corporation, share price of the company fall in a large amount. But
traditional accounting suggests no impact on the financial condition of the company but
the actual scenario is totally different.

Mr. Woodruff Jr. Vice President of R.G. Barry Corporation defines it as follows:
.Human resource accounting is an attempt to identify and report investments made in
human resources of an organisation that are presently not accounted for in conventional
accounting practice. Basically it is an information system that tells the management
what changes over time are occurring to the human resources of the business..

In simple words, human resource accounting is the art of, valuing, recording and
presenting systematically the worth of human resources in the books of account of an
organisation.

Why Human Resource Accounting?

In the recent decades concentration is switching from manufacturing organization to
service rendering organization, where human is the main resource. But not only for the
service organization but also human resource accounting is also necessary for the
manufacturing organization to measure their production personnel expertise. The
necessities of the HRA can be as follows –
1. Measuring the expertise of the employees and management of the organization.
2. Find out the true value of the assets and liabilities hold by the organization. As the
expertise of the employees is considered as assets and value to be provided to the
employees are considered as liabilities.
3. Applying a strong monitoring process on the human resources of the organization.
4. It provides the management a sound basis for controlling the humanresource.

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5. Provide a better basis of determining organizational goal and ways ofachieving these
goals.
6. Provide the investors of the organization, shareholders and debt holders,accurate
information for better decision making.
7. Find out the true picture of the future prospects of the organization, as theutilization
of other resources are fully depends on the human resources.
8. Giving the stakeholders information about, how much value addition isdone by the
organization to country’s human resource as part of thecorporate social responsibility.
From the above mentioned data is clear that necessity of the human resourceaccounting
is very much important for the organization.

HAR VALUATION METHODS

The biggest challenge in HRA is that of assigning monetary values to different

dimensions of HR costs, investments and the worth of employees. The two main
approaches usually employed for this are:
1. The cost approach which involves methods based on the costs incurred by the
company, with regard to an employee.
2. The economic value approach which includes methods based on the economic value
of the human resources and their contribution to the company’s gains. This approach
looks at human resources as assets and tries to identify the stream of benefits flowing
from the asset.

THE COST APPROACH

Cost is a sacrifice incurred to obtain some anticipated benefit or service. All costs have
two portions, viz., the expense and the asset portions. The expense portion is that which
provides benefits during the current accounting period (usually the current financial
year), whereas the asset portion is that which is expected to give rise to benefits in the
future. Arriving at a clear distinction between the two, however, remains an accounting
problem even today (Flamholtz, 1999).

Two types of costs are of special importance in HRA. These are original or historical
cost, and replacement cost.
(1) The Historical cost of human resources is the sacrifice that was made to acquire and
develop the resource. These include the costs of recruiting, selection, hiring, placement,
orientation, and on the job training. While some of the costs like salaries, for instance,
are direct costs, other costs like the time spent by the supervisors during induction and
training, are indirect costs.
Sometimes,
(2) Opportunity cost method, that is, a calculation of what would have been the returns
if the money spent on HR was spent on something else, is also used. However, this
method is seen to be not as objective as desired. Hence its use is restricted to internal
reporting and not external reporting.

38
(3)The Replacement cost of human resources is the cost that would have to be incurred
if present employees are to be replaced. For instance, if an employee were to leave
today, several costs of recruiting, selection, hiring, placement, orientation, and on the
job training would have to be incurred in order to replace him. Such costs have two
dimensions- positional replacement costs or the costs incurred to replace the services
rendered by an employee only to a particular position; and personal replacement cost or
the cost incurred to replace all the services expected to be rendered by the employee at
the various positions that he might have occupied during his work life in the
organisation. Though replacement cost method can be adapted for determining the cost
of replacement of groups, this method is used essentially to determine the replacement
cost of individuals. Other cost based methods that may be used are the standard cost
method and the competitive bidding method. In the standard cost method, the standard
costs associated with the recruitment, hiring, training and developing per grade of
employees are determined annually. The total costs for all the personnel signify the
worth of the human resources.

4) Standard Cost Approach

This approach has been suggested by David Watson, According to this approach,
standard costs of recruiting, hiring, training and developing per grade of employees are
determined year after year. The standard cost so arrived at for all human beings
employed in the organisation is the value of human resources for accounting purposes.
The approach is easy to explain and can work as a suitable basis for control purposes
through the technique of variance analysis. However, determination of the standard
cost for each grade of employee is a ticklish process.

5)Present Value of Approach

According to this approach, the value of human resources of an organisation is
determined according to their present value to the organisation. For determination of
the present value, a number of valuation models have been developed. Some of the
important models are as follows: Present Value of Future Earnings Model This model
has been developed by Lav and
Schwartz (1971). According to this model, the value of human resources is ascertained
as follows:
(i) All employees are classified in specific groups according to their age and skill.
(ii) Average annual earnings is determined for various ranges of age.
(iii) The total earnings which each group will get up to retirement age are calculated.
(iv)The total earnings calculated as above are discounted at the rate of cost of capital.
The value thus arrived at will be the value of human resources/assets.

THE ECONOMIC VALUE APPROACH

39
The value of an object, in economic terms, is the present value of the services that it is
expected to render in future. Similarly, the economic value of human resources is the
present worth of the services that they are likely to render in future. This may be the
value of individuals, groups or the total human organization. The methods for
calculating the economic value of individuals may be classified into monetary and non-
monetary methods.

1) Flamholtz’s model of determinants of Individual Value to Formal Organisations

According to Flamholtz, the value of an individual is the present worth of the services
that he is likely to render to the organisation in future. As an individual moves from
one position to another, at the same level or at different levels, the profile of the services
provided by him is likely to change. The present cumulative value of all the possible
services that may be rendered by him during his/her association with the organisation
is the value of the individual.

2) Flamholtz’s Stochastic Rewards Valuation Model

The movement or progress of people through organizational ‘states’ or roles are called a
stochastic process. The Stochastic Rewards Model is a direct way of measuring a
person’s expected conditional value and expected realizable value. It is based on the
assumption that an individual generates value as he occupies and moves along
organizational roles, and renders service to the organisation. It presupposes that a
person will move from one state in the organisation to another during a specified
period of time. In this model, exit is also considered to be a state. Use of this model
necessitates the following information:

1. The set of mutually exclusive states that an individual may occupy in the system
during his/her career;
2. The value of each state, to the organisation;
3. Estimates of a person’s expected tenure in the organisation
4. The probability that in future, the person will occupy each state for the specified time.
5. The discount rate to be applied to the future cash flows.

3) Hekimian and Jones Competitive Bidding Model

In this method, an internal market for labour is developed and the value of the
employees is determined by the managers. Managers bid against each other for human
resources already available within the organisation. The highest bidder ‘wins’ the
resource. There are no criteria on which the bids are based. Rather, the managers rely
only on their judgement.

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ACCOUNTING STANDARDS

The Accounting standards were not in existence up to the end of 1971 anywhere in the world. In

the beginning of 70.s the advent of MNCs, the need was felt of the some prescribed yardsticks in

connection with preparation of accounts, their presentation and reporting mechanism. It all led to

the birth of A.S. at international level as well as national level. The purpose of A.S. was making

A.S. more identical, comparative reliable, for taking better investment decisions and for better

reporting.

In 1970 standard setting board or committees were active in number of countries such the U.S.A.

UK, Canada, Australia, Japan and India. For making identity in the work of committees of so

many countries, a body at international level was being needed.

Then IASC (International Accounting Standard Committee was established in 1973. Such as

institutions/boards are also prevalent in almost all the countries of the world for example:

Financial Accounting Standard Board in USA (FASB).

Accounting Standard Board of U.K. (ASB).

Accounting Standard Committee in Canada (ASC).

41
Accounting Standards

Accounting standards may be defined as uniform rules for external financial reporting which

may be applicable either to all or to a certain class of entity. Accounting Standards may be

viewed as a method of resolving potential conflicts of interest between the various user groups

which have access to company accounts and reports. The various groups will have different

objectives, information needs, and capacities for the generation and interpretation of information

and, therefore, conflicts may arise between groups outside the entity. For example, inflation

accounting may benefit existing shareholders if corporate tax payments are reduced as a result of

lower reported profits. It may also benefit society by improving the allocation of certain

resources. On the other hand, employees may suffer if lower wage settlements are justified by

lower reported profits. Most often, divergent views are found between the preparers (corporate

managements) and external users. Accounting principles have been developed to provide a

system of financial reporting to reflect management’s description of the financial performance of

an entity. In order to do this, they allow flexibility and choice in both accounting policies and the

amount of disclosure. External users, on the other hand, may require consistency and

comparability. These may lead to conflict between prepares and users.

Types of Accounting Standards

Accounting standards may be classified by their subject matter and by how they are enforced.

According to their subject matter Benston classifies standards as follows:

1. Disclosure Standards. Such standards are the minimum uniform rules for external reporting.

They require only an explicit disclosure of accounting methods used and assumptions made in

preparing financial statements. It is argued that the case of this type of disclosure seems

overwhelmingly strong. Such a standard is unlikely to be controversial or create conflicts of

42
interest, particularly since it does not constrain the choice of accounting policies or items to be

disclosed.

2. Presentation Standards. They specify the form and type of accounting information to be

presented. They may specify that certain financial statements be presented (e.g. a funds-flow

statement) or that items be presented in a particular order in financial statements. Such standards

place only a little more constraint upon the choice of accounting policies than disclosure

standards and aim to reduce the costs to users of utilising financial statements.

3. Content Standards. These standards specify the accounting information which is

to be published. Benston recognises three aspects to such standards:

a. Disclosure-content standards which specify only the categories of information to be disclosed.

b. Specific-construct standards which specify how specific items should be reported in accounts,

e.g., a standard which specifies that finance leases be capitalised and disclosed in balance sheets.

c. Conceptually-bases standards which specify the accounting treatment of items based upon a

coherent and complete framework of accounting.

Another classification of accounting standards may be based upon their method of preparation

and enforcement. Benston identifies:

1. Evolutionary and Voluntary Compliance Standards. Such standards have evolved as best

practices and represent the conventional approach to accounting. As such, their general

acceptability implies voluntary compliance by individual companies.

2. Privately Set Standards. Private accountancy bodies such as the ASC (UK) or FASB (USA)

may formulate standards and devise means for their enforcement. Other bodies, such as trade

associations or stock exchanges may set accounting standards for companies as a condition of

membership or listing. Enforcement powers are thus more readily available.

43
3. Government Standards. These standards may be laws relating to company accounting

practices and disclosures, as in the case of the Nigeria, the Companies Acts, and CAMA or tax

rules defining taxable profit. Alternatively, governmental departments or agencies may regulate

accounting practices for certain industries. It is significant to note that the above two

classifications are complementary and not competitive.

Procedure for Issuing an Accounting Standard

The preparation and issuance of IFRS involves consultations with a number individuals and

following a due process. IASB usually development accounting standards in consultation with

IFRS advisory council and experts from academics, legal authorities, business communities,

accountancy professional bodies, financial analysts, stock exchanges and regulatory authorities

around the world. It also consults the general public through its public meetings, where all

individuals and organizations that have interest on the standard under consideration make their

contributions Melville (2011).

The due process of accounting standards development as outline by IFRS Foundation (2011)

includes but not limited to the following steps; (1) Identification and review of all issues

surrounding the topic under consideration for a new standard by IFRS staff and it applicability

with the conceptual framework; (2) Review and exchange of opinion with various national

accounting standards setters on conformity, or otherwise of the proposed standard with their

accounting provisions and practice; (3) Consideration for possible inclusion of the propose

standard in the IASB agenda by ISAB trustees and IFRS advisory council; (4) Inauguration of

44
advisory group to advice IASB on new project (standard); (5) Circulation of copies of the

working document (discussion document) for public comments; (6) Publication and circulation

of an exposure draft (proposed standard) copies for public comments, which is usually

accompanied by dissenting opinions of some IASB members if any; (7) Receiving and

consideration of all comments made by the public on the exposure draft; (8) Discussion on the

need for conducting of public hearing and field test, if considered important than holding such

hearing and field test; (9) Based on the outcome above, then approval for a new standard by not

less than nine members of IASB; (10) Publication of the new standard together with it basis of

conclusion, explanation on the due process taken, (11) Dissenting opinions of the members if any

and public comments.

Moreover, Melville (2011) said each and every complete IFRS or IAS consists of the following

segments: (1) Introduction, (2) Objectives and scope of the standards, (3) Definitions of terms

used in the standards, (4) The body of the standards, (5) effective date and transitional provisions

and approval by the IASB and dissenting opinions of members if any.

Benefits of Accounting Standards

The benefits of IFRS adoption are numerous. In general, it offers organisations opportunity for a

fresh look at their processes and policies.

It also gives room for one basis of accounting (simplify local statutory reporting, cross-border

transactions, strengthening of controls and efficiencies in future reporting). Furthermore, it may

lead to standardisation of practices across countries (that is, consistency of global accounting

policies and procedures, shared service centre deployment and streamlined merger and

acquisition activities). Finally, it can lead to improved comparability across borders and within

45
global industries, with worldwide peers and competitors. A more specific consideration may

reveal individual benefits as hereunder:

· International Investors

Ability to make useful and meaningful comparisons of investments portfolios in different

countries.

· Multi-national companies

o Easy consolidation of financial statements;

o Better management control; as harmonization would aid internal communication of financial

information; and

o Easier to comply with the reporting requirements of overseas stock

exchanges

· Regional economic groups (e.g. ECOWAS etc.)

o Promotion of trade within the region through common accounting practices; and

o Ability to compile meaningful data on the performance of various

enterprises within the region.

· Governments and National standard setting bodies

o Assist governments in attracting international investors as adoption of

IFRS enables international investors easy monitoring of overseas

investments.

· Local and domestic companies

o Easier access to external capital;

o Global comparability of financial statements; and

o Transparency and enhanced disclosures and seal of quality.

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