Answered Essay: Can you please summarize what this is saying? It is part of the "TheTop 10 reasons to Fix the FASB's Conceptual Framework"

Can you please summarize what this is saying? It is part of the “TheTop 10 reasons to Fix the FASB’s Conceptual Framework”

10. Role for Transactions

Traditionally, great respect has been paid in financial accounting to the entity’s own transactions as reliable sources of information about its assets and liabilities. We speculate that this tradition has roots in the tight rela- tionship between financial reporting and internal control, specifically the fact that an accounting system is the first line of defense against improper transactions. The company’s own transactions may be sparse, even impoverished, sources of useful information. Far more information resides in the multitudes of transactions exe- cuted by other entities.

Can it be wise to constantly look inward and backward at past one-time events that no longer reflect current con- ditions? For example, could investors who bought shares of Wal-Mart in the 1970s or Enron in late 2000 predict current cash flows from these investments using only their original costs? While their original transactions were evi- dence (although incomplete) of probable cash flow poten- tial at the purchase dates, much more information content resides in recent transactions involving other entities. The same applies to all other assets and liabilities as well.

Suppose the goal is to infer the distribution of red and white marbles in an opaque jar by drawing a sample. How useful is a sample of only one marble? And how useless is it to infer the mix in today’s jar based on a past sample of one marble from a jar that existed weeks, months, or years ago? We find no rational justification for acting as if useful information is provided by continuing to report the results of an entity’s historical transactions.

We urge the Boards to break the constraining tie between a company’s financial statements and its unique experiences that may or may not be representative of eco- nomic truth, even at the time they happen.

Who can say an asset’s original purchase price really represented its market value at that date? It was only one event in the population of similar transactions, and there’s no valid reason to believe it was executed exactly at that distribution’s mean. Instead, a sincere search for reliable financial representations leads to considering the much more useful facts inherent in the many transactions engaged in by others.

The consequence has to be more reliable and useful financial reporting.

Expert Answer

 

Paul Miller and Paul Bahson published a report in July 2007 with title “The Top 10 reasons to Fix the FASB’s Conceptual Framework” in which they raised concerns that FASB have produced most of its CFW more than 20 years ago and its time now to update them with the new frameworks. In their report they published 10 reasons for why change in CFW required now and here is the summary of 10th reason ‘Role of Transaction’ for your better understanding:

They make reference to the fact that currently companies follow Historical Cost method to record their assets, i.e. assets are kept on reflecting in the balance sheet at their original price and revaluation is not carried out for number of reasons. Using the theory of relevancy and example of how one sample of marbles in an opaque jar can’t be used to infer the content they made point that value of assets recorded should be made in reference to the industry’s other entities as actual value of asset to be recorded depends on many factors.

To put it through one more suitable example, they made a point that shift needs to be made to the system of recording transaction where say a company purchased a land in Jan 2017 at $50000 and they recorded the same at that value. However, another company purchased the nearby land at $45000 and recorded the same at that value. In such case, there must lay a system which gives the correct figure of the asset. They insist that whether the value of assets recorded is correct or not depends not only on the transactional value but also on market and how other entities are recording the same. One cannot justify the value of asset with just one company’s data and for the proper understanding and true representation of the financial data a proper search should be made across industries.

They strongly argued that value of assets should be revalued consistently with regard to other company’s analysis also.

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