Case Study: Financial Statements

This case study analyzes the challenges of using the historic cost measurement principle in financial statements, particularly in the context of inflation. It explores the importance of reflecting economic reality in accounting and the role of fair value measurements in auditing and accounting education.

CASE STUDY

Table of Contents
Questions 1: What you think is the fundamental problem with financial statements based upon the
historic cost measurement principle used under US GAAP?...................................................................3
Question 2: What do you think of the principle’ … accounts must reflect economic reality’ as a core
principle of measurement in accounting?................................................................................................3
Question 3: How to measure the economic reality?.................................................................................5
Questions 4 - What is reliability in accounting?......................................................................................6
Question 5: How will the use of fair values affect the role of auditors and the audit function? Do you
think it will affect the training of accounting students? How so?............................................................6
REFERENCES............................................................................................................................................7

Questions 1: What you think is the fundamental problem with financial statements based
upon the historic cost measurement principle used under US GAAP?
One of the major issue or problem with financial statements on the basis of historic cost
measurement principles under US GAAP is its assumption concerning the money or currency
unit in which transactions are recorded. The historical cost principle assumes that the currency in
which the transactions are recorded remains stable. For example – If power of purchasing
remains the same over a particular period of time. But it is a fact money not a stable
measurement unit. The value of money as a medium of exchange is determined by its ability to
command services and goods. During the inflation period general level of prices for goods and
services enhances the purchasing power of money decreases. At the time when inflation becomes
a continuing phenomenon, it gives rise to serious measurement issues in financial reporting and
statements (Czerny, 2018). The balance sheet is distorted because it demonstrates assets acquired
at diverse times with monetary unit of varying purchasing power. Along with inflation there are
also other sources for trouble related to historical cost accounting. Even if there is no inflation in
the specific price level changes, economy may occur due to the occurrence of events such
technological upgradation and shifts in consumer preferences.
Question 2: What do you think of the principle’ … accounts must reflect economic reality’
as a core principle of measurement in accounting?
The principal accounts must reflect economic reality acts as a core principal of
measurement in accounting.
The above statement holds true as it is mandatory for an organisation to report true accounting
data in the reports and not misguide the interested parties.
Reality means the present scenario i.e. the existing conditions in any given place.
Economic Reality is hence the portrayal of true image of the economy and its effect on
organisation in the form of accounting.
Accounts are a means or a quantitative portrayal of data through which all the interested parties
like investors; employees; creditors etc. analyse the financial credibility of any organisation.
Therefore, it is mandatory that the information portrayed is true to its core and accurate and does
not misguide the interested parties. It should also be free from any misstatements and error.

Representation of economic reality in the form of accounting cannot be done without
professional knowledge. The qualified professional should carefully study all the relevant
activities and the way they are impacted by the present policies and the scenario; and then the
report should be prepared accordingly without any pressure to help management take better
decisions regarding its internal as well as external environment.
Another major accounting principle backing this management principle is Substance over Form
which states that the quality or economic substance of any transaction should be recorded and
should be correct display of the transaction rather than rigidly sticking to legal norms. It
encourages one to use their judgement. Sometimes certain information which is legally not
required to be disclosed; is affecting an organisation in important manner; then it must be
disclosed.
Each accounting transaction recorded shows the economic position of an organisation.
Therefore, the expenses should be correctly estimated i.e. not overestimated and the profits or
revenue generated should also be correctly displayed (Elkhashen and Ntim, 2018).
Credibility is an important aspect of any organisation. When the management discloses all the
relevant facts truthfully; it earns the credibility of its users. For a report to be credible it must be
depicting the reality i.e. the economic reality. By reality it means that the economic cost or
benefit generated by it should be disclosed fairly. Therefore, if data reported is unrealistic or
untruthful, then an organisation's credibility tends to be questioned.
To ensure that the accounts prepared portray economic reality, the accountant should not be
biased in any way i.e. neutral accounting practices should be made. Many times there are various
ways to record one transaction, the accountant should therefore select the best way which
correctly displays the nature of transaction. Fair representation of the data is a must.
Certain irrelevant transactions which do not affect majorly any organisation but are creating a
negative effect of company on the interested parties’ minds; can be not disclosed if the
accountant feels the need to do so.
For the accounting to portray economic reality; the information provided must be verifiable,
pertinent, truthful and thorough. Accounts which reflect economic reality are the best portrayal
true picture of financial accounting

Question 3: How to measure the economic reality?
Accounting plays a vital role in part of the business. The regulatory body of the
accounting has given its own principle and methods for recording the business transaction.
Accounting is based on various principle such as going concern, separate legal entity, accrual,
matching and consistency. Fair value of transaction is being represented by the accounting. Most
vital information of the economic situation of entity is identified by the accounting (Barth, 2018).
Reality being a Greek word, which means that should be study or what it appears to be.
Economic reality use to have the long-established roots in research and accounting practice as
believed by many practitioners. Professionals skill are being required for the representation of
the economic reality. Many authors have represented the different possibilities-According to
Arthur (1993) the different possibility was that profit is not different and all the objects are
socially constructed though which the profit is also socially constructed. To promote the interest
of the individual the social fiction of the profit is constructed. In the context of the economically
human activity the existence of the profit is there.
According to Mattessich (1995-2003) the economic reality covers many layers of the
hierarchy including the physical, biological, psychic and social. According to his model
economic reality consist of the accounting. As per him tangible assets lie in the physical reality
whereas the debt stands behind the social reality. Social property of the people makes the
existence of the social reality. To shape the reality the accounting is subjectively constructed.
One of the major concepts of the economic reality is corporate accounting-
So better to understand the corporate accounting so it is the branch of the accounts which deals
with the accounting of the companies and the preparation of the financial accounts and cash flow
statements. Analysis and the interpretation are also the major work handing of the corporate
accounting. So the corporate accounting and accounting frauds measure the economic reality. As
per the big example is the construction company Carillon for threatening their shareholders as
the company share started to collapse in the year 2017. hence it was not only the scandal of the
carillon but it was also the whole system of the corporate accountability. To decide the
creditability of the company the financial representation is very crucial. Due to the negligence of
the corporate accountability the billions of dollars have been lost in this financial disaster. Many

more examples are Lehman brothers, and one of the recently Volkswagen for the poor
representation of the financial statements
ACCOUNTING IN PUBLIC INTEREST
Society stand as the important factor to measure the economic reality. Rightfully the
public expect the accounting to be the profession of practicality, intellectual band with the regard
of the public. To strength the public relation and to protect the interest, the accounting
profession states bond with the public (Allen, Ramanna and Roychowdhury, 2018). People
believes and trust in professional accounting as there work shows up the result and measures the
economic reality.
Questions 4 - What is reliability in accounting?
The principle related to reliability is the concept of only recording those transactions within the
accounting system that can be verified with objective evidence. The examples of objective
evidence are as following -
1. Cancelled checks
2. Bank statements
3. Promissory notes
4. Appriasal reports
Reliability principles is tough to meet when an individual record a reserve, an inventory
obsolescence reserve, an allowance for doubtful accounts or a sales return. Since these reserves
are significantly opinion based.
Question 5: How will the use of fair values affect the role of auditors and the audit
function? Do you think it will affect the training of accounting students? How so?
Fair values must be used by the auditors while auditing any project. Management is
responsible for this task. They put the fair value measurement while preparing the financial
reports. The auditor's consideration of such assumptions is based on information available to the
auditor at the time of the audit. It is one of the most important aspect to take fair value

measurement into consideration. Business needs to be transparent while preparing financial
report of any project. Also, the assumptions in fair value are similar in nature. If business is not
aware about any information related to assumptions, they may use their own assumptions.
REFERENCES
Books and Journals
Allen, A.M., Ramanna, K. and Roychowdhury, S., 2018. Auditor lobbying on accounting
standards. Journal of Law, Finance & Accounting, Forthcoming.
Arthur, A., 1993. Critical accounting theory and practical philosophy: Applying the tools.
Critical Perspectives on Accounting, 4(3), pp.209-224.
Barth, M.E., 2018. Accounting in 2036: A Learned Profession: Part I: The Role of Research. The
Accounting Review, 93(6), pp.383-385.
Czerny, M., 2018. The influence of religious principles on the formation of the accounting
system. Annales. Etyka W Życiu Gospodarczym, 21(8), pp.31-45.
Elkhashen, E. and Ntim, C.G., 2018. Accounting and philosophy: The construction of social
reality framework. Elkhashen, EM and Ntim, CG (2018). Accounting and Philosophy: The
Construction of Social Reality Framework. Journal of Accounting and Taxation,
Forthcoming.