Reference no: EM132498206

Question - You are examining the consolidated financial statements of a European company, which have been prepared in accordance with IFRS. You determine that property, plant, and equipment is revalued each year to its current fair value, income and equity are adjusted, and the notes to the financial statements include the following items as a part of the summary of significant accounting policies:

Tangible fixed assets are measured at fair value, less accumulated depreciation. The fair value is based on valuations made by internal and external experts, taking technical and economic developments into account and supported by the experience gained in the construction of plant assets throughout the world.

Valuation differences resulting from revaluation are credited or debited to equity, where it is applicable, after deduction of an amount for deferred tax liabilities.

Depreciation based on fair value is applied on a straight-line basis in accordance with the estimated useful life of each asset.

The provisions of IFRS permit the use of alternatives to historical cost in the valuation of assets.

IAS 16 specifically notes that as an allowed alternative treatment to historical cost:

Subsequent to initial recognition as an asset, an item of property, plant, and equipment shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations should be made with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date.

The auditor of the company has expressed his opinion on the financial statements and concluded that they "present fairly" the financial position of the company.

The use of fair value accounting is a departure from the historical cost principle, which was required under Canadian GAAP prior to the adoption of IFRS and is still required under ASPE. The debate about the relative importance of relevance and reliability is one that surfaces often in the study of international accounting issues. Many countries are very strict as to the use of historical cost for all valuations and in the computation of income, and often allow reductions from historical cost (such as with the application of the lower of cost and market requirement), but not increases. Others are very flexible in the choice of permissible approaches, while still others are very strict in that particular alternatives to historical cost (such as fair value or general price-level-adjusted amounts) must be used.

Required -

(a) Can any alternative to historical cost provide for fair presentation in financial reports, or are the risks too great? Discuss.

(b) Discuss the relative merits of historical cost accounting and fair value accounting. Consider the question of the achievement of a balance between relevance and reliability when trying to "present fairly" the financial position of the reporting entity.

(c) Financial statements are now beyond the comprehension of the average person. Many of the accounting terms and methods of accounting used are simply too complex to understand just from reading the financial statements. Additional explanations should be provided with, or in, the financial statements, to help investors understand the financial statements. Briefly discuss.