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Mixed Measurement Model of Accounting and Reasons to Use It
The main reason for the use of the mixed measurement model is flexibility. Under this model, the various bases of measurement are used in different degrees and varying combinations to prepare the financial statements. The use of a mixed model is also important because of the different situations that companies find themselves in. This approach is vital but very subjective. Thus, it requires professional judgment and ethics when using the various bases (Walton and Aerts 79).
Under the historical cost basis, assets and liabilities are recorded in the books of account at the price which they were acquired. Therefore, the initial cost is used as the fundamental measurement criterion and only takes into account realized revenues. That is, where cash has been received or a reliable undertaking to pay cash has been obtained. Any gains or losses that are realized under historical cost basis are included in the income statement. An example of an account is property, plant, and equipment.
Under current value, assets and liabilities are valued at the price which they can be traded or settled as of the current date. This model is important because the financial statements should give information that resonates with the present business condition. Examples of accounts under this model are future contracts and derivatives. Some other assets and liabilities are valued using the mixed measurement model. Examples are assets that have longer lives such as bank loans when the company intends to hold them for collecting cash flows (Warren, Reeve and Duchac 231).
Earnings Management
Earnings management is a deliberate action by the executive to manipulate the financial statements. The figures are always manipulated so that they can show predetermined and not the actual results. Some of the methods that are used by the management are legal but not ethical. Accountants manipulate the financial records within the limitations of the accounting standards. Therefore, accountants make use of these standards to influence the results so that the earnings can reach the expected level.
One of the main motives of earnings management is its smoothing of the returns. Therefore, it is used by the management to maintain steady earnings growth or to avoid reporting undesired results. This is due to both internal and external pressures. Thus, it is a tool that is used by the management to maximize the value of the firm. Some of the other motives are incentives in the stock market, hinting and hiding private information, personal and internal motives, and regulatory and lending contract motives.
The first earnings management technique is the ‘cookie jar reserve’ technique, which deals with estimations of future earnings. The second approach is the ‘Big Bath’ technique and it involves writing down assets, alteration of operating segments, and restructuring of debts. Another technique is the ‘Big Bet on the future’ technique, which occurs during acquisition. Some of the other techniques are: ‘flushing’ the investment portfolio, ‘throwing out’ a problem child, introducing a new standard, writing off of long-term operating assets, sale and leaseback, early retirement of debt, operating versus non-operating income, shrinking the ship, and using derivatives (Bierman 391).
Forces and Circumstances Creating Incentives for Firms to Produce Financial Information
Some several forces and circumstances create incentives for firms to publish financial statements. Based on the agency theory, financial information is used to evaluate and remunerate managers and to supervise the employment contracts. Also, entities have incentives to report willingly to the capital markets. Failure to report the financial results can be inferred as bad news. Besides, users of the information may engage private contractors to get the information.
Failure to provide accounting information may lead to explicit and implicit market failures. Explicit market failure occurs when the market solution results in non-Pareto resource allocation. Thus, the quality and quantity of information that will be obtained in the private market will not be similar to the socially optimal level. In this case, accounting information is viewed as a public good. Some of the implicit market failures are monopoly control over information, lack of objectivity, misleading numbers, and diversity procedures among others (Scott 134).
Due to market failure theories, it is important to have regulations. Lack of regulation will result in information asymmetry among players in the market. It will also lead to a higher transaction cost. It can as well lower the liquidity for trading shares. This can result in lower prices of stock and the high cost of capital. The market failure theory is an indication of the problems that may arise due to a lack of regulations. Thus, regulations help in improving the quality of accounting information.
The Theories of Regulation
The theories of regulation are public-interest and interest-group or capture theories. The public- interest theory maintains that regulations are put in place to protect the general public. They are also for the benefit of the public. In most cases, the authorities provide these regulations as a response to the needs of the public. These regulations seek to correct unproductive or unjust market prices (Baldwin, Cave, and Lodge 198).
On the other hand, the interest-group theory states that regulations are provided in response to the needs of special interest groups. Such groups aim to maximize profit. Further, there are two versions of this theory. The first one is the political ruling-elite theory of regulation. The second version is the economic theory of regulation.
The theory that best applies to the current business environment is interest-group theory. This premise makes use of both economic and political power to gain regulatory control. However, none of these theories best explains the accounting standard-setting. Thus, studies are being carried out to develop the theory of regulation for accounting standards (Riahi-Belkaoui 209).
Works Cited
Baldwin, Robert, Martin Cave, and Martin Lodge. Understanding Regulation: Theory, Strategy, and Practice, New York, NY: Oxford University Press, 2012. Print.
Bierman, Harold. An Introduction to Accounting and Managerial Finance, Finlay, Singapore: World Scientific Publishing, 2010. Print.
Riahi-Belkaoui, Ahmed. Accounting Theory, Boston, MA: Cengage Learning EMEA, 2004. Print.
Scott, William. Financial Accounting Theory, New Jersey, NJ: Pearson Prentice Hall, 2011. Print.
Walton, Peter, and Walter Aerts. Global Financial Accounting and Reporting: Principles and Analysis, Boston, MA: Cengage Learning EMEA, 2006. Print.
Warren, Carl, James Reeve, and Jonathan Duchac. Financial and Management Accounting, Boston, MA: Cengage Learning, 2013. Print.
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