Implications of Using Acquisition Method
The acquisition method determines the real cost of an overhead before assigning the costs to such activities. Therefore, a company allocates costs to those units that require the activity. The approach appreciates the fact that at any point, the company’s activities will occasion cost, which will vary with production levels. Therefore, the costs should be assigned to the products that require such activities to arrive at a more accurate measure. The distinguishing feature of the acquisition method is that it links the output of the manufacturing entity to the cost of all activities involved in production. Value added activities could be determined using this approach. The manufacturing entity can proceed to eliminate activities, which are not adding value to the product. This will improve the manufacturing system’s performance (Walter, 1999).
With acquisition method, you take all activities required to produce an item into consideration. This can include R&D, testing, purchasing, set up of machines, packaging, and cleaning and maintenance. These are all necessary to produce an item; however, they are not considered when using the traditional method of costing (Ayers, 2002).
The acquisition method leads to generation of activity rates. Acquisition rates are vital to management since they enable management to determine with great accuracy the cost involved in production. The management can quickly estimate the cost of producing at a certain level using activity rates. Acquisition rates are also important in determining the efficiency of production. The management can use these rates to determine which activities add most value to the production process. The production process can thus be improved by eliminating non-value add activities. This allows for a flexible process; which companies can modify to reduce the negative effects of some activities. Acquisition rates also offer management information, which greatly improves their decision-making ability (Ayers, 2002).
Comparisons with Historical Methods
Acquisition method differs from the traditional methods in the allocation of manufacturing overheads. Acquisition method does not allocate overheads on the simple basis of time like the traditional approach. It instead determines the real cost of the overhead before assigning the costs to such activities. A company allocates costs to those units that require the activity. The approach appreciates the fact that at any point, the company’s activities will occasion cost, which will vary with production levels. Therefore, the costs should be assigned to the products that require such activities to arrive at a more accurate measure. The distinguishing feature of the acquisition method is that it links the output of the manufacturing entity to the cost of all activities involved in production (Ayers, 2002). Value added activities could be determined using this approach. The manufacturing entity can proceed to eliminate activities, which are not adding value to the product. This will improve the manufacturing system’s performance. In contrast, the traditional methods link the direct materials cost and labor costs to the product. While the acquisition method employs an hourly costs system in determination of the costs of each unit, traditional approaches relies on historical measures or average costs of processes similar to the one employed in determining these costs. This may lead to inaccuracies when factors change. Therefore, the acquisition method is more flexible than traditional costing methods. Managers can use this flexibility to predict costs using scenario analysis (Walter, 1999).
Differences between U.S. GAAP and IFRS
International Accounting Standard 1 (IAS 1) lays down the principles or rules of financial reporting. Following these principles ensures fair representation of financial statements. Just like any other rules, these rules also have their own implications on financial statements. The first principle is the historical cost principle. This principle mainly affects the statement of financial position. The second principle is the matching principle. This principle provides a way of measuring profitability. The matching principle advocates for the comparison of revenues earned in a specific period with the costs of the same period (Hawkins, 2008). This principle mainly affects the statement of comprehensive income. It gives two alternatives for matching the revenues with the costs. The other principle provided for by (IAS1.27) is the principle of revenue recognition better known as accounting on accrual basis. This principle requires management to recognise revenues at the point where earning occurs and not the point where money is received. Similarly, managers should recognise costs at the point where they incur them and not when they pay out the money (Beets, 2001).
The fourth principle is the objectivity principle. Here, an entity is required to prepare financial statements that are unbiased. The financial statements should be fair to the extent that, any third party contracted to review them, should come up with the exact same information. The fifth principle is the consistency principle (IAS 1.39). This principle requires entities to treat similar transactions and events in the same way in every accounting period (Hawkins, 2008). This increases the usefulness of financial statements as it enhances comparability both internally and externally. It also makes it possible for the management to carry out a trend analysis. Another principle is the full disclosure principle, which requires an entity to disclose all the relevant facts that may influence a stakeholder’s decision. This principle mainly stresses the importance of disclosing the different accounting policies adopted by the entity. Managers practice full disclosure through the financial statements or notes of disclosure (Hawkins, 2008).
For financial statements to give a true and fair view, they must possess the most important qualitative characteristics. The International Financial Reporting Standards (IFRSs) clearly gives the major characteristics that financial statements must possess for them to give a true and fair representation. It is important to note that an entity’s stakeholders include its customers, creditors, its owners, the government and investors. Content related characteristics and presentation related characteristics form the two major categories of qualitative characteristics. Relevance and reliability make up the content related characteristics. Relevance means that the given information shown on the financial statements should be good enough to influence a stakeholder’s decision. Relevance draws from the materiality principle (Hawkins, 2008).
Relevant financial information must have three components beneficial to a stakeholder: predictive value, timeliness and a feedback value. Predictive value means that the stakeholder should be able to use the given information to make decisions about the future. Timeliness on the other hand means that the stakeholder should have the required information when he or she most needs it and not earlier or later. Feedback value means that the information provided should be good enough such that the users are able to voice their opinions about that information (Beets, 2001).
Reliability means that the information provided should be very precise such that it gives no room for misinformed decisions on the user’s part. In other words, it should be dependable. Reliability draws from the consistency principle. Reliable information must have some crucial aspects helpful to the stakeholders. Completeness means that the financial statements should be complete. All the items provided for by IAS 1 should be present. There should be no omission of information unless it is immaterial. Objective information is information that is free from any biased perspectives. Financial statements need to be comparable (IAS 1.38) and understandable for them to possess the presentation related characteristics. Comparability draws from the consistency principle and the full disclosure principle (Hawkins, 2008). For the information presented by the financial statements to comparable, managers have to make sure that for every financial period, they treat similar items in the financial statements in the same way. This is in line with the principle of consistency. This enhances the usefulness of the financial statements. It gives managers the option of using the financial statements for internal trend analysis. In addition to this, it allows for comparisons with other entities in the same industry Full disclosure requires managers to disclose all the relevant information either by way of disclosure notes or on the face of the financial statements. This is important because two entities comparing each other may not use the same accounting principles for example depreciation. Lack of full disclosure may therefore create the wrong picture, making an accounting entity too comfortable or too uneasy (Beets, 2001).
For financial statements to be understandable, the accounting entity must consider many things. They must consider the target group, the users of their financial statements and their respective abilities. In principle, entities assume that the people using the information from the financial statements possess some knowledge on the subject. However, managers should be aware that, for example, the knowledge possessed by a customer is not the same as that possessed by say an investor. Managers should tailor their financial statements accordingly in order to meet the expectation of all its users. The user should be able to obtain the relevant information that they need for their decision-making. The International Financial Reporting Standards (IFRSs) give the above qualities as the minimum requirements financial statements should have for the information provided to be true and fair.
Recommendation of the Better of the Two
Through this discussion, it is evident that the manner in which managers prepare financial statements is very crucial to both the entity and the stakeholders. It is also evident that financial statements must possess certain characteristics. Due to the importance accredited to the financial statements by its various users, managers must ensure that they remain a faithful representation of the entity. The information provided in the financial statements must not be the cause of a user’s wrong decision. The international accounting body should never compromise on these qualities, as this could prove detrimental to stakeholders (Agami, 2000).
The accounting body should put in place strict measures and policies to ensure quality remains the driving force in the accounting profession. To curb creative accounting, professional bodies should establish a system that allows for the constant review of the accounting standards. The accounting body should strictly punish managers found guilty of this crime. Managers should also take responsibility and shun the use of this accounting technique despite its allure. The use of sound accounting techniques will ensure that financial statements prepared by accounting entities give a true and fair view. Managers must always prepare financial statements with the stakeholders’ best interest at heart.
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Beets, S. (2001). Accounting for pollution: the effects of emissions trading. Advances in Public Interest Accounting, 8(1): 21-59.
Hawkins, D. (2008). Choosing cost or fair value in the adoption of IFRS. Harvard Business Review, 30(9): 108-130.
Walter, J. (1999). Pooling or purchase: A merger mystery. Economic Quarterly, 85(1): 27-48).