For a long time, companies have consistently measured asset impairment in a subjective manner. This kind of reporting has been done in very shallow ways; meaning that the kind of accounting practices undertaken is more applicable in theory than in practice. However, there are many advantages attributed to the measurement of asset impairment in company reports such as the representation of factual state of company affairs and the simplicity in representing asset information.
Normally, conventional asset impairment reporting techniques provide a basis through which comparisons can be made (between different company assets) and often, the figures are rarely disputed because it is difficult to argue with numbers (Bryant 1). However, many experts have observed that such accounting practices are undertaken from one perspective; meaning that most of the practices are done in a subjective manner (American Dental Association 49). This therefore means that the information portrayed in the financial statements is relatively historical and bluntly irrelevant.
The information represented in financial statements therefore represent a shallow analysis of the real company state of affairs and in a more general sense, it leaves a lot of factors unaccounted for (Alexander 405). This is normally because conventional asset measurement practices exclude a lot of external factors that ought to be considered in the final representation of a company’s state of affairs.
These flaws have caused a number of accounting bodies such as FASB and IASB to look for alternative ways of representing assets in financial books (Warren 584). Part of the motivation for this development is the need for investors to be supplied with the right type of information to make sound financial decisions. This study points out that there are many factors which are against the measurement of asset impairment than those which are in support of the accounting procedure. This study expounds on this fact.
Measuring asset impairment has been conventionally done using numerical means (Bryant 1). This kind of accounting approach implies that businesses and companies in general can control or manage their operations, assets and liabilities through simple arithmetic. This kind of perception does not represent the actual state of company affairs because it is wrong to represent reality by simple numbers (Bryant 3). To a large extent, this can be viewed as a flaw in accounting (in general) because accounting basically advocates for the representation of a company’s state of affairs through arithmetic means (Koch 30).
Conventional asset measurement procedures advocate the fact that companies can be managed and quantified through numbers (Bryant 3). A number of other significant factors like social and environmental forces are therefore left out in the numerical representation of company state of affairs because it is difficult to quantify the impact of social or environmental forces on a company’s assets. In relation to this assertion, Bryant (486) reiterates that:
“Numbers are a simple way of conveying information. They are seen as factual, and are hard to dispute as they are fixed and do not change. In general, people are drawn to facts and numbers because they appear to reflect the reality of information in an organized and straightforward way. This presents a sort of illusion, called the “myth of objectivity”.
This assertion therefore portrays the fact that companies heavily rely on numerical data, assuming that it represents the real state of company affairs; but in real sense, numerical data cannot accommodate all the important information pertaining to various company assets. This kind of assertion (shared by many accounting experts), can be traced to the historic attribution of numeric accounting to objective and subjective points of views (Bryant 3).
The subjectivity exhibited in this kind of argument can be especially attributed to the fact that the interpretation of reported asset measurement is largely reliant on individual perception. Its objectivity on the other hand, can be traced to the fact that the numeric representation of accounting practices is largely based on arithmetic practices.
Another major observation noted by many accounting experts is that the measurement of impaired assets is basically an interpretive exercise as opposed to a scientific exercise (Mart 307). The same point of view is also held by Bryant (482) who says that “Objective Accounting is meant to be about expressing the facts as they are, but really it is up to the individual to decide how this is done”.
This observation therefore implies that the art of measuring asset impairment is basically an exercise undertaken from only one viewpoint. In fact, measuring asset impairment from a numeric point of view is similar to representing how an individual perceives the situation and how he interprets it (Bryant 3). This kind of situation brings about an inconsistent way of undertaking accounting practices because accounting practices represent facts in a standard manner, but individuals on the other hand, interpret the facts in varied ways.
This kind of problem is unavoidable because no matter the extent accounting practices are standardized; the manner in which different people (and more so, investors) would perceive the information is obviously going to be different and inconsistent. This fact exposes the subjective nature of measuring asset impairment. Unfortunately, not much modification has been done to correct this flaw in measuring asset impairment and this implies that the representation of such records is possibly incorrect and largely meaningless.
Most of the information represented in the measurement of asset impairment is normally undertaken in different time periods. This kind of accounting practice poses a problem of relevance because asset measurement is based on historic costs (Ahad 1). In this manner, the measurement of asset impairment is rarely of use to investors. This kind of accounting practice also posses a problem in the reporting of financial information because it causes a wrongful representation of future budgets, corporate plans and company forecasts.
The importance of representing relevant information is especially important in today’s business world because the business environment is increasingly volatile and change can be easily evidenced even in unprecedented grounds (as can be seen from the collapse of former business giants in the global business map) (Panzner 2). For instance, if an investor wanted to purchase a given asset from a company, based on the measurement of asset impairment done, say, a year ago, the investor would go a ahead with the purchase because he or she would assume the information represented in the company’s financial books is up-to-date.
This decision will be misguided. This kind of analysis represents a situation where it is obviously depicted that a reliance on past figures is inaccurate and possibly irrelevant to most investors when they intend to purchase assets or invest in a particular company.
There are a number of disadvantages attributed to the measurement of asset impairment using historical accounting techniques. One of such possible disadvantage is the fact that the measurement of asset impairment is basically inclined towards the allocation of asset costs as opposed to the real evaluation of assets. In this regard, Ahad (1) notes that “…conventional asset measurement methods disclose the acquisition cost of an asset and its depreciation in the following year, but ignores the possibility that the current market value of the asset may be higher or lower than the disclosed amount”.
Secondly, the accounting technique is flawed, in the sense that, it fails to include certain environmental factors (like inflation) which are quite important in the measurement of asset impairment (Ahad 1). In other words, the accounting technique assumes that the purchasing power of money remains constant for a long period of time (in reality an asset purchased or valued at a given point in time may be quite expensive when compared with its future value). In fact, in times of inflation, the profits of financial companies are normally inflated as well (Implying a wrong representation of the real financial situation).
Basing the measurement of asset impairment on historical costs therefore represents a failure of companies to adjust to inflationary pressures and it also implies a subjective representation of the true financial position of a company. The danger lies in the fact that when measuring asset impairment on historical costs, old interest rates are factored in or an outdated assessment of financial figures are employed or incorrect timing are applied towards the overall ascertainment of the degree of asset impairment (Ahad 2).
The problem is especially compounded when companies have to report on intangible assets because in this type of asset category, there needs to be a strict adherence to external environmental forces (because of the dynamic changes affecting intangible assets); as opposed to an extrapolation of past gains and losses on historical costs. This situation can be best conceptualized by the following example explained by Ahad (22).
“A company reports its inventory on the balance sheet at a historical cost of $ 10,000. The fair market value (FMV) of this inventory may be is only $7,000. On the other hand, a corresponding current account payable of $10,000 appears as a liability on the credit side of the balance sheet. It is likely that the “FMV” of the liability is at or near $10,000. From a historical cost perspective, the debit balance (inventory) and the credit balance (accounts payable) are offsetting. However, from a market value perspective, the debit balance of $7,000 (inventory) is less than the offsetting credit balance (accounts payable) of $10,000”.
This study points out the fact that current accounting practices observed in the measurement of asset’s impairment fails to conceptualize environmental and social effects on asset values. Likewise, this study acknowledges the measurement of asset impairment values is a significant accounting procedure in most companies (meaning that the accounting technique serves a given purpose, otherwise it would have long been abolished). However, the basis of contention is the subjective manner asset measurement is done.
From this understanding, this study identifies that the heavy reliance on numerical techniques to accommodate all significant factors affecting asset measurement is a flawed concept because it represents objective and subjective assessments of company status. Additionally, this study identifies that the quantification of asset impairment based on historical costs represents a flawed representation of asset values. These two factors greatly represent the increasingly subjective techniques most companies engage in measuring asset impairment.
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American Dental Association. Valuing a Practice: A Guide for Dentists. New York: American Dental Association, 2010. Print.
Bryant, Sarah. Management Accounting – An Excellent Control Instrument?. 2010. Web.
Koch, Christian. The Arbitrage Pricing Theory as an Approach to Capital Asset Valuation. London: GRIN Verlag, 2009. Print.
Mart, Martin. Accounting for Fundamentalisms: The Dynamic Character Of Movements. Chicago: University of Chicago Press, 2004. Print.
Panzner, Michael. When Giants Fall: An Economic Roadmap for the End Of The American Era. London: John Wiley and Sons, 2009. Print.
Warren, Carl. Corporate Financial Accounting. London: Cengage Learning, 2008. Print.