The paper 'Link between Decision Usefulness and Measurement Approach" is a great example of a finance and accounting report. Investors have a right to know the performance of the organization to enable them to make a better decision. The investors are mainly classified as owners and creditors. Owners are concerned about the level of the returns accruing to them while creditors are keen to gauge the safety of their lending (Deegan, 2009). Thus, the financial records have to serve this purpose owing to the fact that the stakeholders, as well as investors, are the providers of the finances invested.
Owing to this fact financial statements are required to clearly indicate the performance of a firm’ s securities for proper decision making by the investors (Schroeder, 2009). Without the accurateness of the financial statements information, the financial records may not serve the required functions as well as they can be deemed insufficient for use by investors. As a result of these facts today the trend has changed with many accountants moving towards Measurement Approach in financial reporting. Measurement approach to decision usefulness entails proper usage of current values in the financial statements.
The current value is a term which can be defined from two perspectives thus fair value referring to an exit price and value-in-use defining the present value of future cash receipts or payments. Primarily, the goal of the measurement approach is to increase decision usefulness over that of information approach (Scott, 2012). This implies a larger role for the financial statements proper in assisting investors to predict firm’ s fundamental value, thus the exact value of the firm’ s share if all the relevant information has been communicated to the investors. Discussion Reasons as to why financial reporting is moving towards a Measurement Approach Problems associated with Historical costs Historical cost-based accounting over the years is associated with low ability to explain abnormal securities returns hence in accounting these costs are of low-value relevance.
Moreover, with increasing investor pressure many firms’ want accurate and best asset evaluation and liabilities(Schroeder, 2009). With this, in mind, many questions have been raised about including relevant information in the financial statements without really sacrificing its reliability. As a result of this many accountants have been forced to adopt a measurement approach to decision usefulness as a way of increasing information reliability. Explanatory Power of Net Income Previous research studies done by Ball and Brown (BB), indicates that security returns of a specific firm respond quickly to new information releases on earnings.
In conclusion, BB research studies indicate that there is a strong reaction thus deviation from zero around this period (Schroeder, 2009). On the other hand, a study by Lev (1998), reveals that this effect can be as small as 2-5% of the abnormal variability of narrow window security returns around the date of the new release.
Analyzing the two studies by Ball and Brown (BB) and Lev (1998), it is quite evident that the effect on security returns around the date of the new earnings release is very small as proved by Lev (1998). From “ Low R2” argument, greater use of fair values in financial reporting, as well as the measurement of net income, is important in reversing the unexpected earnings caused by apparent declines as well as inappropriate information on abnormal share price variability.
Incorporating Low R2 is important because it will result in better measurement which in turn may increase accounting “ market share” in explaining share price changes(Scott, 2012 ).
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