Proceedings of the 5th WSEAS International Conference on Economy and Management Transformation (Volume II)
Ways to use the reasonable estimate of the patrimonial elements in
preparing financial statements
NICOLAE BOBITAN, CIPRIAN SIPOS
Department of Accounting; Department of Business Statistics
West University of Timisoara, Faculty of Economics and Business Administration
Timisoara, Pestalozzi 16, 300119
ROMANIA
[email protected], [email protected], http://www.feaa.uvt.ro
Abstract: - The Fourth European Directive referring to Accounting Standards authorizes a number of
alternatives for the estimation of the patrimonial elements based on historical cost such as valuation by the
replacement value of tangible assets and inventories, valuation methods that consider inflation rate,
revaluation of tangible and intangible assets. Conceptual framework of international accounting standards
provides a significant freedom in terms of choice of estimation base as long as the chosen provide relevant
information and released credibility of financial statements. The paper aims to present several options for
estimating the value of the patrimonial elements, especially, tangible assets, to ensure compliance with the
national and European legal regulations.
Key-Words: - financial statements, accounting recognition, reasonable estimates, discount rate
1 Introduction
2 Patrimonial elements recognition in
financial statements
Patrimonial elements recognition in financial
statements is the moment of effective incorporation
for an element of balance sheet or profit and loss
account, when the reality begins to act on the
company's financial position and performance.
Dilemma of options on recognition items
described in the financial statements are
materialized in two criteria required by international
standards: the probability of achieving future
economic benefits and the credibility and
professional ethics of the estimation process [1].
The main idea is based on facts that the complex,
uncertain and risky environment require the
companies to estimate items from financial
statements and to make a permanent revision of
those estimates. The credibility of valuation can be
achieved only by revising estimates when new
information occurs.
It appears that the number of accounting
information users is growing, but the problem is that
each of them shows different requirements. So, the
accounts and the financial statements can address
only a single common language to the great
diversity of expectations and demands, often
contradictory.
With its specific language, the accounting must
provide a true, a very real image about the financial
position, the financial performance and cash flows
of the entity, these requirements being the primary
objectives of the accounting.
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If, over time, the first function of the accounting was
the recording of transactions with suppliers and
customers, or the recording of the revenues and
expenses and to determine the net income of activity
(profit or loss), we can say that today the role of
accounting were amplified, based at least on the
following key objectives:
- Valuation of assets, liabilities, revenues and
expenses and determining of the outcome of
economic activity entities;
- Supporting the background process of management
decisions to increase economic efficiency;
- Protection of property and assuring the
accomplishing of obligations to third parties.
Therefore accounting information has become a
control tool for shareholders or stakeholders on
leadership and an auxiliary support of taxation and
even of conflicts in social relations [2].
To achieve the accurate image of accounting on
company’s activity are necessary:
a. The accounting data is recorded immediately to
be processed and used in a timely manner;
b. The accounting information to provide an fair,
accurate and complete description of operations
and processes of patrimonial elements;
c. The facts to be accounted for and disclosed in
accordance with their legal and economic basis;
d. The summary information to be useful to the
recipients when they take economic decisions;
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ISBN: 978-960-474-241-7
Proceedings of the 5th WSEAS International Conference on Economy and Management Transformation (Volume II)
permanently located in a dynamic trend, the
financial statements can no longer confine only to
describe the past.
The second recognition condition requires that
the recognized element to possess a cost or value
that can be reliably measured. Accounting
conceptual framework emphasizes that, in some
cases, the cost or value will be estimated using
reasonable estimates that will be an essential part of
preparation of financial statements and does not
affect their credibility. International Accounting
Standards presents often cases where the accounting
treatment is based on current estimates during the
evolution of future situation.
So, given that some elements, such as useful life,
residual value, provisions, etc., is determined by
estimating into an accounting environment
characterized by uncertainty, wonder how you could
have met the second recognition criterion namely
the reliability of assessment.
Exit from such a dilemma is the accepted
professional reasoning and indicated in the
International Accounting Standards, which must be
faithful, prudent and neutral to provide credible
information.
The complex, uncertain and risky accounting
environment in that entity operates, requires the
necessity of estimate in accounting, but more than
that, the permanent review of elements estimated.
Credibility assessment may therefore be achieved in
conditions where is starting from the estimates, but
only if are made revisions every time when new
information appears and request review of initial
estimates.
Conceptual accounting framework emphasizes
the two recognition criteria for the nature of
structures in the financial statements as follows:
1. Assets - are the existing resources at the present
time, resulting from past events which will generate
future economic benefits that form flows to the
entity. Therefore, an asset will be recognized in the
balance sheet when:
- It is possible that a future economic benefit to
enter into the entity;
- Asset possesses a cost or value that can be
reliably valued.
2. Debts - are existing obligations at the present time
resulting from past events which will generate future
economic benefits flows from the entity. Therefore,
a liability will be recognized in the balance sheet
when:
- There is an outflow of resources that can generate
economic benefits;
- Valuation can be reliably made.
e. The building information is in accordance with
existing rules and procedures which are defined
starting from basic principles;
f. Good faith application of these rules and
procedures based on knowledge that accountants
must have about the reality and importance of
operations, events and situations;
g. If in exceptional circumstances, the accounting
prescription application proves improper,
altering reflects on the heritage, of financial
situation or outcome, it can be made exceptions
to that limitation, stating and justifying
explicitly the derogation.
In literature, the equation of true image is defined
by the following terms: normalizing + relevance +
regularly + sincerity + credibility = accurate image.
Accounting information is affected by the
contradictions between the true image on the one
hand and certain accounting principles, by the other
hand, or, sometimes by the contradictory nature of
accounting principles [3].
However, some difficulties in achieving the true
image are determined by the implications of
inflation on assets and by the limitations of methods
used to taking in account these implications. As a
result of the fact that the record unit used in
accounting is the nominal monetary value and
assessment of any asset or liability is carried at cost,
is difficult to gather assets and liabilities expressed
in monetary units that refers at different periods,
which in times of inflation have different purchasing
power.
At the same time the interests of managers may
also be contradictory. Some managers may be
interested in overstatement of assets and profits or to
increase their credibility when they want to attract
shareholders, but may be inclined to underestimate
when they paid taxes, duties or pay dividends.
The problems of recognition items described in
the financial statements are reflected in two criteria
required by the accounting concepts, namely:
- The probability of achieving future economic
benefits;
- The credibility of assessment.
Criterion of probability of future economic
benefits associated with an element of financial
statements realities circumscribe a complex
dynamic, uncertain and risky reality in that the entity
is acting and refers to the uncertainty that such
benefits will be facing a stream to or from the entity.
Financial statements are useful if induce a vision
or a future-oriented bridge, respectively if it helps
users to assess the entity's ability to generate future
cash flows and the timing and certainty of their
generation. Thus, in an economic environment
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ISBN: 978-960-474-241-7
Proceedings of the 5th WSEAS International Conference on Economy and Management Transformation (Volume II)
• The future value - characterizing the process of
establishing the growth which a patrimonial element
will have in the future;
• The discounted value - characterizing the process
of determining what means an amount of money
obtained in the future in today's currency value.
Value of a future single cash flow is the sum, at
some point in the future, with which will increase
the present value of a patrimonial element if it is
endowed with a specified efficiency rate (or interest
rate). Future value of a patrimonial element for a
cumulative annual rate of interest (compounded
annually) at some point in the future can be
determined using the following relationship:
3. Equity - known as funds of shareholders,
representing the residual interest in assets of a
company after liabilities have been deducted.
Seen in the light of international accounting
standardization, analysis of assets and liabilities in
terms of their recognition in financial statements
refers to the duo - flows entering or leaving the
future economic benefits to / from entity - cost or
value reliably determined. As the future economic
benefits associated are uncertain, the entity will face
with the certainty degree attached to them, which
depends on the achievement or failure in forecasting
of future economic benefits flows. Regarding the
second part of duet namely determining cost or
value reliably, you can base, where warranted, on
estimates made reasonably.
The moment in time of elements recognition in
financial statements involves options also in terms
of attention to confidence level of estimation. Thus,
under the provisions stipulated in International
Accounting Standards, grounded on professional
reasoning, each entity must assess the level below
which a patrimonial element must not be capitalized,
but may be subject to the profit and loss account,
being seen as an expense. General accounting
framework states that "information is material if its
omission or erroneous declaration may influence the
economic decisions of users taken based on the
financial statements”. To use reasonable estimates of
the economic value of certain elements in preparing
financial statements that would not affect their
credibility, is mandatory to be used proper
estimation techniques.
FVt = S0 · (1 + r)t
Where: FVt is the future value at the end of year t;
So is the initial value of the patrimonial
element;
r is the annual discount rate;
t is the number of years from period
considered.
Discounted value of a single or a multiple cash flow
is the calculated value of cash flows to be obtained
in future at actual cash value. Therefore, the present
value of future cash flows are the sum of money that
if we invest today with a discount rate increases
with the same amount of a future cash flow,
reported to a future reference. Setting process is
called discounting present value and the rate used to
calculate present value is called the discount rate.
To calculate the present value of future cash
flows, given the discount rate and number of years
for which the calculation is made, it is used the
following relationship:
3 The estimation techniques
Estimation techniques are methods and estimates
adopted by an entity to determine monetary values
corresponding to the selected measurement bases for
assets, liabilities, gains, losses and development
funds to owners.
A given amount of money today is more valuable
than the same amount received in the future
PV = FCF t / (1+ r)t
(2)
Where: PV is the discounted value (present value);
FCFt is the future cash flow that results at t
years from present;
r is the annual discount rate;
t is the number of years.
because the money available today can be
invested to generate interest and gain more than
the same amount in the future. Time value of
It has to be noted that relationship on the future
value was used to describe the relationship between
present value and future value.
Present value of a multiple cash flow is equal to
the sum of discounted singular cash flows:
money quantifies mathematically the value of a
given quantity of money, respectively a patrimonial
element value in time. This of course depends on the
discount rate.
The concept of time value of money can be
divided into two categories:
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(1)
PVM = Σ [FCF t / (1+ r)t]
805
(3)
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Proceedings of the 5th WSEAS International Conference on Economy and Management Transformation (Volume II)
IRn = IRr + IRa
In which: PVM is the discounted value of a multiple
cash flow;
FCFt is the future cash flow that results at
the end of the year t;
r is the annual discount rate;
t is the number of years.
4 Conclusion
Thus, in conclusion, the paper shows that the use of
reliable estimates for patrimonial elements of
financial statements of economic entities assures a
real utility to users. The general managers or
accounting managers may base on estimation
techniques to valuate correct the entity's ability to
generate future cash flows and the timing and the
certainty of their generation, especially in a dynamic
economic environment conditions.
Financial statements should therefore be directed
towards the future and not only to relieve past
events. To achieve this goal, the accounting
responsible for financial statements must use the
best techniques for estimating the assets of
economic entities.
The refinement issue of this analysis consists in
determining which are the proper discount rates that
can be used for each type of patrimonial element.
Accounting provocation consists in choosing the
most suitable type of rate used in the estimation
process for each asset or liability in the financial
situation. So, the use of estimation techniques in
accounting recognition is a combination of
professionalism, experience and art.
In many cases, the discount rate is considered to
be the interest rate or the inflation rate, but on
determining the levels of discount rate has been and
still are many controversies [4].
In the determination of this rate regularly are
standing:
The cost of Equity;
The cost of borrowed capital;
Weighted average cost of capital;
Marginal cost of capital;
Average profitability of the industry;
Adjusted interest rate, representing the
interest rate on assets or risk-free
investments plus a risk premium related to
industry;
From these variants, at least theoretically,
most experts agree on the last, in which the
discount rate is:
r = r0 + rr
(4)
Where: r is the annual discount rate;
r0 is the interest rate of risk-free assets
(bonds);
rr is the risk rate.
References:
[1] X1. Cernuşca, L., Strategii şi politici contabile,
Economic Publishing House, Bucharest, 2004
[2] X2. Feleagă, N.and others, Principii şi opŃiuni
contabile,
Infomega
Publishing
House,
Bucharest, 2008
[3] X3. Ionaşcu, M., Ionaşcu, I. – Raportarea
financiară
conform
normelor
contabile
internaționale (IAS/IFRS), Tribuna Economică
Publishing House, Bucharest, 2007;
[4] X4. Negrilă, A., Proiectele investitŃionale.
Fezabilitate şi eficienŃă, Mirton Publishing
House, Timisoara, 2003
[5] X5. Popa, A., Studii practice privind aplicarea
Standardelor InternaŃionale de Raportare
Financiară în România, Contaplus Publishing
House, Bucharest, 2007
Interest rate in relation to long-term bonds (r0) is
considered to be required rate of return on any
investment without risk. Given that the efficiency
calculations are made at current prices, interest rate
taken into account in the discount rate is the
nominal interest rate. Nominal interest rate includes
the average expected inflation [5]. The following
relationship linking the nominal interest rate with
real interest rate and inflation rate based on the idea
that all interest rates reflect expected rates of
inflation:
IRn =[(1 + IRr) ×(1 +IRa)] – 1
(6)
(5)
Where: IRn is the nominal interest rate;
IRr is the real interest rate;
IRa is the anticipated inflation rate.
When the anticipated rate of inflation is low
(below 10%), the relationship above can be reduced
to the following form:
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ISBN: 978-960-474-241-7