Group Assignment

Discuss other reasons for differences between the value of net assets recorded in
the Financial Statements and the value which the firm may be worth.
The role of financial reporting is to provide the investors and capital markets with as transparent
and true a picture as possible (ACCA 2014, p.4). However, there are different values trying to
reveal a companys performance such as the net asset value, which is defined as the value of an
entity's assets less than the value of its liabilities and the market value (Atrill 2015). Eskildsen et al.
define the market value as the investors perception of the companys present and future value, as
manifested by stock prices (Eskildsen et al. 2003, p. 47). There is usually a difference between
the value of net assets recorded in the financial statements and the value which the firm may be
worth. But why is there such a main discrepancy between both values?
In order to determine whether a business is regarded as a failure or success, the basis of
measurement plays an important role. The historic cost approach implies that the value of net
assets shown in the statement of financial position is based on their historic costs (=the acquisition
cost), where unrealized gains are excluded. Historic costs and thus the value of net assets may
become obsolete over time whereas the market value shows current market prices and therefore
provides a more realistic view of a companys financial position. That is because the approach of
market value (or fair value) recognizes gains as they arise rather than as they are realized (ICAEW
2011 and Atrill 2015). A fair value measurement assumes the highest and best use of the asset by
market participants (ICAEW 2011,p. 29). Therefore the value of net asset can be, in general,
considered as more objective compared to the market value as historical costs are usually taken
from prices in real transactions whereas the market value relies primary on estimations. The choice
of the measurement basis leads to a high subjectivity of the business value, which has already
been discussed earlier in this paper (ICAEW 2011).
Another main reason for the difference between the net asset value and the market value is the
constant movement of markets. Financial reporting measurements attempt to capture a
continuous process of business activity at a particular moment in time (in the balance sheet) or
between two moment in time (in the profit or loss account and income statement) (ICAEW 2011, p.
14). The problem hereby is that a business might be in the middle of numerous incomplete
activities such as research and development activities whose results are still uncertain (ICAEW
2011). Moreover, the value of assets and liabilities are able to change over time for instance
properties often gain remarkable value over years. Therefore, data shown in financial statements
can be valued as non-current and therefore hardly relevant and reliable for decision makings
because financial reporting is usually only prepared yearly - a long time, in which much can
happen in todays active markets (Atrill 2015).
Monetary instability is a further reason for the discrepancy of both values. Financial reporting
measurements are expressed in monetary terms, but there is always the uncertainty of money to
stay stable. A persistent problem all over the world, but especially in the UK, has been inflation. In
times of inflation, the value of net assets stated in the statement of financial position, which were
prepared on historic cost basis, is much lower than current market values. Even though the rates of
inflation have been reasonably low in recent years, this can lead to significant differences between
both values (Atrill 2015).
Regarding those reasons among others for the differences between the value of net assets
recorded in the financial statements and the value which the firm may be worth, prudence should
be reintroduced as a key accounting concept to aim an understanding for the values differences.
As economic activities involve risks and uncertainties, which create greater demands on
judgement, prudence should be used to correctly reflect the economic reality. Although the
valuation of assets is based on the principle of historical cost, attributable figures of the realtime

value of assets as well as foreseeable liabilities and potential losses should be documented
appropriately so that an adequate assessment of all items involving situations of particular risk is
achievable (Accounting Advisory Forum 1995). Especially in fair value and cash-flow-based
measurements, prudence can lead to unquantified bias in accounts. However, reflecting
uncertainty in measurement can be an attempt to enable an honest application of the valuation of
risks and insecurities. A main concern of prudence is being over-prudent, where one creates
deliberate understatements of results. This leads to a false and unfair view of financial information
whereas it should be a reliable, unbiased record of performance (ACCA 2014). Even if there are
no clearly defined rules and criteria to determine the level of prudence (Accounting Advisory
Forum 1995, p.17), it can help to enable and provide a more neutral and comparable result in
financial statements.

Bibliography
ACCA, 2014. Prudence and IFRS. Online. Access from:
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Accounting Advisory Forum, 1995. Prudence and matching. Online. Access from:
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Eskildsen, J., Westlund, A.H., Kristensen, K., 2003. The predictive power of intangibles. Measuring
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ICAEW, 2011. Measurement in financial reporting. Information for better markets initiative. Online.
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