Accounting Theory

1. Introduction

Financial reporting is designed to provide business skills, financial reporting, technical accounting and values. In current competitive economic environment, financial reporting provides users with information of business plans, corporate developing strategies and leadership ability. Financial reporting plays the important role to prove financial performance of company for investors and creditors. They could though financial reporting to evaluate company’s financial performance. It also important to company managers. Company management can use financial reporting to explain the behaviour of the firm to outsiders. To doing financial reporting, balance sheet-based approaches and income statement approach are two alternative and competing methods. In this essay, we will evaluate these two approaches. They have different nature and focus.

1.1Income statement approach (HCA)

Income statement approach is the primary goal of financial reporting which determination of revenues, expenses and earnings (Revenues –Expense=Earnings).The timing and magnitude of revenue and expense amounts are emphasis on the determination. Also, balance sheet accounts and accounts are secondary.

1.2Balance sheet-based approach (Exit price or fair value)

In financial reporting, the suitable valuation of assets and liabilities is the main task, with the determination of other accounting variables, such as revenue, expense. They are considered secondary task and derivative.

In 2007, Ilia D. Dichev and Stephen Penman mentioned that “The principal implication from this perspective is that the determination of income statement amounts and especially earnings is governed by balance sheet considerations. The balance sheet approach, take in to its logical conclusion and extreme, prescribes that the correct determination of assets and liabilities completely determines earnings, where earnings for a given period is simply the change in net assets over that period.”

1.3Difference

The difference between balance sheet-based approach and income statement approach is calculate the profit. The two major guiding principles in the process are the matching of expenses to revenues principle and the revenue recognition principle and the revenue recognition principle.

• Income statement approach(HCA: traditional historical theory)

[Revenues-expenses=earnings]

This approach focus on operating process of the firm. It is measuring and reporting profit from operations which refer to an entity’s business activity. Financial analysts and investment are thinking stock value as rising from company’s ability to generate earnings. This approach has strong support in investment and also accounting practitioners.