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![](/i/favi32.png) Financial Accounting for Decision Makersfinancial-accounting-for-decision-makers-ninthnbsped-9781292251356-1292251352 compress56
CHAPTER 2
MEASURING AND REPORTING FINANCIAL POSITION
The bias towards the understatement of financial strength evolved in order to counteract
the excessive optimism of managers. However, just as overstatement can lead to poor deci-
sions, understatement can lead to the same. It may, for example, result in existing owners
selling their business too cheaply, lenders refusing a loan application based on a distortedly
pessimistic picture of financial strength and so on.
The systematic bias towards understatement just described clashes with the need for
neutrality
in preparing financial statements.
In Chapter 1 we discussed neutrality as a desirable element of one of the major qualita-
tive characteristics of financial information. Can you remember which one?
Neutrality is one of three elements needed to ensure faithful representation. (The other two
elements are completeness and freedom from error.)
Activity 2.15
Neutrality, by definition, requires that financial statements are not slanted or weighted so
as to present either a favourable or unfavourable picture to users. To accommodate the con-
cept of neutrality, therefore, prudence must be interpreted and applied in a different way than
described above. Adopting a cautious approach to preparing financial statements should not
result in the deliberate understatement of financial strength. In other words, assets and profit
should not be understated and liabilities should not be overstated.
Going concern convention
Under the
going concern convention
, the financial statements should be prepared on the
assumption that a business will continue operations for the foreseeable future, unless there
is evidence to the contrary. In other words, it is assumed that there is no intention, or need,
to sell off the non-current assets of the business.
Where a business is in financial difficulties, however, non-current assets may have to be
sold to repay those with claims against the business. The realisable (sale) value of many non-
current assets is often much lower than the values reported in the statement of financial
position. In the event of a forced sale of assets, therefore, significant losses might arise.
These losses must be anticipated and fully reported when, but only when, a business’s going
concern status is called into question.
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