One of the issues dealt with by the Accounting Standards Board in its Statement of Principles for Financial Reporting is the measurement of assets and liabilities in financial statements.

The Statement notes that the historical cost system is the one most widely used in financial statements at present. However, the Statement suggests that financial reporting may well evolve towards a mixed measurement system, where some assets and liabilities are measured based on historical cost, while others are based on current values. The use of current values is already accepted practice for measuring certain categories of fixed asset, particularly properties. Recent developments appear to suggest that this practice may in future be applied to the measurement of financial instruments.

In September 1998, the ASB published FRS13 – Derivatives and Other Financial Instruments: Disclosures. Then, in December 2000, the ASB published a discussion paper that suggested measuring most financial instruments at current values, rather than merely providing information about current values in the notes to the financial statements. The discussion paper proposes that hedge accounting should be prohibited. Such a proposal, if implemented, would have a significant effect on current financial reporting practice in the UK. In particular, SSAP 20 – Foreign Currency Translation would need to be reviewed because this Accounting Standard currently permits hedge accounting in certain circumstances.

Required

(a) Identify the strengths and weaknesses of using a historical cost system of measurement for assets and liabilities. (5 marks)

(b) Explain why a current value measurement system is more appropriate for financial instruments than a historical cost system. (5 marks)

(c) Explain why the disclosure requirements of FRS 13 are insufficient on their own to satisfy the needs of users. (4 marks)

(d) Discuss the effect of prohibiting hedge accounting on current UK accounting practice.

(6 marks)

CIMA, Financial Reporting – UK Accounting Standards, May 2002 (Total = 20 marks)