Respond to the following: a. What is meant by the “articulated” approach to financial statements? b. How does the revenue-expense approach differ from the asset-liability approach for defining accounting elements? c. What, if any, would be the advantage of using a non-articulated approach to financial statements?

Question

What will be an ideal response?

Answer 1

ANSWER:
a. Articulation means that the income statement and balance sheet are mathematically defined in such a way that net income is equal to the change in owners’ equity for a period, assuming no capital transactions or prior period adjustments.

b. The revenue-expense approach focuses on defining the income statement elements. It places primary importance on the income statement, principles of income recognition, and rules of income measurement. Assets and liabilities are defined, recognized, and measured as a by-product of revenues and expenses. The asset-liability approach is the antithesis of the revenue-expense approach because it emphasizes the definition, recognition, and measurement of assets and liabilities. Income is defined, recognized, and measured as a by-product of asset and liability measurement. This approach is arguably superior to the revenue-expense approach because assets and liabilities are real. It is the increase in the value of net assets that gives rise to what we call income, not vice versa. The revenue-expense approach turns things around the other way and implies that changes in net assets are the consequences of “income’ measurement. Although the revenue-expense approach is the basic orientation of current financial reporting practices, some specific accounting standards reflect an asset-liability emphasis.

c. Revenue-expense proponents are primarily concerned with stabilizing the fluctuating effect of transactions on the income statement and are prepared to introduce deferred charges and deferred credits in order to smooth income measurement. Asset-liability advocates are mainly concerned with reporting changes in the value of net assets, and they are prepared to tolerate a fluctuating income statement that may include unrealized holding gains and losses. If the financial statements were severed, both the income-expense and asset-liability groups might be satisfied with a revenue-expense-based income statement and an asset-liability-based balance sheet.