Market Value and Change in Accounting Policy Essay

Market Value and Change in Accounting Policy - Essay Example Any organization in the market has to ensure that it chooses the correct accounting policy to attract more investors. The investors usually have an interest in studying the financial situation of the company to allow them to make an effective marketing decision. Insightfully, this means that the choice the company makes will affect the reflection and recording of financial statement to the investors. Consequently, the earning management by a company highly depends on the accounting policy that a firm uses in showing its financial position. Discussion The switch between FC and SE, as accounting methodologies, depending on the reasoning that one capitalizes while another expense the cost. Successful Efforts refers to the methodology where the unsuccessful exploration cost is expensed and usually integrated as part of the income statement. However, Full Cost involves capitalizing the unsuccessful exploration cost meaning that this cost is not part of the income statement in this situati on. The choosing of the two alternative methods relies on their effectiveness in achieving transparency related to the accounting information about oil and gas company’s earnings and cash flows. Based on the Successful Cost method, the objective of an oil and gas company is to produce oil or gas from its reserves hence the view that only the costs related to successful efforts are capitalized. On the other hand, the cost incurred is usually expensed, because successful results rely on the change in productive assets. Conversely, the FC method holds that the main objective of the oil and gas companies is to explore and develop oil and gas reserves. This implies that the costs incurred in the process of exploration and development should be capitalized followed by writing them off as the operation cycle continues. However, the regulatory approval from the Financial Accounting Standards Board (FASB), which looks over the establishment of the governing GAAP, required the oil and gas companies to adopt the SE method. In rejecting the change from FC to SE method, the users argued that this could substantially depress reported earnings and equity figures; and increase the volatility of earnings over time. This means that a change from FC to SE will reduce the capabilities of the firm to raise capital in the stock market thereby leading to vulnerability to competition. The increased volatility of earnings implicates a limitation in the ability of the firms to carry out new explorations in the industry. To support its view on the potential effect coming with adopting FASB Exposure draft, the journal presents statistics showing that 70 out of 109 FC firms would have their average earnings reduced by at least 5%; and 86% of these companies will also witness at least a 5% decrease in their owner’s equity (Lev, 1979, p. 487). Impact of the change on cash flow The shift in the accounting method, from FC to SE had no impact on the cash flow albeit the decrease in the market value. A no-effect theory as stated by HOLTHAUSEN, argues that there is no effect on the stock price associated with the change in accounting policy (Holthausen & Leftwich, 1998, p. 114). The accounting methods are just a facade for the accounting numbers, available for the investors. The author notes that the firms, adopting policy change can unravel the accounting numbers, without spending any dollar, implying that the choice of accounting methods do not affect the wealth of the company.     Ã‚