Learn, Explain Value Added Statements: Definition, Advantages, and Disadvantages!
The main thrust of financial accounting development in the recent decades has been in the area of `how’ we measure income rather than `whose’ income we measure. The Concept of Value Added Statements: Meaning of Value Added Statements, Definition of Value Added Statements, Advantages of Value Added Statements, and Limitations or Disadvantages of Value Added Statements! The common belief of the traditional accountants that profit is a reward of the proprietors has been considered as a very narrow definition of income. This was so because previously the assets were assumed to be owned by the proprietor and liabilities were thought as proprietor’s obligations. Also learned, Guide to Theories in Human Resource Management! Value Added Statements: Definition, Advantages, and Disadvantages!
This notion of proprietorship was accepted and practiced so as long as the nature of business did not experience revolutionary changes. However, with the emergence of corporate entities and the legal recognition of the existence of business entities separate from the personal affairs and interest of the owners led to the rejection of the proprietary theory.
Definition: The financial statement which shows how much value (wealth) has been created by an enterprise through utilization of its capacity, capital, manpower, and other resources, and how it is allocated among different stakeholders (employees, lenders, shareholders, government, etc.) in an accounting period.
Value added is now reported in the financial statements of companies in the form of a statement. Value Added Statement (VAS) is aimed at supplementing a new dimension to the existing system of corporate financial accounting and reporting. This is called value-added statement. This statement shows the value created; value added (value generated) and the distribution of it to interest groups viz. Employees, shareholders, promoters of capital and government.
Since VAS represents how the value or wealth created or generated by an entity is shared among different stakeholders, it is significant from the national point of view. ICAI, 1985 has defined Value Added Statement as a statement that reveals the value added by an enterprise which it has been able to generate, and its distribution among those contributing to its generation known as stakeholders.
For the purpose of calculating the amount of value added and its distribution, the value added statement is prepared. The main concern of this statement lies in deriving a measure of wealth (i.e. value), the entity has contributed to the society through the collective efforts of the various stakeholders. This statement is prepared and published voluntarily with the annual financial reports. Thus the presentation of a statement of value-added aids in the disclosure of VA by an enterprise.
The value-added statement may be defined as a statement, which shows the income of the company as an entity and how that is divided between the people who have contributed to its creation.
Assumptions in Value Added Statements:
Following are the basic assumptions which are used for computation of value-added income through the preparation of value-added statements.
- VAS is a supplement, not a substitute to P&L account.
- The same data which is recorded and processed by the conventional accounting system is used in the preparation of VAS.
- The basic accounting concepts and principals of accounting remain the same in preparation of VAS.
It is convenient to prepare Value Added statements from conventional Profit & Loss account. However, there is a lot of difference between these two statements since the income statements contain certain nonvalue-added items e.g. provisions, interests, non-trading profit, and losses, etc.
Objectives of Value Added Statements:
The main objectives of preparing Value Added Statements are:
- To indicate the value or wealth created by an enterprise. In a way, it shows the wealth-creating ability of the organization.
- To show the manner in which the wealth created is distributed amongst the employees, shareholders and the government. The pattern of distribution of value added can be clearly understood.
- To indicate the organization’s contribution to national income.
- To use it as a basis for making inter-firm and intra-firm analysis, for preparation of financial plans and targets, for developing productivity linked incentive schemes.
Value Added Statements v/s Profit & Loss Account:
The traditional Profit & Loss Account is prepared on the theory that the company was created by its shareholders and exists for their benefit. However, the traditional accounting system shows only the profits or losses made by a business enterprise and do not provide any information showing the extent to which the wealth is created by a business unit in a given period.
The newly developed accounting method of value added is aiming to add a new dimension to the existing system of corporate financial accounting and reporting through the disclosure of additional information regarding the amount of wealth an entity has created in an accounting period and how it has been divided up by the entity amongst those who have contributed to its creation.
The statement of value-added conceives the company as the corporate entity in which those who provide capital and those who provide labor cooperate to create wealth which they share amongst themselves and with the government. When the value added statement is prepared, then the company is viewed as a `wealth’ producing entity of a number of groups which are known as stockholders.
The value-added statement shows the wealth obtained by its employees, government, providers of capital or business itself during a period of time and the manner in which the generated value is distributed among the employees, government and the providers of capital. It shows the companies contributing to the national income.
The value-added statement is not a substitute, but a supplement to the Profit & Loss Account although it is based on the figures from the latter. The value-added statement is essentially a much simpler statement than the profit statement. The Profit & Loss Account is prepared on the basis of double entry system and its preparation is statutorily compulsory, but the value added statement is not prepared in the statutory account.
Advantages of Value Added Statements:
The following are some of the advantages of Value Added Statements:
- Reporting on VA improves the attitude of employees towards their employing companies. This is because the VA statement reflects a broader view of the companies objectives and responsibilities
- VA statement makes it easier for the company to introduce a productivity linked bonus scheme for employees based in VA. The employees may be given productivity bonus on the basis of VA/payroll ratio
- VA based (e.g. VA/Payroll, taxation/VA, VA/sales, etc.) are useful diagnostic and predictive tools. Trends in VA ratios comparisons with other companies and international comparisons may be useful.
- VA provides a very good measure of the size and importance of a company. To use sales figures or capital employed figures as a basis for company ranking can cause distortion. This is because sales may be inflated by large bought-in expenses or a capital-intensive company with a few employees may appear to be more important than a highly skilled labor intensive company
- VA statement links a company’s financial accounts to national income. A company’s VA indicates the company’s contribution to national income.
- Finally, VA statement is built on the basic conceptual foundation which is currently accepted on the balance sheet and income statements. Concepts such as going concern, matching, consistency, and substance over form are equally applicable to the VA statement.
Criticisms and Limitations or disadvantages of Value Added Statements:
It is argued that although the Value Added statements shows the application of VA to several interest groups (like employees, government, shareholders, etc.), the risk associated with the company is only borne by the shareholders. In other words, employees, government, and outside financers are only interested in getting their share in VA, but, when the company is in trouble the entire risk associated therein is borne only by shareholders. Therefore, the concept of showing value added as applied to several interested groups is being questioned by many academics.
They advocated that since the shareholders are ultimate risk-takers, the residual profit remaining after meeting the obligation of outside interest group should only be shown as value added accruing to the shareholders. However, academics have also admitted that from the overall point of view value-added statement may be shown as the supplementary statement of financial information. But in no case can the VA statement substitute the traditional income statement (i.e. Profit and loss account).
Another contemporary criticism of VA statement is that such statements are non-standardized. However, this practice of non-standardization can be effectively eliminated by bringing out an accounting standard on value added. Therefore, this criticism is a temporary phenomenon.
Thus, along with the advantages, the value added statements embody certain limitations also. These limitations are as follows:
- Preparation and presentation of the value-added statement may lead to information overload and confusion, as an ordinary employee reading his company’s corporate annual report may not be able to reconcile the value added statement with the earnings statement.
- Another limitation of Value-added statement is that it raises a danger that management may take the maximization of value added as their goal i.e. the inclusion of the value added may wrongly lead management to pursue maximization of firms value.
- Another argument against a value-added statement is that its inclusion in the corporate annual report would involve extra work, therefore, extra costs and delay and also a slight loss of confidentiality in view of the additional disclosure involved.
- The most severe limitation of value-added data emerges from lack of any uniformity and consistency amongst different companies in the preparation and presentation of Value Added statements. VAS is flagrantly standardized.
- Since there are various methods of calculating VA, it is difficult to make inter-firm comparisons. An even intra-firm comparison is not possible if the treatment of these items is changed in the subsequent years.
- Value Added statements may lead to confusion especially in the cases where wealth or value added is increasing while earnings are decreasing.
In spite of these limitations, it may be said that the value-added statement brings about certain changes in emphasis rather than the change in the content in the traditional financial statement. Thus it is considered as a valuable means of social disclosure.