‘Accounting is the process of identifying, measuring and communicating economic information to assist informed decisions by users of the information’ (The American Accounting Association). The users of the financial information communicated vary from managers, government, tax authority, auditors, investors etc. However, the primary users of general purpose financial reports are lenders and other creditors. Before presenting the financial information to the users, the prepares which in most case is an accountant must ensure that the information has been prepared according to the International Accounting Standard Board’s (IASB) Standards and Conceptual framework. The main purpose of conceptual framework is to help entities and users deal with practical problems in absence of accounting standards such as the treatment of complex transactions which may not be covered by an accounting standard. This will help to instil the user’s confidence in the accuracy and transparency of the financial information presented. The purpose of this essay is to critically evaluate how the conceptual framework is making sure financial statements that is useful in assessing the prospects for future net cash inflow to the entity are relevant and faithfully represented.
The argument that the conceptual framework for financial reporting and accounting standards facilitates the reporting of relevant and faithfully represented information is strengthened by the approach elected by IASB. According to PWC, the conceptual framework is evolutionary and therefore the IASB will constantly look for ways to update and improve the framework. The proactive approach undertaken by the IASB strengthens the conceptual framework and its accomplishments. The three main objectives of the framework the IASB strive to reach are : provide assistance in the development of future financial reporting and accounting standards and the review of existing standards, increase comparability from company to company and country to country by promoting the harmonisation of accounting practises and standards which is achieved through efforts of reducing the number of alternative accounting treatments amongst corporations, and as mentioned in the paragraph above, assist preparers with the application of financial reporting and accounting standards especially where standards may be limited. It is important to note, that the conceptual framework is crucial as observed in the past where rule based accounting systems prevailed as a result of the absence of the conceptual framework, but where/if the conceptual framework conflicts with the financial reporting and accounting standards, then the standards will always have the upper hand over the conceptual framework.
First and foremost, the revised conceptual framework emphasises the qualitative characteristics of financial information. Furthermore, it highlights the differences between fundamental characteristics and enhancing characteristics of the useful financial information. Fundamental characteristics refer to the qualities that every financial information reported must attain. The first mandatory quality stated by the conceptual framework is faithful representation. This quality suggests that the financial information reported is accurate as can be and free from any intentional or unintentional ambiguities. For example, if a public limited company (PLC) publishes its annual accounts and the income statement in this report shows a total sales revenue figure which differs from the reality, and as a result shows a higher net profit than what is truly the case, then this financial report would fail to meet its first fundamental quality as the report would be regarded as unfaithfully represented. The second quality is relevance, for financial information to meet this criterion, it must have the ability to assist users in making an informed economic decision. Relevant information would have a confirmatory (Confirm previous predictions on future outcomes) and predictive value (enable users to predict or anticipate future outcomes). If financial information is unable to hold these values, then that financial information is useless. The enhancing qualities are as follows: comparability, verifiability, timeliness and understandability. Therefore, in order for financial information to be useful, it must possess the 2 fundamental qualities explained above and may increase its usefulness by acquiring the enhancing qualities also mentioned. The emphasis placed on the fundamental qualities by the revised conceptual framework suggests that the International Accounting Standards Board are working to enhance the confidence of users of such information by ensuring that all information reported are useful sources to make economic decisions regarding the future. However, it can be argued that, the emphasis on these qualities may be problematic as it is allegedly counterproductive to what the IASB look to achieve. This is because, the strong focus on faithful representation and relevance of financial information may compromise other enhancing qualities such as timeliness simultaneously. This is because, as preparers of financial information must meet fundamental qualities, they will focus on the verification of information which can be a timely process. As a result, financial information may be constrained to meet its optimal utility.
The revised conceptual framework gives rise to the issue of stewardship also referred as the agency theory. One reason for the introduction of financial information is to allow the creditors or the shareholders of a company to measure the performance/decisions of the manager(s) i.e whether the allocation of resources are sustainable. This is because, the managers have not invested any capital into the business and therefore are not exposed to the risks that the creditors are facing. Subsequently, this may lead to irresponsible decisions being made on the managers behalf and not act on the interest of the company. For example, the manager may allocate capital to buy a luxury car for themselves during their duration at the firm. On the other hand, the financial performance and the position of the firm will have an impact on the manager’s reputation and position at the firm. For this reason, managers do have the incentive to overestimate profits or under estimate expenditure for their own benefits. To tackle this, the prudence convention was introduced. Under this convention, it is required that the revenue and assets shall not be overstated whilst expenditures and liabilities shall not be understated. The aim of this convention was to avoid any bias and therefore produce conservatively-stated financial statements. However, in the review of the IASB conceptual framework, it was concluded that the produce convention was not productive and therefore in 2015 the revised framework had eliminated the prudence standard.
The positive impact and success of International Accounting Standards and IASB’S conceptual framework is portrayed through the large international support it has gathered from various countries who look to utilise and adopt these frameworks and standards amongst their own business practises. One example of many is Australia. Australia has implemented the accounting standards and framework and has gone further to make it a legal obligation for all companies operating within the country to adhere to. However, Australia has selected specific which standards they will be following. The 28-member states of the European Union (EU) also adopt the conceptual framework. Italy is an example of an EU member state that adopts the standards to the extent where it is an obligation for domestic public companies and foreign companies to abide to the accounting standards set. This suggests, that the conceptual framework is of huge importance to many sovereign nations including large economies such as Brazil, Russia, India and China (BRIC economies). India and china have their own standards setters Indian Accounting Standards and Chinas National standards, however these standards are based on and heavily converged with International Financial Reporting Standards and conceptual frameworks.
However, the implementation of IASB’s conceptual framework did have some resistance and still does in some countries. The main reason for the opposition to the International Accounting standards is due to the significant costs that may have incurred as a result of replacing previous standards set for all companies. For this reason, some economies have decided not to adopt the international accounting standards completely for various reasons such as they have concluded that the cost of replacing old standards outweighs the benefits of the International Accounting standards whilst some countries such as China as mentioned earlier have converged with the international accounting standards but at the same time have not replaced the national standards of the country. The process of weighing the costs and benefits of a concept is referred to as Cost Benefit Analysis (CBA). Other reasons include the desire of independence, and setting own standards which can be used and adjusted as leverage to attract business to these economies to fulfil national interest without constrain from any international bodies. This is a major problem, because one of the aims of the conceptual framework as discussed was to increase comparability by enforcing a single set of standards and regulations which all companies follow world wide. However, as some countries partially adopt the financial reporting and accounting standards, this will most probably make it increasingly difficult to conduct inter-firm comparisons with companies that are operating in different regions, as one region may make their companies treat a specific element i.e. assets in one way, whilst the country in the alternative region treats the same asset in a different manner. For example, company A recognises plant and machinery which is a non-current asset in the statement of financial position at fair value, whilst company B measures its plant and machinery at cost value. In order to make a viable comparison ideally Company A and Company B would both measure their Non-current and Current assets at either fair value or at cost value. This would be ideal for investors as this is one of the elements which investors may want to compare to make a buy/hold/sell decision and would make the process slightly easier.
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Despite the efforts of International Accounting Standards Boards and other reporting regulators, the conceptual framework for financial reporting and accounting standards does not consistently produce relevant and faithfully represented financial reports. This line of argument has been evident for many decades through real world cases. A popular and fairly recent example of this, is the Tesco scandal. The supermarket chain made an announcement that it had suffered its first annual profit drop in two decades which consequently led to Tesco witnessing its market value dramatically plummeting by £10 billion pounds in 2014. Subsequently, Tesco adopted an aggressive accounting approach which led to an overstatement of profit by £263 million pounds as observed by Deloitte, a big four accounting organisation. In this case, the overstatement of profits meant that the information reported was not a true representation of the financial performance of the entity for that reporting period, therefore it has failed to meet this fundamental criterion and as a result it is not useful. This is one example of many which illustrates how the conceptual framework for financial reporting is subject to manipulation. However, it can be conceded that the conceptual framework is subjective and therefore, cases like the one mentioned above is what leads to the strengthening of the framework. Furthermore, it is argued that the implications of Tesco’s actions which saw a further £2 billion-pound fall in market value amid the overstatement of profits, accumulating fines and compensation payments which exceeded £241 million pounds, and a long-damaged image of the brand can all be seen as an example which will deter potential manipulation of the conceptual frameworks in the future.
To conclude, the revision of conceptual framework in 2015 refocused its aim on enhancing the usefulness of financial information by providing a way to measure the usefulness through the fundamental and enhancing qualitative characteristics. However, the framework which is a guideline of the prevailing accounting standards is evolving and therefore has not reached its full potential in achieving the objectives. Nevertheless, if International Accounting Standards Board continues to take a proactive approach as well as a reactive approach, this will allow the standards and conceptual framework to remain useful and relevant as situations are constantly changing the framework will continue to be successful in facilitating the reporting of relevant and faithfully represented information.