Usefulness of Accounting Theory to Practicing Accountants Today - Research Proposal Example

Running Head: FINANCIAL ACCOUNTING THEORY Financial Accounting Theory in APA Style by Question: Critically evaluate the usefulness of accounting theory to practicing accountants today. To illustrate your arguments, discuss in depth one module covered in the course-Conceptual Framework Projects. Introduction Each individual has his/her own perception of what relevance accounting theories bring to the accounting profession. Some express comfort knowing that the theories have evolved from a systemic line of problem solving since the early 1800's, while others embrace the fact that scientific method and practical application has played a huge role in developing a more consistent baseline in latter years. In order to look at how accounting theories impact practicing accountants today, this paper will give an extensive discussion of how the history of accounting thought evolved in order to form a conceptual framework that is currently utilized in the business world. Throughout history, the need of a single and unified conceptual framework which will embody the needs of business organization for financial reporting has been a pressing concern. The lack of established accounting theory to support the reporting of financial transactions and production of financial reports called for the foundation of financial reporting. Without accounting theory, accountants grapple with the difficulty of producing reports which will clearly represent the company's performance. Comparison and benchmarking cannot be accomplished since reporting is not supported by the same foundation. The need of a conceptual framework is even highlighted by the era of globalisation which aims the creation of a single global village. However, it should also be noted that the usefulness of accounting theory is limited by the adherence of accountants which utilizes it. The financial fiascos that shook the global community highlights the need of a more stringent control and adherence to the reporting process in order to produce financial reports which fully embodies the financial position of a business organization. The Normative Era In the early 1800's, accounting theories were random and ill-defined. Development was unstructured and the formalisation of existing practices was still in the very preliminary stages. Scientific development was also quite ad hoc and inconsistent, yet 42 bulletins were already developed before 1970. These facts help magnify the importance of having a united adaptable system for the accounting profession to work consistently from. The normative period began to emerge in 1956 and developed until 1970. This stage allowed the development of a set of norms for accounting practices and the commencement of the conceptual framework for accounting. It was divided into two dominant groups-the conceptual framework and the critics of historical cost. As the normative era was not being successfully accepted by the community the period ended as an availability of financial theories, and computer databases led to empirical research. The Positive Accounting Theory Era In response to the early dissatisfaction to the normative theory, the positive accounting theory era began in 1977. This theory reached its plateau of popularity in the 1980's, under the Regan and Thatcher administrations. The theory assumed that every individual is a rational wealth maximiser whose main goal is to generate the highest return given his limited resources. This lead to three different scientific conclusions: 1) the Bonus plan hypothesis which assumes that all individuals were wealth maximisers; 2) The debt to equity hypothesis; and 3) The political cost hypothesis. The critical perspectives of this train of thought highlighted that accounting could not be separated from its societal context (Cooper & Shearer, 1984). The aim was to stress inequities and pursue social justice thus, putting an end to exploitation. This process brings about growing interest in social and environmental reporting and corporate social responsibility. The Dialectic Period The Marxist theory stresses that labour creates value while machinery and raw materials simply transfer their value to the finished product. The value of a commodity is the "socially" necessary labour time needed to produce it. Marx maintained that surplus value was the proceeds from the sale of commodities, minus the socially necessary value of labour, time, materials and equipment depreciation needed to produce it. According to Marx, surplus value is the capitalist's profit which is unpaid labour time that occurs due to labour force's exploitation. The Marx theory became the cornerstone of the 'Dialectic' period. This period maintained that qualitative changes occur within the system as one side gains control in the struggle between opposites. Today's application is reflected in shareholder wealth maximisation and free market theories that dominate the business world. From here, post-modernism theories follow creating the notion that there are simultaneous multiple realities emphasizing that history has a purpose and is ongoing. This theory played a big role in giving voice to marginalised groups which include African Americans. The Foucaldin Perspective and Others The Foucaldin perspective asserted that power and knowledge in society is controlled by largely established discourses or accepted rules of speech and behaviour within communities. It presented power as an insidious everywhere force which is connected to knowledge. This can either be positive or negative. Liberal feminists fought for changes to see women accepted into influential positions. The radical/ Marxist/ social feminists believed that society itself was fundamentally flawed. Many more theories existed and were announced to the public for critical analysis throughout the time period. The discussion above shows how environmental forces and evolving philosophies have contributed to the formation of accounting theories. Overall these theories can be seen to be creating an instrument to develop an adaptable, ever changing precedent for analysing and producing methods to support the accounting baseline upon. As discussed, these theories inspired the methods for recognising and measuring income and capital. Essentially, their influence developed a set of rules, a blueprint, for constructing specific accounting systems for the recognition and measurement of income and capital adapted to suit the needs of a particular business entity. The integration of the theories provides a guideline for professional bodies to produce financial statements. The documents provide a journal of information for the relevant entity to examine what has historically happened to them in past reporting periods and an insight into what adaptations can be made to strengthen their financial position in the future. The Conceptual Framework During the last decade, the accounting statutory and professional bodies have been working for the development of a conceptual framework for financial recording and reporting. A conceptual framework represents a logical theoretical structure to support and direct accounting practice. Up until 2004, four statements of accounting concepts had been issued under the Australian Conceptual Framework Project: SAC 1 'Definition of a Reporting Entity' SAC 2 'Objective of General Purpose Financial Reporting' SAC 3 'Qualitative Characteristics of Financial Information' SAC 4 'Definition and Recognition of the Elements of Financial Statements' As part of the process of issuing AASB equivalents to IFRS, the AASB reviewed the Australian concept statements (SAC 1-4) for consistency with the internationally accepted framework. The AASB decided to retain SAC 1 and 2 to ensure clear interpretations of the application paragraphs of AASB equivalents to IASB standards. The IASB has no equivalent to SAC 1 Definition of the reporting entity yet this concept is embedded in Australian GAAP. SAC 2 Objective of general purpose financial reporting is also essential to the application of AASB standards. Retaining these statements does not compromise compliance with IASB standards (AASB 2004b). SAC 3 and 4 are superseded by the AASB equivalent to the IASB Framework which will be applicable from 1 January 2005. SAC 3 and 4 were withdrawn because of the overlap between the materials in them with that in the IASB's Framework. Consistency between the AASB and IASB frameworks was necessary because Australian standards refer to the Framework (as in AASB 108 discussed below). In addition, the Framework is considered when the AASB evaluates proposed standards for application in Australia (AASB Framework, p.7). The AASB Framework is equivalent to the IASB Framework and it has additional paragraphs inserted to explain its application in Australia (AASB Framework, p. 9). The aims of framework are unchanged. They encompass: 1) assisting the AASB in the development of future accounting standards; 2) promoting harmonised regulations and reducing the number of alternative treatments; 3) assisting preparers, auditors and users of financial reports; and 4) showing the AASB's approach to formulating accounting standards (AASB Framework, para. 1). The IASB Framework covers similar topics to SAC 3 and 4, namely objectives of financial reports, qualitative characteristics that determine the usefulness of information in financial reports, the definition, recognition and measurement of the elements from which financial statements are constructed and the concepts of capital and capital maintenance (AASB Framework, p. 37). The AASB has stated that the Framework is relatively brief in comparison to SAC 3 and SAC 4. Two key differences are that the Framework includes prudence as a qualitative characteristic and identifies two components to both income and expenses. The Framework (pp. 37-38) explains the implications of the differences in this manner. (a) The framework includes prudence as a qualitative characteristic while SAC 3 places more emphasis on neutrality. Under the Framework it is more likely that assets or income are understated and liabilities or expenses are overstated. (b) SAC 4 defines revenue as 'inflows or other enhancements, or savings in outflows, of future economic benefits in the form of increases in assets or reduction in liabilities of the entity'. In the Framework, income is defined as both revenue and gains. Thus, under SAC 4 inflows are shown on a gross basis, while under the Framework some inflows are shown on a gross basis and others on a net basis. (c) SAC 4 defines expenses as "consumptions or losses of future economic benefits in the form of reductions in assets or increases in liabilities of the entity, other than those relating to distributions to owners, that results in a decrease in equity during the reporting period". Under the Framework, expenses include losses that are determined on a net basis and may or many not arise in the course of ordinary activity of an entity. Thus under SAC 4 outflows are shown on a gross basis while under the Framework some outflows are shown on a gross basis while others are shown on a net basis. During 2004 the Australian Accounting Standards Board, in its move to adopt International Accounting Standards, replaced the Australian Conceptual Framework with the International Framework. As a result SAC 3 and SAC 4 have been replaced by the Australian adoption of that framework which is now referred to as the AASB framework. Even though SAC 1 and SAC 2 were not covered by the International Accounting Framework, they have continued to be included in their previous format. Thus, while the framework and statements of accounting concepts are not mandatory, they continue to have a significant influence on new and revised accounting standards being used. SAC 1 is concerned with setting the boundaries of financial reporting and thus, the scope of the Concepts Statement. It involves consideration of the types of activities or information to be included in the discipline of financial reporting and consideration of the skills that the accountants can reasonably claim. The considerations are relevant in distinguishing general purpose financial reporting from special purpose financial reporting and determining which parts of a periodic report by an entity should be subject to reporting requirements and audit, considering whether non financial information has a part to play in financial reporting, and whether new areas of reporting should be included within financial reporting. An example of this is prospective financial information. Critics of this process have isolated some interesting points. SAC 1, paragraph 12, describes that 'individual reporting entities be identified by reference to the existence of users who are dependant upon general purpose financial reports for information for making and evaluating resource allocation decisions.' Critics emphasize that the public's right to information arises not from a direct financial or human relationship with the reporting entity, but from the general role played in society by economic entities. SAC 2 critics voice the dissatisfaction regarding the objective of general purpose financial reporting. This objective is to provide information useful to users for making and evaluating decisions about the allocation of scarce resources. Many assert that this statement focuses only on the primarily economic aspect of accounting and fails to include important issues such as safety and environmental issues. More criticisms of the framework include crucial issues involving the recognition and measurement principles. The critics imply that measurement is based on unspecified rules, logic is circular, and definition of elements is unworkable, providing little guidance to practising accountants. Further criticisms emphasize that accounting can never be neutral and unbiased. Dean and Clarke (2003) described many issues that are relevant to understanding why the development of the conceptual framework has been problematic. The authors argue that development of the framework has been more a search for a rationale for current practice, than a reaffirmation of the legal, social and economic framework within in which accounting is to function. They suggest that current framework projects have sought to develop a constitution-based framework for accounting instead of focusing on concepts underpinning ordinary everyday commerce. SAC 4 was introduced in 1995 and proved to be highly controversial as critics were not agreeable to the principles surrounding the recognition of the elements of the financial statements. The boards attention was increasingly taken up with the harmonisation of both Australian and international accounting standards. SAC 5, dealing with measurement methods was not released to the accounting community, as it was decided by the board that the community was not ready to accept a standard prescribing measurement method. It is stressed that more ground work needed to be done. The AASB issued SAC 1, 2, 3 and 4 in Australia over the period 1985 - 1995. The statement provided significant guidance to standard setters and financial report preparers in Australia. They represented innovative work in the area of a reporting entity concept and illustrated how one framework could apply to the private, public and not for profit sectors. Following the decision to adopt IFRS in Australia from 1 January 2005, the AASB has reviewed the Statements. It has retained SAC 1 and 2 and withdrawn SAC 3 and 4, replacing theism with IASB's Framework. Future work on the conceptual framework in Australia is likely to be led by the IASB's agenda. Convergence of accounting standard means that the AASB will not proceed with the work on the framework independently of the IASB. The IASB has several projects that may influence its framework and thereby affect Australian financial reporting, including the measurement project and the concepts of revenue, liabilities and equity project. While the framework has an important role to play in future standard setting, the ability of the IASB to develop and apply a robust conceptual framework is uncertain. The decision in the US to refine and develop a conceptual framework as a joint project with the IASB is timely. It will assist the IASB in developing its framework because the joint project provides both resources and legitimacy. A joint project between the FASB and the IASB combines the resources of the two most powerful standard setting bodies in the world. It provides a unified approach, which increases the chances that the resulting frameworks will be more acceptable. However the extent to which the IASB framework is accepted and used in standards will be the real test of its success. The development of national conceptual frameworks has been controversial. The example of IAS 39 suggests that gaining international agreement on measurement concepts that depart from historical cost will be difficult. The political processes that surround standard setting may hamper the development and use of a sound framework in future years, this could mean that the objectives of the framework are not fully met, to the detriment of the standard setting process and goal of high quality financial reporting. The Future of the Conceptual Framework National conceptual frameworks, such as those developed in US and Australia, have played a key role in guiding standard setting initiatives. For example, FASB stated that the framework provides both a foundation for setting standards and concepts to use as tools for resolving accounting and reporting questions (FASB, 2001). Although existing concept statements have not been recently issued (the FASB's most recent statement was SFAC No. 7 in 2000), convergence of accounting standards has highlighted the importance of the conceptual statements that underpin the development of accounting standards and the quality of financial reporting. A study by the SEC (required by the Sarbanes- Oxley Act) has recommended that US accounting standards should be developed using a principles-based approach and that standards should be based on an improved and consistently applied conceptual framework (SEC, 2003a). FASB has adopted an objectives-oriented approach to standards setting which includes addressing deficiencies and inconsistencies in the conceptual framework and ensuring that new standards are aligned with an improved conceptual framework (SEC, 2003b). Thus, events in the US following the collapse of Enron, WorldCom and Arthur Andersen, together with international activity to converge accounting standards, have revived interest in conceptual framework projects at the FASB and IASB. The SEC's study recommends that as FASB adopts a more objectives-oriented approach to setting standards it should improve its conceptual framework in the following ways: 1) More clearly articulate how the trade-offs among relevance, reliability and comparability should be made. 2) Eliminate the inconsistencies between the discussion of the earnings process (found in SFAC No. 5) and the definitions of the elements of financial statements (found in SFAC No. 6); and 3) Establish a paradigm for selecting from among possible measurement attributes (FASB, 2004). Conclusion The conceptual framework has played a key role in the development of accounting standards. However, given international differences among national accounting systems on topics such as measurement, the process of developing and applying a robust international conceptual framework is still ongoing and is challenged by the evolving issues in the global business environment. Objectives include addressing deficiencies and inconsistencies in the framework by more clearly articulating how the trade offs among relevance, reliability and comparability should be made. It should be noted that the primary goal is coming up with a specific framework which will embody relevance, reliability, and comparability of financial statements. These also include the elimination of the inconsistencies between the discussion of the earnings process and the definitions of the elements of financial statement and establishing a paradigm for selecting from among possible measurement attributes. It has been observed that financial reporting which is currently done according to the preset guidelines of the IFRS follows to a great extent the underlying age old accounting concepts. Overriding of such concepts is granted only if such need arises for the presentation of fair and true presentation of all material facts to its users. One more interesting point to be noted here is that, confirming to one concept may result to overriding of another concept in which case, the concept which results in the ultimate transparency is preferred. Such a stance is taken up to ensure that entities do not involve themselves into dubious reporting. However, there are cases wherein tampering has been done which is against the IFRS, GAAP and the SEC guidelines and detection of such frauds may result in serious allegations like the one suffered by Enron recently. List of References Aboody, D, Barth, M &Kaznik, R 1999, 'Revaluations of fixed assets and future firm performance: evidence from the UK', Journal of Accounting and Economics, pp. 149-78. Alfredson, K., K. Leo, R. Picker, P. Pacter and J. Radford (2005) Applying International Accounting Standards, John Wiley & Sons, Australia. Anthony N. & Reece S., 1994, Accounting Principles, New Delhi, AITBS Publishers and Distributors. Australian Accounting Standards Board (AASB) (2003) ED 124 Released: The definition of reporting entity, the IASB framework and revenue and government grant standards, Media Release, 1 October. Available at http://aasb.com.au. Australian Accounting Standards Board (AASB) (2004) Concepts and policies Available at http://aasb.com.au/pronouncement/policies.htm. Godfrey, Accounting Theory 2005 updates John Wiley & Sons Australia, Ltd . Australian Accounting Standards Board (AASB) (2004) AASB plans for adopting IASB standards by 2005, 17 March. Available at http://aasb.com.au. Benston, GJ 1982, 'Accounting and corporate accounting', Accounting, Organizations and Society, vol. 7, no. 2. Bradbury, M. (2003) 'Implications for the conceptual framework arising from accounting for financial instruments', Abacus, 39(3): 388-397. Deegan, C 2006, Financial accounting theory, 2nd edn, McGraw-Hill Irwin, North Ryde, NSW. Financial Accounting Standards Board (FASB) (2004) 'FASB response to SEC study on the adoption of a principles-based accounting system', July 2004. Available at http:// www.fasb.org. Foster, J. and L. Johnson. (2001) 'Understanding the issues: Why does the FASB have a conceptual framework' Available fromhttp://www.fasb.org/articles&reports/conceptual_framework_uti_aug_2001.pdf. Francis RD, Business Ethics in Australia - a practical guide. The Law Book Company, Melbourne, 1994. Godfrey ,J, Hodfson, A,Homes, S& Tarca,A2006, Accounting theory,6th edn, John Wiley& Sons, Milton, Queensland. Henderson, S, Peirson, G & Herbohm, K 2006, Issues in financial accounting, 12th edn, Pearson Education Australia, Frenches Forest, NSW. IAS PLUS (2004) IASB Potential agenda project: Measurement, 4 August. Available at http://www.iasplus.com/agenda/measure.htm. International Accounting Standards Board (IASB) (2004) 'History'. Available at http://www.iasb.org/about/history.asp. Institute of Chartered Accountants in Australia (ICAA) (2004) Accounting and auditing today, Issue 23, 18 June. Available at http://www.icaa.org.au. International Organization of Securities Commissions (IOSCO) (2000) IASC Standards', Press release, 17 May 2000. Available http://www.iosco.org/press/presscomm000517.html. Jones, S. and P. Wolnizer (2003) 'Harmonization and the conceptual framework: An international perspective', Abacus, 39(3): 375-387. Loftus, J. (2003) The 'CF and accounting standards', Abacus, 39(3): 298-324. Morris, RD 1984, 'Corporate disclosure in a substantially unregulated environment', Abacus, vol.20, no. 1, pp 52-86. Reddy. D, 2004, Advanced Managerial Accounting, Hyderabad,Osmania University. Securities and Exchange Commission (SEC) (2003a) 'Study pursuant to Section 108(d) of the Sarbanes Oxley Act of 2002 on the adoption by the United States Financial Reporting System of a principles-based accounting system'. Available from http://www.sec.gov/news/studies.shtml. Securities and Exchange Commission (SEC) (2003b) 'SEC study on adoption by the US financial reporting system of a principles-based accounting system', Press release, 25 July. Available at http://www.sec.gov/news/press/2003-86.htm. Shukla. M.C., Grewal. T.S. Gupta. S.C., 2008, Advanced Accounts, Volume 1, New Delhi, S. Chand & Company Ltd. Wolk, HI, Francis, JR & Tearney, MG 1992, Accounting theory. a conceptual and institutional approach, 3rd edn, South Western Publishing, Cincinnati, Ohio. Read More