Conceptual Framework - Essay Example

A CONCEPTUAL FRAMEWORK FOR FINANCIAL ACCOUNTING Introduction: The meaning of ‘conceptual framework’ A conceptual framework, according to the online Business Dictionary, is “a theoretical structure of assumptions, principles, and rules that hold together the ideas comprising a broad concept.” From this generic definition, one may arrive at a derived meaning for the conceptual framework for financial accounting; however, this writer defers to the definition provided by the Financial Accounting Standards Board (FASB), which describes the conceptual framework for financial accounting as: “… a constitution, a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, functions and limits of financial accounting and financial statements.” (Macve, 1997, 45) In order to understand how this conceptual framework tries to accomplish the objectives set before it by the FASB and the International Accounting Standards Board (IASB) jointly, Macve suggests establishing the following particulars: A. As to the objectives of accounting - 1. The parties for whom and by whom the accounts are to be prepared; and 2. The purposes for which they are wanted. B. As to the form and content of accounts and methods of their preparation - 3. The kinds of accounting reports that are suitable for these purposes; 4. The degree to which present accounts fit the bill; and 5. The manner in which accounting practices may be improved in order to make them more suitable. Historical basis of the need for a conceptual framework Gore (1992), traces the need for such a framework to the credibility crisis in the accountancy profession in the United States, where developments preceded those in the UK. In 1916, the Committee on Accounting Practices (CAP) began cataloguing “accepted” practices, without seeking to prescribe or proscribe, and without establishing any underlying philosophy (Gore, 1992, 10). The methods describe therein, however, were used by the SEC in filed accounts. By 1959, due to concerns of vagueness in the Generally Accepted Accounting Practices and the poor quality of financial reporting, the CAP was replaced by the Accounting Principles Board (APB) which issued more definitive guidelines. By 1965. controversies surrounding merger accounting and the treatment of goodwill, together with allegations of fraudulent reporting, again prompted the American Institute for Certified Public Accountants (AICPA) to revamp the APB to include academics and a wider representation for accountants. Over time there thus developed a greater appreciation for research and theoretical support in determining accounting practices and standards, leading to the present thrust towards defining a cohesive, conceptual framework for financing accounting and reporting (Gore, 1992, 15). In the UK, prior to 1970 there were no regulations on accounting principles, and companies could choose from many possible approaches to reporting transactions. This freedom was abused, as exemplified by the Pergamon Press case, with the aim of influencing decisions of those relying on financial reports. By the early seventies, the Accounting Standards Committee (ASC) was charged with developing accounting standards and reducing the number of acceptable practices. Despite its best efforts, the ASC was criticized for its lack of autonomy because it relied on six accountancy bodies that often lobbied for comprises before the standard could be approved; so too did the enforcement of the standards rely heavily on said accounting association. Needless to say, the resulting “regulation” was more lip service than actual event (Dodge, 1987, 517). By the eighties, strong economic growth and a stock market boom called for more credible financial reporting than the capricious manner it had been undertaken until then. That is when the Consultative Committee for Accountancy Bodies (CCAB) caused the Review Committee, under Sir Ronald Dearing, to recommend possible actions after a careful study of prevailing accounting procedures. Part of the findings of the Dearing report, submitted in 1988, called for the formulation of a conceptual framework for financial accounting. The importance of a conceptual framework Any recommendation for a particular accounting practice must necessarily establish a basis defined by an implicit conceptual framework, which at some point should be made explicit if a discussion and consensus on the accounts is to take place (Macve, 1997, 47). To do otherwise would be arbitrary or capricious, or based solely on precedent with little other logical basis. Financial reporting would be, as it had been, generally perceived to give undue advantage to those who caused its preparation and misleading to unwary parties. What is worse, the adoption of an unfair practice, when condoned, invites competitors to follow suit – an example of bad accounting driving out the good (Mumford & Peasness, eds., 1993, xxiv). The present inadequacy of accounting practices, based solely on precedent, presents a problem when seen from the context of the U.K. Companies Act, which requires that the annual accounts (balance sheet and profit and loss account) should reflect “a true and fair view of the state of affairs of the company…and…of the profit or loss … for the financial year” (Section 149). On the other hand, promulgation of hard and fast rules that outlaws “unacceptable” practices detracts from the independent judgement of the accounting professional, and would just as much distort the “true and fair” picture that well constructed financial reports seeks to create. There is, therefore, a need to create a solid basis for accounting practices that is grounded on a theoretical or conceptual framework from which most auditors, who for the greater part are professionals in their motives and conduct, would adhere to in deciding the appropriate treatment of accounts. By defining the theoretical foundation, the accountant would have the discretion, appropriately delimited by reason, to craft the way he could best reflect the true and fair view of a company. At the same time, the conceptual limitations would provide sufficient basis by which third parties could view with confidence the audited financial reports, and a criterion for detecting possible abuses for which the accounting professional should be held accountable. The nature of financial accounting is both science and art. Sufficient conceptual foundations should define the former, with adequate decision-making power left for the accountant to effectively employ the latter. [WORDCOUNT = 1,000 excluding title] REFERENCES Conceptual Framework. BusinessDictionary.com Accessed 4 November 2009 from shttp://www.businessdictionary.com/definition/conceptual-framework.html Dodge, R 1997 Foundations of Business Accounting, Second Edition. International Thomson Publishing, Inc. Gore, P 1992 The FASB Conceptual Framework Project, 1973-1985: An Analysis. Manchester University Press, Manchester, U.K. Macve, R 1997 A conceptual framework for financial accounting and reporting: vision, tool, or threat? In New Works in Accounting History. Brief, Richard P., ed., Garland Series. Mumford, M J & Peasnell, K V, eds. 1993 Philosophical Perspectives on Accounting: Essays in Honour of Edward Stamp. Routledge, New York, NY. Setting Accounting Standards, American Standards Council, 1978. The U.K. Companies Act, 1948. Read More