Management Accounting in Business - Essay Example

?PLEASE ANSWER THESE QUESTIONS SEPERATELY Table of Contents Table of Contents 2 SECTION A 3 a.Usefulness of financial ments in decision making process 3 b.Fundamental properties of reporting information identified by the IASB Framework 4 SECTION B 6 a.Liability as Regards to IASB Framework 6 b.Recognition Criteria under IASB Framework 7 c.Disclosure of absence of earthquake insurance by a company 7 References 9 SECTION A a. Usefulness of financial statements in decision making process Accounting is the process of representing financial information of any organization in the form of financial statements. Financial statements like balance sheet, profit and loss account, cash flow statements, etc. include a systematic representation of all the financial transactions carried on by an organization. These financial transactions are first identified, recorded and then communicated to the interested users in the form of financial statements. The users can be either internal managers of the organization or the outsiders like the stakeholders of the company (Kimmel, 2011, p.5-6). Out of many uses of these financial statements to its users, decision making is one of its most crucial aspects. Interpretation and financial analysis of these financial statements facilitates decision making process of a company. Business organizations have to take so many vital decisions on a regular basis. These strategic decisions, whether it is long term or short term, can either make or break a company. A company’s future is dependent the soundness and efficacy of the financial statements. Now in order to facilitate decision making, the financial statements prepared must exhibit relevant information required by the managers to interpret and come to a decision. It includes information regarding relevant costs and revenues associated with it. A few examples of some vital decisions taken by an organization, requiring specific relevant information are as follows: Whether to make or to buy: Whether it is better to make the product within the company or whether it should be bought from outside by sub-contracting it to some other company is more often or not are to be decided upon the internal managers of the company. This often requires a comparative study of the relevant costs that are likely to be incurred in both the alternatives to come to the most cost effective decision. These costs data are provided by financial statements of an organization. Whether to increase output or sales: In order to decide whether to increase output or not, again a comparative study of the additional costs involved and the additional revenue that can be generated is required. This will give the estimate of the profits involved to help taking the decision. Decision to set up a new production line: Feasibility or viability of taking such investment decision requires projected figures of the running costs involved including the investments that would be required as well as the cash flows generated. These are all part of preparing financial statements that reflects these crucial financial elements of a business organization. Decision to put a hold or completely close down a business activity: This again requires information regarding avoidable costs and unavoidable costs involved in order to facilitate the management to take such decision which can only be analyzed through detailed financial statements of an organization (Bendrey, M, Hussey, R. & West, 2003, p.4-8). Thus, financial statements hold the key to various strategic decisions taken by business concerns in order to successfully run the business. b. Fundamental properties of reporting information identified by the IASB Framework The International Accounting Standards Board (IASB) Framework, also known as Conceptual Framework provides information and guidelines that are to be maintained while preparing and presenting financial statements. The standards that are set out contains information regarding concepts about objectives of financial statements, the underlying assumptions involved, the fundamental qualitative characteristics that shows how the information is useful in financial statements. In addition to this definitions of sources of financial information obtained and the criteria of reporting the financial information are also included under these frameworks. This framework actually helps or guides IASB while setting up new standards (Nandakumar, 2010, p.11). The fundamental characteristics or properties of financial reporting also include information that is most useful in decision making process (Kieso, 2010, p.43-44). Four important fundamental properties have been identified by the IASB Framework (Nandakumar, 2010, p.12-14). They are as follows: a. Understandability This refers to the property that every financial statement should be easily understood by any person who is analyzing the information recorded in them. The users can be just a layman who might invested some of his money in any of the shares of listed companies and may not have any specific knowledge about financial accounting or any accounting standards. But the framework defines that the financial statements may not be understandable by everyone but can be understood by a person who has the basic knowledge of accounting in business and is reasonably willing to study or analyze the information required. b. Relevance Relevance means the information provided should be relevant to its user while taking economic decisions and should also be available to the users at the appropriate time. All relevant information must have two basic characteristics, firstly it should have a predictive value and secondly, it should also have confirmatory value to the users of financial statements. c. Reliability Any financial information provided by the financial statements must be reliable in the sense that it should be free from any errors, should not be biased and represents complete and authentic information about the business concern. d. Comparability It means the information should be such that it can be easily compared with other business entities and are also comparable over a specified time period. Thus these are the four fundamental properties that have been identified by the framework and are of great importance to facilitate economic decision making process to any of its users. SECTION B a. Liability as Regards to IASB Framework Liability is defined in paragraph 49 of IASB framework. An obligation which has aroused from some events of an organization that occurred in past and it exists as an obligation to the organization at present, can be called as a liability to the company. In addition to this, cash or other resources outflow should be the only consequence upon settlement of such obligation. For liabilities, it will never result in inflow at any instance. IAS 32.5 [IAS 32.11] gives an overall idea about financial liabilities and how they are categorized. Financial liabilities are such which is comprised of contractual obligation, either for the delivery of financial assets like cash to a different entity or for the exchange of instruments like derivatives that may arise in case of unfavorable conditions (International Monetary Fund, 2006, p.221). In the given case or situation, there was a substantial loss due to earthquake and it is for the first time that it has happened in the Pacific Island. According to IASB framework guidelines, this type of potential loss from earthquake is a part of financial risk to the company and meet the requirements mentioned in the definition of liability because the event of earthquake has already occurred, which has created an obligation for the company and this obligation still persists in the company. Also on settlement of this liability on any time in future, it will always create an outflow for the company, if there is no insurance contract with some insurer, who has recognized it as an existing and significant insurance risk. b. Recognition Criteria under IASB Framework According to IASB framework, the recognition criteria of a liability are mentioned in IAS 37. Under IAS 37, a business entity is required to recognize a particular event as a liability, if it satisfies three criteria. They are as follows: i. Firstly, it must satisfy the definition of liability mentioned under IASB framework. ii. Secondly, during settlement of the obligation, an outflow of benefits which are economically linked must have a probability i.e. the occurrence of event is more likely than not. iii. Finally, reliable means of measurement of the liability is possible (IASB, n.d.). Thus, in the given example, potential loss due to earthquake is defined as liability under the guidelines of IASB framework as mentioned earlier. But the second and third criteria for recognition of liability are not fulfilled in this case because there was no probability of occurrence of earthquake in the area and thus, the liability cannot be measured with reliability. Thus it satisfies only the first condition and not the other two and in that case according to IAS 37, it is known as ‘contingent liability’ and is not recognized in financial statements and should be attached to the financial statements as notes (Nandakumar, 2010, p.215). c. Disclosure of absence of earthquake insurance by a company As discussed earlier, relevance and reliability are two fundamental characteristics of IASB framework. All information if at all disclosed in any form in the financial statements of a company should be relevant to the person who uses the financial statements to make some economic decision. Moreover, the financial information should also be reliable as it can affect the conclusion drawn from non-reliable information that may have been presented in the financial statements. Relevance is a characteristic which is a part of every framework and it has an influence on various economic decisions taken by its users while evaluating any event or confirming any prior expectations. Timeliness is also an important aspect of relevance because relevant information should be available on time while taking any decision. Reliability is another important fundamental characteristic of financial information so that it is neutral and can be verified (IASB, 2005). In the context of the given example, potential loss due to earthquake being a contingent liability, should be disclosed as a note to the financial statement since it is a relevant information for the users and can influence their decision making capability (Friedrich, 2009). References Bendrey, M, Hussey, R. & West, C. (2003). Essentials of management accounting in business UK: Cengage Learning EMEA. Friedrich, B & Friedrich, L. (2009). International Accounting Standard 37 (IAS 37), Provisions, Contingent Liabilities and Contingent Assets. [Pdf]. Available at: http://www.cga-pdnet.org/Non_VerifiableProducts/ArticlePublication/IFRS_E/IAS_37.pdf. [Accessed on February 29, 2012]. IASB. (2005). Qualitative Characteristics 1: Relevance and Reliability (Agenda Paper 7). [Pdf]. Available at: http://www.iasb.org/NR/rdonlyres/B961E3F8-A77C-43B3-8B8C-5B5AB3504E27/0/May050505ob07_b.pdf . [Accessed on: February 29, 2012]. IASB. (no date). IASB press summary. [Pdf]. Available at: http://www.ifrs.org/NR/rdonlyres/2C92E25A-F831-4399-95F2-A6840DCBFA1F/0/IAS37roundtablespresssummary.pdf [Accessed on: February 29, 2012] International Monetary Fund. (2006). Financial soundness indicators: compilation guide. USA: International Monetary Fund. Kieso, D.E, Weygandt, J.J. & Warfield, T.D. (2010). Intermediate Accounting: IFRS Edition, Vol.1. New Jersey, NJ: John Wiley and Sons. Kimmel, P.D, Kieso, D.E & Weygandt, J.J. (2011). Financial Accounting: Tools for Business Decision Making (Ed. 6). New Jersey NJ: John Wiley and Sons. Nandakumar, A. (2010). Understanding IFRS Fundamentals: International Financial Reporting Standards. New Jersey NJ: John Wiley and Sons. Read More