The Usefulness of Accounting Standards - Term Paper Example

ADVANCED FINANCIAL REPORTING: ASSEING THE USEFULNESS OF ACCOUNTING STANDARDS INTRODUCTION Accounting standards are set rules according to which financial statement are prepared. These rules tell us how we should value our basic business operations and they also tell us about the accounting treatment of various transaction. They give us basis for the valuation of our stock, building, fixed assets and other items used in business operations. These standard are rigid and do not vary from one business to another. Ever business is bound to follow these standards in order to maintain the usefulness of information that is displayed in financial statements. These standards are promulgated not by individuals but they are formed by a committee which includes people from all walks of life. The reason behind this is that inclusion of people from all walks of life is that this committee wants to create principles or accounting laws which are helpful for everyone in the every field of life. There are several organizations which work day-in and day- out for developing such principles. These principles give much more meaning to the financial statement and provide value to the financial figures contained in these statements. IASB and ITS PRINCIPLE: One such organization is International Accounting Standard Board, IASB, which was formed in 2001. The purpose of this organization was to propose different accounting standards which might be the basis of preparation of financial statements. Since, these rules are followed by all the business; they make the comparisons between two businesses more useful and more accurate. The IASB Handbook describes the consultative arrangements of the IASB. The Trustees’ Procedures Committee is in charge of regularly reviewing and updating the IASB due process procedures. (IASB.org) IASPLUS.com states the summaries of various accounting principles that have been promulgated by IASB. This site can be used to view the principles that have been developed by IASB. In the times of recession also, these standards have become very important in the valuation of various businesses and in giving meaning to the financial statement prepared by these businesses. Some people still favor the fact that these accounting standards are really useful for the interpretation financial prepared by various businesses headed by different accountants having different mind-set and company policies, where as others people hold the view that these accounting standards only distort the financial picture of these businesses and give an unrealistic picture of theses businesses, in the times of recession. They oppose these standards because they think that certain accounting standards ‘window dress’ the actual position of the business, and can be misleading for the users of financial statement. By window-dressing techniques we mean that these financial statements are designed in such a way that they do not give the true picture of the business and therefore are less useful than they should have been. The IASB publishes its standards in a series of pronouncements called International Financial Reporting Standards or IFRS. Now, we will have a look at the various pronouncements that have been developed by this board. CRITICAL ANALYSIS OF PRINCIPLES PULISHED BY IASB: According to Frank Wood (2002, p. 234), FRS1 which is about cash flow statement provide that in order to give ‘fair picture of the business, it is necessary that a cash flow statement is to be prepared for all businesses. IASB believes that in the short-run cash is more important than profit figures. So, providing cash flow statement will provide more purpose to the financial statements. However, this might be partly true but in business scenario profit is more important that cash flow. No business will operate unless it is earning a good profit. Similarly, opponents of accounting standard deny the fact that cash flow is a necessity for every business and oppose this accounting standard. They support their argument by saying that all businesses set-up to earn profit and therefore cash movement have far less importance than the profit-earning power of the business. However, one thing that must be noted here is that cash-movements can pose serious problem for the business as some cash is always needed for the smooth operations of the business. However, if you ignore basic financial statements, i-e balance sheet and profit and loss statement and just focus on cash flow statement, you wont be able to make and good and strong decisions for your company. According FRS 3, every business should include the analyses of continuing operations, discontinued operation and acquisitions in their profit and loss account. Similarly, they should also make provisions for extra-ordinary items in their financial statements. This might be misleading because discontinued operations have no relevance for the business, after they are dumped and may overstate or understate the performance of the company. Similarly, extraordinary items are of little or no importance for the company, and including such items in the financial statement will only increase the burden and paper-work for accountants. This understatement or overstatement of profits in the financial statement will give in accurate information to the managers to base their decisions on. When the information give is wrong, the decision based on this information will also be wrong and as a result of these accounting standards the company may get inaccurate information for decision making which may ultimately lead to weak or bad decisions. The purpose of FRS4 is to ensure that all the companies treat their capital instruments in a clear, coherent and consistent manner in all financial statements. This way these statements will give a true and fair view of company’s financial position and profit or loss for a period. The need for this standard may be understood if one imagines a company which shows a loan as a long term liability when it should be shown as a short term one. This misrepresentation may cause hindrance in decision making process and may conceal a liquidity problem. From this argument, one can conclude that these standards are helpful in this type of cases and help the companies to be consistent and this aids the decision making by the users of financial statement as they get a fair and true picture of the accounts of the company. However, some people oppose FRS4 on the basis of: It does not tell how to treat shares issue to employees. Leases are not properly discussed in this standard How to treat equity share that are issued as part of a business merger. So, In this case these standards may distort the true picture of the company’s equity and may lead to faulty decision making. According to Leslie Steven (Nov 2007), another FRS which is about fair values in acquisition also poses a problem in decision making. This FRS concerns the acquisition method of account for the combination of businesses. It states that assets and liabilities of the acquire company should be recognized only when if they existed on the purchase date. So, you cannot add any other claims into the balance sheet if they are discovered after purchase date. If any assets operating company is found after the purchase date it cannot be added in to the assets. As a result, the value of company may be understated and decision-makers won’t be able to assess the true worth of business. Similarly, if any liability is claimed after the purchase date and it is not added in the balance sheet, then the value of your business will be overstated. Hence, in any case, the balance sheet won’t be representing the true financial health of the business and this may lead to hindrance in decision making. FRS7 states that Intangible assets should be valued at their replacement cost. Since, the value of intangible assets is only an estimate, you will be either overstating, or understating your assets and this discrepancy may pose a problem or two in decision making process. John Blake (2000, p. 223) FRS2 which is about accounting for subsidiary companies may also lead to faulty decision making. The objective of this FRS is to provide details about their undertakings or subsidiary businesses. The main purpose of this principle is that you cannot make the balance sheet of the entire business as one group but instead you need to prepare balance-sheet of each subsidiary separately. This may be misleading to the users of financial statements. This is because the loss in one business may be offset by large profit in other businesses of the same group. So it is always good to look at the broader picture rather than just at a small component part of a large picture. This division of a large company into small groups may be misleading to many and may result in errors in decision-making process. Another issue that is widely discussed, in the accounting policies, is the importance of pension costs. Randall (1996, p.200) conclude that the provision of a pension is a part of the remuneration package of many employees. These pension costs form a significant portion of total payroll cost and they give rise to problems of estimation and allocation of these costs between different accounting periods. As already discussed above that accounting standards provide that consistency should be maintained in all accounting affair of the company, similarly, these costs also have to be treated in the same manner from one year to another. You cannot use different methods for recording and recognizing these costs in different years. Therefore, it is imperative that that a single standard accounting policy should exists concerning the recognition of such costs, in the company’s financial statement. This deals with the accounting for, disclosure of, pension costs in the financial statement of companies that give pension benefits to their employees. A good pension scheme should consider all the given accounting standards and should not violate any set accounting procedure. A defined contribution scheme is one in which the benefits are directly determined by the value of contribution and paid in respect of each member; the benefits are not guaranteed. The cost to the employer should be easily determined and could be proved by the substance and documents. The rules of a good pension scheme should also specify the benefit to be paid and the financing scheme that has been selected to cover the costs of this scheme. Contributions to the funds are expected to be sufficient to enable the benefit to be paid. An employer may have to make good any flaws or deficiencies, and to that that extent, the cost to the company is uncertain. Defined benefit schemes reply upon periodical actuarial valuations to determine the cost of pensions to be charged to the company each year. These pension costs, as discussed above, should be calculated using actuarial valuation methods. The method of providing for expected pension cost over the service lives of employees should be such that the regular pension cost is substantially level percentage of the current and expected future pensionable payroll in the light of the current actuarial assumptions Variations in the regular cost should be allocated over the expected remaining service live of the current employees in the scheme. Prudence may require that a material deficit be recognized over a period shorted than the expected remaining service live of employees. CONCLUSION: In the light of above discussion, we can safely conclude that these accounting standards do conflict with the decision making process of the company and may cause hindrance in smooth and accurate information flow. So, the IASB should look at the problems that various companies are facing in adopting these accounting standards and should try to develop more pragmatic accounting standards by involving people in the development process who are more close to these companies such as accountants and managers of these companies. This will help not only in the drive, of the IASB, in making financial statement as useful as possible, but it will also help the users of financial statements to benefit from the accurate and meaningful information of these statements. References: 1. International Accounting Standards Board(IASB), Visited on 12 June 2009, a. 2. Frank Wood. Accounting. Pearson Education, Low-Price-Edition (2002) 3. John Blake. Accounting Standards. Pearson Education; 7 Sub edition (August 2000) 4. Leslie Steven. Smart Business Orange County (November 2007) a. 5. IAS PLUS. Summaries of International Accounting Standards, Visited on 12 June 2009. a. http://www.iasplus.com/standard/standard.htm 6. Harold Randall. Accounting. Letts Educational (1996) 7. Eugene F. Brigham and Michael C. Ehrhardt. Financial Management. 11th Edition. South-Western College Publishers (2004) 8. John Sloman. Economics 5th Edition. Pearson Educational (2001) 9. Richard L. Daft. Management 5th Edition. The Dryden Publishing (1997) 10. International Accounting Standards. Report by : PriceWaterCoopers (2001) a. http://www.accountancy.com.pk/docs/funds.pdf 11. Thomas Corbett. Throughput Accounting. North Press River (1998) 12. Haka Better and Meigs Williams. Accounting 11th Edition. Jeffrey J. Shelstad Publishing (1999) 13. Financial Reporting Council. Visited on 13th June 2009 a. www.frc.org.uk 14. Answers.com. “Objectives of Financial Reporting”. Visited on 29th June 2009 a. http://www.answers.com/topic/objectives-of-financial-reporting 15. Yasushiro Yamada. “Objectives of Financial Reporting and Their Problems”. a. http://www.jbaudit.go.jp/pr/pdf/e14d01.pdf 16. Economics Experts. “International Financial Reporting Standards”. Visited on 30th June 2009 a. International Financial Reporting Standards 17. Collin Bamford. Economics. Letts Education (2003) 18. Financial Accounting Standard Boards. Accounting Standard. Publish by the board itself in 1983 19. R.A. Rayman. Accounting Standard: True or False? Rutledge Publishing (2005) 20. Robert G. Eccles. The Value Reporting Revolution: Moving beyond the earnings game. Wiley Publishing (2001) Read More