The Regulatory and Conceptual Framework of International Accounting - Assignment Example

Part A The regulatory and conceptual framework of international accounting A conceptual framework of accounting is the theoretical principles, which strengthens both the development of new reporting practices and the evaluation of the existing ones. It underlies why we do, what we do and how we do it. The conceptual framework will determine what business information is to be reported, how it should be reported, how it should be measured and how the information should ultimately be communicated. The IASB-international Accounting standards Board issued a system for the arrangement and presentation of money related explanations. This framework states the concepts that must be considered in the reporting of financial information to the external users. It is expected that the framework would assist the IASB in not only developing new international accounting standards, but also in the revision of the existing ones. It may also help in reducing the many alternative accounting treatments which are outlined by various accounting standards and regulations (Pounder, 2009). The conceptual framework presents key issues relating to the preparation and presentation of the financial statements. These include objectives, underlying assumptions, qualitative characteristics, recognition and measurement of elements of the financial statements, and the concepts of capital management. Though there are other ways measuring the elements of the financial statements, “historical cost” is the most commonly used by entities. This basis renders accounting information of less value in the prediction of future performances of the entities. Before the introduction of a conceptual framework, the accounting system could be said to have been “rule based”, governed by rules on how to treat each and every transaction. Such a system was inflexible and rigid but it promoted excellent comparison of financial performances. Contrastingly, the introduction of a conceptual framework which is “principle based” has led to the development of accounting standards from a generally accepted conceptual basis with clear and specific objectives. It could be argued that the conceptual framework ensures that the information in the financial statements present a “true and fair view” financial position of the entity. This means that based on the management estimates and judgment, the financial information presented is fairly accurate. It could also be taken to mean that the financial information does not have material errors, and the users of such information can used it to make meaningful decisions. It is also worth noting that the conceptual framework specifies some qualitative characteristics that should be displayed by the financial statements. These are understandability, relevance, reliability and comparability. The financial statements should be readily understandable by the user. However, this should not discourage the use of accounting concepts and terms. Use of accounting concepts and terms is very important in ensuring efficiency and accuracy of accounting information. In the modern accounting world, though technology has facilitated introduction of many accounting concepts and techniques, the same technology has facilitated easy understanding of those accounting concepts and techniques. The financial information is said to be relevant if it can assist the users in evaluating the past, present and the future in a comparable way, thus influencing their economic decisions. For the information to be useful, it has to be reliable. This means that it has to have no errors or bias and have a faithful presentation. Moreover, the issue of uncertainty needs to be addressed by the preparers of the financial statements. For example in the provision for bad debts, prudence needs to be exercised. Prudence is a considerable level of caution when dealing with financial information. Finally, the financial statements need to have comparability; they should be comparable with other statements for other accounting periods as well as those of other similar firms. In this case, the set accounting standards need to be applied consistently in the preparation of financial statements. Accounting for intangible assets An immaterial stake is an identifiable non-fiscal possession without physical substance. A stake is an asset that is regulated by the element therefore of past occasions for instance, buy or self-creation) and from which future investment profits (inflows of money or different holdings) are needed (IAS 38). According to IAS 38.12, an elusive holding is identifiable when is divisible (fit for of being disconnected and sold, exchanged, permitted, leased, or traded, either independently or as one unit with an identified contract) or rolls out from contractual or different legitimate rights, paying little respect to if the aforementioned rights are transferable or divisible from the substance or from different rights and commitments. Examples of conceivable elusive holdings incorporate: patents, copyrights, film pictures, client records, licenses, establishments, and advertising rights. They could be obtained trade of possessions, as a component of a business fusion, split buy or self-creation. Elusive holdings gathering the significant distinguishment criteria are at first measured at expense, in this way measured at expense or utilizing the revaluation model, and amortised on a methodical groundwork over their suitable exists (unless the stake has a uncertain of service existence, in which case it is not amortised). IAS 38 needs each substance to distinguish an immaterial possession at expense in the event that it is likely that the destiny investment profits that are attributable to the possession will flood to the element; and the expense of the possession might be measured reliably. It is moreover a necessity to uncover certain informative content identifying with the impalpable stakes. For every class of immaterial holding, an element is needed to uncover the functional essence, amortisation strategy, gross conveying sum, aggregated misfortunes, line things in the wages explanation in which amortisation is incorporated, harmonization of the conveying sum at the starting and the finish of the period, premise for confirming that an elusive has a uncertain existence, portrayal and conveying sum of exclusively material impalpable stakes, certain extraordinary exposures about elusive stakes gained by way of legislature allows, qualified information about elusive holdings whose title is confined, and contractual responsibilities to secure elusive stakes (Pounder, 2009). Accounting for leases There are two types of leases set out by IAS17. These are finance and operating leases, there difference in their terms and accounting treatment are also clearly addressed. Under a money rent, the whole dangers and compensation over a lease asset are substantially transferred to the lessee. The “economic ownership of a leased asset is transferred at the inception of the lease, while the legal ownership is transferred after the end of the lease term. It is also worth noting that the lessee uses the leased asset for most of its economic life. Furthermore, a managing rent is arranged as whatever viable rent different from an account rent. Under a working rent, the lesser remains with every last trace of the dangers and remunerates coincidental to the rented possession. The bookkeeping medication of the lease transactions is distinctive between an account rent and a managing rent. The boarder distinguishes fund rents as possessions and liabilities in their articulations of fiscal position, but this is not the case with operating leases. The lessees recognize the expenses in form of rental payments (including accruals and prepayments). In addition, both the lessor and the lessee are required to make specific disclosures in their financial statements. For example, in a finance lease agreement, the lessee is required to disclose the carrying amount for each class of assets, contingent rents recognized during the period, reconciliation between the total future minimum lease payments during the reporting period and their present value, among others, (IAS 17). These disclosures are meant for the users of the financial statements such as the creditors who want to know the other commitments of the firm and any contingencies associated with those commitments. By so doing, they will be informed in making credit commitments with the firm. Accounting for leases has often raised the issue of “substance over for”, where the treatment of lease transactions is basically based on their substance rather than their legal form. This is featured in the classification of leases as either finance or operating leases. IAS 17 states that “Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract.” So this means that the legal form of the contract between the lessee and the lessor does not matter in the classification of leases, what matters is the substance of those transactions. Ways in which creative accounting activities are exercised in financial reporting and the extent to which the responses of UK and US legislators and standard setters have succeeded in minimizing the scope for such activities. Creative accounting is the manipulation of the financial statements, normally within the requirements of the law and accounting standards, but generally leading to a failure of to provide a “true and fair view” of the company’s financial position that such statements are expected to. Creative accounting methods include off-balance sheet financing, unrealistic revenue recognition, and the use of overestimated non-recurring items. What motivates the management of a firm to employ creative accounting in their financial statements? It could be said that the regulatory flexibility of the accounting regulation is one of the reasons. An example of this flexibility is witnessed in the asset valuation where a choice has to be made between depreciated historical cost and the revalued costs. Another reason could be lack of full regulation in some areas such as the accounting for stock options. In addition, the options for estimating some items the provisions for bad debts could provide an opportunity for the managers to overestimate or underestimate them thus manipulating the financial statements. The legislators in the US and the UK have not succeeded fully in discouraging the scope of creative accounting. This is because the tricks used in creative accounting keeps on changing and thus making it difficult to completely eradicate the issue. Even though U.S., UK and other legislators have enacted standards discouraging such activities, some of those standards (such as the use of fair value) have opened up new ways of creative accounting (Rutherford, 2007). International standards need to be revised in order to address the discretionary options available to the managers such as the estimation of bad debts which has various methods. The argument behind this is that the many options available motivates the mangers to indulge in creative accounting. Part B Why does Bellever PLC categorize this lease as an operating lease? As per IAS 17, “a lease is arranged as money rent if exchanges significantly impact every last trace of the dangers and remunerates coincidental to possession. Contrastingly, a lease is ordered as managing rent depending on if it tries not to exchange generously every last trace of the dangers and remunerates coincidental to possession.” Risks include the chances of losses from unused capacity, obsolescence due to technological changes, and reduced returns caused by economical variations. On the other hand, rewards may include the expected profits from operations over the asset’s useful life, and gains arising from appreciation in the asset’s value or the disposal of the residual value. Under a fund rent, the proprietorship of the rented holding is exchanged to the resident upon installment of the final portion. At the beginning of the money rent assertion, the investment possession of the rented stake is exchanged to the boarder, but its legal ownership remains with the lessor. IAS 17 states that the lessee reserve the right to purchase the asset at a price that is “sufficiently” lower than the fair value at the date the option is exercisable. The lease is additionally ordered as a fund rent if rent period blankets the vast majority of the monetary existence of the possession, regardless of the possibility that the proprietorship is not exchanged (Rutherford, 2007). Under managing rent acquiescence, the possession comes back to the lessor at the finish of the lease term. This lease period is typically short and does not blanket the major investment essence of the possession. As it may, the resident has the choice of obtaining the holding at the closure of the lease term. On account of Bellever Plc, it is ideal for the possession to be grouped as a working rent subsequent to the crane. In addition, the Bellever Plc gave Mobaco Ltd $120, 000 to cover relocation costs of the crane, and the first year’s rent has been waived. This shows that all the risks have not been substantially transferred to Mobaco Ltd, the lessee. Accounting treatment in the records of Bellever PLC, the lessor i) At the end of each year, Bellever Plc will continue to recognize the depreciation expense of the Crane, calculated on straight-line depreciation method as follows: Depreciation expense, year 1=$1,800,000/20years =$9,000 Journal entries Debit Credit Depreciation expense $9,000 Accumulated depreciation $9,000 Lease initiation expense $45,000 Lease initiation costs $45,000 Income statement of extract at the end of year 1: Rental revenue - Depreciation expense $9,000 Relocation costs $20,000 Income statement of extract at the end of each year of the other 5 years: Rental revenue $150,000 Depreciation expense $9,000 Lease initiation expenses $45,000 Balance Sheet Extract: Fixed Assets Crane $1,800,000 Add Lease initiation costs $270,000 Less accumulated depreciation x+$9,000 Less accumulated lease initiation costs $45,000 Net Value xxxxx Current assets Un-earned rentals $150,000 Disclosure Notes as at end of year 1 Commitment note: a) Future minimum lease payments under non-cancellable operating lease with Mobaco Ltd i. The company waived the first year’s rental payments for the Crane leased to Mobaco Ltd ii. A sum of $600,000 is expected from Mobaco Ltd in the next four years, as rentals as per the lease agreement made. iii. A sum of $150,000 is expected to be received from Mobaco Ltd on 31 December, 2016 as a final rental payment. b) The company recognized $250,000, as rental income from Mobaco Ltd, due on 1st January, 2011. c) Bellever Plc entered into a six-year lease agreement on a Mobile to Mobaco Ltd on 1 January, 2011. Mobaco Ltd was required to pay $250,000 on 1 January, 2011, and pay the rest on five installments of $150,000 each payable on 1 January, 2012 to 2016. Bellever Plc contributed the relocation costs amounting to $120,000. The crane is supposed to be returned to Bellever Plc on 31 December, 2016. The crane cost $1,800,000 and has a 20-year useful life with no residual value. Accounting treatment in the records of Mobaco Ltd, the lessee Income statement of extract at the end of year 1: Rental expenses - Income statement of extract at the end of each year of the other 5 years: Rental expenses $150,000 Balance Sheet Extract at the end of each year: Current assets: Prepaid rent expense $150,000 Disclosure Notes: Commitment Note a) A sum of $120,000 was expected to be received from Bellever Plc as relocation costs of the Crane. In addition, the first years rent amounting to $250,000 was waived by the lessor. In the next four years, Mobaco Ltd is required to pay $600,000 to Bellever Plc and the remaining $150,000 after five years. b) There were no sub-lease agreements entered during the year c) A sum of $150,000 was recognized as prepaid rentals at the end of the year, 2011. The rentals amounting to $250,000 due on 2011 was waived by Bellever Plc d) The rent payable of $150,000 was agreed upon by Mobaco Ltd and Bellever Plc at the inception of the lease agreement. Mobaco Ltd is required to return the crane to Bellever Plc on 31 December, 2016. The option of purchase was not included in the lease agreement. Capitalisation of leases The issue concerning capitalisation of leases arises when classifying them as either finance or operating leases. It is a requirement for lessees to capitalize a finance lease; they should recognize both fixed asset and liability, posting the depreciation expense and the finance charge to their income statement. But the lessee should not capitalize operating lease, they should only charge payable rentals to their income statement as per the accrual concept. This is a case of consideration of the substance of the transactions and not just their legal form. IAS 17, paragraph 10 states, “Whether a transaction is a finance lease or an operating lease depends on the transaction rather than the form of contract.” It is therefore generally accepted to capitalize leases by considering the transaction itself and not the legality of the lease agreement. However, leasing some assets such as land and buildings which have infinite values is considered to be operating leases without looking into the substance of the transaction. The existing standards should be revised to further address the issues surrounding the capitalization of leases (Rutherford, 2007). References Pounder, B., 2009. Convergence Guidebook for Corporate Financial Reporting. New York: John Wiley & Sons. Rutherford, B.A., 2007. Financial Reporting in UK: A History of the Accounting Standards Committee, 1969-1990. London: Taylor & Francis. Read More