Accounting Conceptual Framework for Financial Reporting - Assignment Example

Accounting Conceptual Framework for Financial Reporting i) Manners of development of Conceptual frameworks. IASC was constituted in June 1973 with Australia, Canada, France, Germany, Japan, Mexico, Netherlands, U.K., Ireland, and United States as members. In 1981 it was agreed upon that IASC will have autonomy in setting International Accounting Standards. Originally the framework was adopted by IASC in 1989 and that was later inherited by IASB with its adoption in 2001. In fact IASC adopted the US framework ‘Framework of Preparation and Presentation of Financial Statements’ that it published in 1989. The objectivity of IASB is to achieve harmonization in accounting world by making mandatory application of International Accounting Standards among member countries. The manner of setting conceptual frameworks surrounds two basic theories- one is traditional theory and the other is assets- liability based theory. Interestingly both these theories have different objectives. As stated in Ludwig Erhard Lectures 2004 (page 1)1 traditional theory believes “the traditional objective of accounting is accountability- holding management accountable for the realized rate of return on the capital under their control. The traditional theory says financial reports provide a factual basis for judging management’s performance, and this underlies the traditional requirement of true and fair.” On the other hand it is emphasized by same Ludwig Erhard Lectures 2004 (p.1)2 that “the assets liability based framework is based on decision making objective- providing investors with information for investment decisions- whether to buy, sell or hold financial securities.” The FASB of US based its framework on assets- liabilities theory of setting the framework and that framework has been adopted by IASC. In other words the emphasis of the framework of IASB is to provide information to users and not for judging the performances of management seeking directly the true and fair presentations. There is no direct dictum of presenting the true and fair statements but the framework describes that true and fair may be the result of application of standards when paragraph 46 of IASC framework3 states that “Although this framework does not deal directly with such concepts, the application of financial qualitative characteristics and of appropriate accounting standards normally results in financial statements that convey what is generally understood as a true and fair view of, or presenting fairly such information.” Another angle to judge the manner of development of framework for setting standards is the manner in which those standards have been described. Generally regulatory standards or principles are expressed either in a prescriptive manner or in a descriptive manner. “The IASB framework is written in a descriptive style (in fact it is IASB policy to use the word ‘should’ only in standards) and seeks to avoid being excessively prescriptive. A principal reason for this is that it needs to have broad international applicability.” (David Alexander, page 2.02)4 Regulatory bodies have always tried to set the framework that help external users of financial statements. This exactly was the approach of IASC when it adopted the framework of FASB, The framework’s insistence that financial information has to be relevant, reliable, understandable, and comparable is an effort to serve the purposes of users of the financial statements. The IASB framework may not be able to comply with legal and conventional requirements of member nations, but the initiative and approach to converge international accounting standards with local national standard conveys a message that IASB framework of accounting standards follows the flexible approach that will enhance the financial statement qualities for the sake of external users. The flexible and informative approach of the framework in standards setting will also remove the hurdles in bringing all entities world over at a common platform so that understanding and comparability may not look like only a skilled professional domain. ii) Concepts of valuation and economic income Valuation The concept of valuation has gained importance with the introduction of IAS (now known as IFRS). The valuation concept envisaged by IASB is the fair value concept which is similar to market value concept stated by International Valuation Standards Committee (IVSC). “IVAC defines market value as the estimated amount for which an asset should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction after proper marketing wherein the parties had each acted knowledgably, prudently, and without compulsion.” (IASC Foundation Education, page 2171)5. Though IAS has made the use of valuation model optional but at places fair value application has been made compulsory. Like in combinations of entities the valuation of goodwill is based on fair value of assets acquired, and again intangible like goodwill are not required to be amortized but tested for impairment as and when the financial statements are required to be framed. Impairment involves comparison of fair value with book value of assets and impairment loss, if any, is recognized in the income statement unless it relates to revalued assets where it is recognized directly in equity. On the other hand FASB adopted fair value concept earlier than IASB and is all for fair value concept. That is many concept statements like SFAS 115 (accounting rules for financial instruments), SFAS 140(impairment of long lived assets), SFAS 142(goodwill), and SFAS 123R (share- based payments) have adopted the fair value concept in their applications. However, there is a problem with application of fair value model as market price is not always available for particular asset. As a solution to this, FASB has introduced present value as proxy to fair value in concept statement no. 7. Economic Income Income specifies increase in economic benefits in the accounting period in the shape of inflows or increase in assets and decrease in liabilities. Increase in assets will provide benefits in future years. Similarly expenses implies decrease in economic benefits during the accounting period resulted by outflows, depletion of assets, and increase in liabilities. Increase in liabilities indicates that expenditures will accrue in future periods. “Economic Income therefore incorporates future effects of decision made by the management into the current measure of income.” (Normative financial accounting research, page 5)6 From this it can be suggested that economic income be used as a benchmark for evaluating financial income. Regulators have so far never considered economic income as their domain of regulations, but IASC has brought revolutionary orientations towards accounting fundamentals. “IASC believes that financial statements are prepared for the purpose of providing information that is useful in making economic decisions. The first type of economic decision mentioned by IAS is the decision to sell, hold or buy an equity investment (IAS framework for preparation, Preface); the first user groups mentioned by IASC are the investors (IAS framework for preparation, Users and their information needs). Furthermore, the IASC requires that financial statement should provide future cash generating abilities” (Issues in Financial Reporting Regulations, page 16)7 FASB introduced the SFAS 1308- Reporting Comprehensive Income in June 1997 and defined comprehensive income as “the change in equity (net assets) of a business enterprises during a period from transactions and other events and circumstances from non owner sources” By recognizing changes in equities or net assets in the comprehensive income FASB in a way provided recognition to some economic income that may be a part of financial gains from transactions with assets. iii) Comprehensive Income Statement as per amended IFRS 1 Presentation of ‘Other Comprehensive Income’ as part of Income Statement has been recommended by amended IFRS 1 that will become applicable from January 2009. Current IAS 1 provided two options. The first option was that a Statement of Recognized Income and Gains comprising changes in non- owner equity (means changes in other recognized income and expenditure) was presented and changes in owner equity were provided by way of a note. The other option was presenting a Statement of equity that comprised both changes in owner equity as well changes in non- owner equity. As per amended IFRS 1, now the Statement of Changes in Equity will include only the changes in owners’ equity. Non- owners’ equity changes will be presented as a single line as – other comprehensive income. Now the statement of comprehensive will either be a part of income statement or appended to income statement. When the statement of comprehensive will be appended, the first portion of income statement will be like earlier income statement and the appended portion will start with income for the year and then include other items of comprehensive income. Details about taxes involved in other comprehensive income may be given either in the statement of comprehensive income itself (which may now be the second part of income statement) or provided in the notes to the accounts. There is a view that changes are effected to bring more clarity in the income statement. Separation of income of the current financial period from the details of other comprehensive income may transmit the information more effectively to financial statements users. “This brings IAS1 largely into line with US FASB Statement No. 130 Reporting Comprehensive Income…… and the revised standard is a result of Phase A of IASB’s Financial Statement Presentation project.”(KPMG, July 2008)9 Many organizations, like European Financial Reporting Advisory Group (EFRAG), have supported the changes and rightly so. EFRAG has cited the following reasons for supporting the changes: “ It is not contrary to ‘true and fair’ principle, and It meets the criteria of understandability, relevance, reliability, and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management.”(Stig Enevoldsen, 17 April 2008)10 However, there is another view that treats changes as only cosmetic. No additional information has been added to the statements. Rather providing a single line about ‘other comprehensive income’ in Statement of Changes in Equity will confuse the users of financial statements as all of them are not financial experts to observe the details in the second part of income statement. Secondly the option of providing income tax details relating to other comprehensive income in notes makes the main statement less informative. No constructive changes have been brought by amended IFRS 1 and the purpose of making the financial statements more illustrative and useful to readers has not been achieved by the efforts made under phase A of IASB’s Financial Statement Presentation Project References Read More