Statement of Principles and the Issues - Research Paper Example

MENT OF PRINCIPLES Explain ment of Principles and its focus on assets and liabilities College/ Introduction ment of principle is likely to gain increasing importance in the future and therefore it has recently become a matter of debate among financial experts and companies that concern standard financial reporting. ‘Statement of principles’ is the standard conceptual framework that highlights the Financial Reporting Standard issued by Accounting Standard Board (ASB). Statement of principles sets out those principles and conceptual background that ASB consider it to be of greater importance for preparation and presentation of the financial reports and company accounts. It is a tool by which ASB is able to ensure that accounting standards are followed by companies in consistent manner. This piece of research work presents an analysis on Statement of Principles and it addresses issues regarding it. Statement of Principles ASB (1999) defines statement of principle as “the fundamental approach that the Accounting Standard Board believes should in principle underpin the financial statements of profit-oriented entities”. Statement of principles was first prepared in 1991 and the final version was issued in 1995 as a complete draft with seven chapters. The primary purpose of the statement of principles, as is stated in the introduction, is to provide a rational frame of reference to help the ASB in establishing and developing newer accounting standards and reviewing existing standards (ASB, Introduction, p. 3). This statement describes the views of ASB on: The activities that must be contained in financial statements The accounting concepts of those business activities that need to be highlighted The features that information must contain in the financial statements, and How financial information can be presented in financial statements (frc.org.uk) Alexander and Britton (2004) set forth that the statement of principles met with deals of criticism mainly because of that it focuses on the balance sheet rather than on the profit and loss account. It also was criticized that the statement of principles ignores the significance of matching principles and the calculation and reporting of earning (p. 230). Explain the focus on assets and liabilities in Statement of principles. (Essay Question) According to ASB’s statement of principles (1999), the statement places greater significances to assets and liabilities and it defines what items and transactions shall be included in the profit and loss account in terms of assets and liabilities (p. 5). The criticism against statement of principles was that it views balance sheet as more important than the profit and loss account. According to ASB’s introduction to the statement of principles, it recognizes that the main focus of users of financial performance on the profit and loss account and other performance records. The traditional accounting system and international standard have been familiar with the concept that assets are things that are owned by the entity. This concept emphasizes that assets include both tangible things like building, vehicles etc and intangible things like goodwill, royalty etc. But, the concept of assets in statement of principles is different from this. ASB (1999) defines assets as “rights or other access to future economic benefits controlled by an entity as a result of past transactions or events” (p. 48). This definition has brought attention that it becomes quite useful in some circumstances when the business organizations does not own the assets in legal perspectives, but it has the possession of the risks and returns that are associated with ownership (Dodge, 1997, p. 503). Properties like vehicles and buildings sold on hire purchase term, the properties are not legally owned by the entity until the last installment is done. The assets can be possessed by the entity and it can be used by them for their business purposes. But, the ownership is still with the seller and accordingly, if the buyer fails to make installment payment on time, the properties can be taken back by the seller. The properties are legally owned by the seller. Dodge (1997) emphasizes that there are provisions in SSAP 21 that necessitates the hirer to treat the properties as assets equal to its normal cash purchase price. It was considered that a business entity must legally treat an item based on the commercial substance of a transaction rather than basing on the legal perspectives (p. 504). Holgate (2006) stated that FRS 12 applied the concept of liability from the definition of liability given in the ASB’s Statement of principles. Liability was defined in statement of principles as “obligation of an entity to transfer economic benefits as a result of past transactions and events” (p. 36). Some companies used to provide for alleged liabilities so as to avoid future contingencies. It was treated as liabilities on the ground that it becomes future costs. The definition of liabilities in statement of principles restrain companies from providing for those items that are not mere liabilities but are likely to be future costs. Assets and liabilities According to ASB’s explanation about emphasis on assets and liabilities, it is merely a tool to improve the quality of financial statements generally. The definition of assets as “it is the right or other access to the future economic benefits” explains the following salient features Though the assets normally have features like exchangeable, tangible or intangible, that are not essential characteristics and hence their absence is not a reason to exclude an item from qualifying as asset. An asset is not the item of property itself, but, rights or other access to some economic future benefits. These rights or access can be obtained either from legal ownership or it can be derived from an item of property which is obtained with out having legal ownership of the property itself. Other legal rights include other parties’ right to make payments or provide services and the right to use patent, trademark etc. Access to future economic benefit may be there in the absence of legal rights. An item, to be treated as asset, must be capable to obtain future benefits, but same time, this future economic benefit needs not to be certain or it does not need to be obtained to the extent expected. The definition of liability as “the obligations of an entity to transfer economic benefits as a result of past transactions” explains the following. An item, to be treated as liability, must be an obligation and this denotes that the entity is not free to avoid outflow of resources. A liability can happen in the absence of legal obligation if commercial considerations create a constructive obligation. It is not necessary that obligations must result in a transfer of future economic benefits. Conclusion This research work is an attempt to analyze and detail statement of principles and its roles and implications in financial reporting standards. This work focuses on the views of ASB regarding assets and liabilities and related transactions. References Alexander D and Britton A (2004), Financial Reporting, Illustrated 7th Edition, Cengage Learning EMEA ASB (1999), An introduction to the statement of principles for financial reporting, The Accounting Standards Board Limited, Retrieved 26/10/09 from http://www.frc.org.uk/asb/technical/principles.cfm ASB (1999), Statement of principles for financial reporting, The Accounting Standards Board Limited, Retrieved 26/10/09 from http://www.frc.org.uk/asb/technical/principles.cfm Dodge R (1997), Foundations of Business Accounting, Second Edition, Cengage Learning EMEA Holgate P (2006), Accounting principles for lawyers, Law practitioner series, Illustrated Edition, Cambridge University Press Read More