International Financial Reporting Standards - Essay Example

RUNNING HEAD: Finance and Accounting “True and fair view" vs "faithful representation"; "principles based" standards vs "rules based " standards Name of Student Name of Subject Name of Professor Date 1. Introduction This paper seeks to critically compare and contrast the terms “true and fair view” and “faithful representation”. This will also critically compare and contrast principles based” standards “rule based” standards. In addition, this paper will critically analyse this researcher’s own personal learning outcomes from completing assignment and the impact it will have on future career opportunities. 2. Analysis and Discussion 2.1 Critically compare and contrast "true and fair view" with "faithful representation". Both of the two terms are used in the making and application of accounting reporting standards. Both come closer to the concept of reliability rather than relevance. This would mean that both terms have their concerns on the objectivity or truthfulness or accuracy of accounting information. They therefore have the same purpose, that is, to enhance the value or quality of information to be used for decision makers. “True and fair view” is of British origin (Zambon, 2002) while “faithful representation” is of American origin (Belkaoui, 2004). The first was used as referring to objectivity of the information by management and auditors in making an opinion as the comparison or presentation of the financial statements in relation with accounting reporting standards. On the other, the second term has been used for a long time by US FASB is a qualitative characteristic of information. The first term belongs to United Kingdom while the second belongs to the United States. Each term is part of the language of one culture different from the other. While the first aims for objective quality of information, the second, although called as a qualitative characteristic is also aimed at attributing an objective quality of information. Since the first would expressly describe the status or condition of the financial performance and financial condition of a company in relation or in comparison with given standards, the second was an implied description attaining the same purpose since to say that information conforms to US GAAP, it is presumed to have qualitative characteristic of information. As opinion is just an opinion and cannot be conclusively taken as perfect or absolute, thus the phrase "true and fair view" should be taken as modifier. However, it has legal consequences that could possibly make the person using liable if such opinion has no basis at all or is not supported with evidence. Under, the American practices of accounting, the phrase "faithful representation” is not used expressly in making an opinion on the financial statements but the same in deemed included when fair presentation is also asserted by one making the professional opinion. This is how the first term is used by a typical auditors report on a UK company: “In our opinion the Group financial statements; give a true and fair view….” (Taylor Wimpey, 2011) of a company’ state of affairs and results of operation for given period of audit. Instead under US practice, the statement of the auditor would look as follows: “In our opinion, the consolidated financial statements…presents fairly, in all material respects…” (KBR, 2010) the financial position and results operation of the company being audited. From this, it would appear that” true and fair view” takes the place "presents fairly". In addition the US treatment of "faithful representation," is not mentioned in the auditor’s reports. It is however deemed part of the US GAAP as it is a qualitative characteristic of information that must be attained under US GAAP. Thus the expression in standard opinion would mean that the “fair” presentation of the financial statements would simply mean that faith representation is considered deemed accomplished by the preparers of the financial statements that get audited by external auditors. The correctness of the representation may just be a reaffirmation or denial of statement made by management on the compliance of the financial statements in relation required accounting reporting standards. Under the UK experience, “true and fair” as understood in American cannot be deemed to cover only objectivity of information. The word “true” may indeed refer to objectivity but the word fair should be deemed to modify the word “true” because of the presence of estimates in the preparation of accounting information. For example the provision of depreciation would entail an estimate on the life of the asset to be depreciation. Since the actual life of the asset could vary, the reported and presented information cannot be realistically called to true as it is not something historical. Rather, it is a view of the future on how long wills the depreciable asset could be used. There the word “fair” in combination with true must be taken as a just interpretation or judgement on what the future may bring to the company. Therefore the term “true and fair view” can also be inferred to have covered the qualitative characteristic of relevance of the information. When use in the British financial statement, the true and fair view would indeed take the place of the “presents fairly” GAAP in the American way of having an opinion expressed by an external auditor on the financial statement. Thus they could be similar in some respects that faithful representation may be deemed to be included as far as the British companies are concerned. The American must be therefore deemed to agree to legal representation of the “true and fair view”. Two of the most influential accounting standards setters, the IASB and FASB have considered qualitative characteristics of decision-useful financial reporting information. These boards have refined the approach in the discussion paper on two fundamental qualitative characteristics: namely, relevance and faithful representation. Relevance refers to predictive value or confirmatory value of the financial statements (Kieso, et al, 2010) prepared for in influencing the decisions of the investors. Faithful representation is dwells on having financial information to represents realistically the economic phenomenon of transaction (Kieso, et al, 2010) entered into by an entity. In other worlds, it is about objectivity and reliability. The standard setters however want to further enhance qualitative characteristics by including timeliness, comparability, verifiability and understandability to relevance and faithful representation. The term “true and fair view” was considered an additional candidate for qualitative characteristics of but not included in the proposals by both the US FASB and IASB (Deloitte Global Services Limited, 2011) since the term was deemed the equivalent of “faithful representation. ” Thus from the point of view of standard setters, the consequences of having included one of the terms and excluding the other may not raise a material issue since the standards themselves are convinced of the seeming common or equivalent meanings of the terms. It may be further be noted that in an effort to understand the implication of two terms and possible issues that may be generated in the future, there is good reason to point out the close links of international financial reporting standards (IFRS) by the IASB and statement of financial accounting standards (SFAS) or GAAP by the US FASB (Walton, 2009). 2.2 Critically compare and contrast "principles based" standards with "rules based” standards . Principles-based and rules-based standards are both means to an end in bringing the kind of information that is needed by decision makers. However, because of the need for qualitative characteristics of information for the latter to be useful, the standards used must really have to do their functions in order to attain the desired qualitative characteristics of the information that would get produced. In particular, the financial information would refer to the financial statements including the income statement, balance sheet, statement of cash flow, statement of changes in equity and the notes to financial statements. The principles-based standards would be taking things in general and therefore it generally applies to all companies while rule-based are used to those that cannot be addressed by principle-based. Thus it would be wrong to have all standards as rules-based since that the same would not be able to allow the comparability of information on companies across industries. It is a fact that there similarities of companies which cannot be regarded like the valuation of fixed assets used in business. In such case, making rules-based standards would be defeating the purpose of standards making. However due to peculiarities of certain industries where the general principles could not apply, it is best to have rules-based accounting standard. An example of this would be on lease. It can be safe to say that there could be more companies owning fixed assets than companies engaged in leasing. Thus the peculiarity of situation requires the peculiarity of rules. In finding the difference between principles-based accounting and rules-based accounting, it may be interesting to use on which of the two is used by FASB and IASB. Both standard setting bodies applies principles-based accounting and rules-based accounting. Since it is easier to have a set of general standards that would apply across industries, there is logical basis to connect the use of principles-based standard to many of companies and only the rules-based would be required to specific industries. This is the reason for the reality that almost all companies are required to prepare their financial statements as required by the GAAP promulgated by the FASB, whose standards are generally principles-based. There is an obvious advantage of doing the same since it will enhance comparability of financial statements across industries. However, the use principle-based accounting standards were put to test because of accounting scandals, such as Enron and WorldCom. The main explanation therefore was that principles based-standards could better encourage creative accounting since the companies are freer to configure their financial statements. It allows companies wider discretion compared with the rules-based accounting. Rule-based accountings have certain limits compared with principles in the same way that a special law can only apply to specific cases. While general law may be likened to principles-based, the rules based are closer to special legislation or law to address that which cannot be addressed in by the general principles . This argument is supported by the nature of rules-based which basically consists of a list of detailed rules that should be complied with by the companies or industries that are required to make use of them in organizing financial statements. There are those accountants who favour the prospect of using rule-based standards, as way to protect themselves in case of suit. Their main line of defence would be as long as they can prove that they have complied with the rules, there should be valid reason to hold them responsible. Thus if the rules are not clear the same would be interpreted favourably in their favour. They could be brought to court only under rules-based if their judgements of the financial statements were incorrect. Thus it could be inferred that they would have less chances of being brought to court if they have strictly followed the rules that need to be followed. With lower chances of lawsuits being diminished, the argument for rules-based in understandable. The effect however would work against the final users of information since the failure of standard setters to make rules would have them live under the mercy of creative accounting practitioners. Moreover focusing into details in having rules-based increase accuracy and reduce the vagueness that can generate problem complexity in the preparation to financial statements and this would against the quality of understandability as a necessary or valuable characteristics of information Given the nature of principles-based accounting , the same can be presumed to be used by generally accepted accounting principles from the US and international reporting standards passed by IASB. Both standards there have the nature of conceptual basis for accountants which would allow professional judgements of accountants to prepare the financial statements along the same line of reasoning. This could therefore a choice for companies the adoption of accounting policies that as long the same would not contradicts the principles enshrined with the conceptual framework. It may thus be deduced that the tendency for creative accounting can be both present in rules-based and principles based standard. The complexity that could be created-by rules-based could actually encourage creative accounting when companies do not have a way to present their financial statements that would suit their purpose. There is greater tendency however to practice the same under standards-based standards. Professionals are recognized as such because of the responsibility that go with them and responsibility can only mean freedom. For them to be given freedom as basis for responsibility is to allow then discretion in the design of policies for their companies or clients of the appropriate accounting policies. Between the two sets of standards, principles-based would be better used if the accounting professional should be better expected to be responsible. On the other hand, making rules-based standards only would just be making accountants as mere implementers of government regulation that would implement adopted standards which are primarily made by the standard setting bodies. Each type of standards has each own advantages and use of one cannot completely exclude the use of other (Nobes, 2005). It is best therefore that having two sets of standards are necessary and when there is a need to complement one with the other, the same must be done. 2.3 Critically analyse own personal learning outcomes from completing this assignment and the impact of future career opportunities. To learn the differences of the concepts, one cannot avoid going back to the origins of the words and terms how they actually evolved and relating them to their significance in the preparation of the financial statements, which are the end-products of financial accounting. Comparing then the concepts led me into knowing about the plans of the two major standard setting bodies of financial standards –- IASB and FASB, which would really have to reconcile their outputs given the globalization of the economy. This would mean that my career in the future would have to consider the realities of globalization that are unfolding in front of me. As to whether the harmonization becomes successful will have to consider the other factors which may be unique to each country like culture. Can culture be harmonized too or will this depend to evolutionary factors that cannot go ahead? The different learning outcomes that I got from completing the assignment may be described as exploration of more possibilities that could happen in the international business. In comparing ‘true and fair view” with “faithful representation”, I had to look when and where these terms were used and I had to investigate what is essence of comparing and contrasting the same. To answer the questions demanded by comparing and contrasting the terms could only cause the processes of bringing the parts into whole and whole into parts. I sensed that that the need to define those terms is related for the need to clarify the seemingly analogous or similar meanings as issues could arise. It is possible that a legal conflict would happen as to the interpretation of the rights and obligations of parties who may be involved in a globalized set of business and the possibility that their cases will have to be decided by a neutral party. Most logically the internationally recognized institutions like FASB and IASB would have to be surely consulted in case of conflict and it’s a good thing to note that harmonization of the accounting standards around the world is being aimed as desirable point at this time by the two bodies. It would seem that globalization would be leading to a common international accounting standard body that would serve as the final authority when it comes to formulation, application and interpretation of standards. The enforcement of course could be retained by local authorities as what happen in EU when it prescribed the use of IFRS to be used by companies. This is of course subject to the realities of international law. I could therefore prepare my career in the context of what is happening and what it may happen in the near future. I must be seeing where the standards are going in relation to the different economies in the world. The business consequences related to adoption of a common reporting standard may have to be necessarily linked with the usefulness and validity of information by the users who will still be the final judge on whether they have been guided or misled and just informed with what the standards would offer. References: Belkaoui, A. (2004) Accounting theory. Cengage Learning. 2004 Deloitte Global Services Limited. 11 (2011). IASB Agenda Project. November 2011 Walton, P. An Executives Guide for Moving from US GAAP to IFRS. Business Expert Press. 2009 Kieso, et al (2010). Intermediate Accounting: IFRS Edition, Volume 1. John Wiley and Sons Nobes. Rules-based standards the lack of principles in accounting. Accounting Horizons, 19(1), 2006, pp. 25-34. Previts, G. (2008). Research in Accounting Regulation, Vol. 20, Elsevier Taylor Wimpey (2011). Annual Report for 2010. Retrieved 11 November 2011 from < http://plc.taylorwimpey.co.uk/Resources/Documents/InvestorRelations/ReportAccounts/2010%20Annual%20Report%20and%20Accounts.pdf > Walton, P. (2009) An Executives Guide for Moving from US GAAP to IFRS. Business Expert Press Wittsiepe, R. (2008). )International financial reporting standards for small and medium-sized enterprises: structuring the transition process. Gabler Verlag, pp. 21- 22 Zambon, S. (2002) Locating accounting in its national context:the case of Italy. Franco Angeli. Read More