Developing Conceptual Frameworks as a Time Wasting Activity - Case Study Example

DEVELOPING CONCEPTUAL FRAMEWORKS ARE A TIME WASTING ACTIVITY Contents Contents 2 Introduction 3 Conceptual Framework 4 Financial Accounting Theory 4 Conceptual Framework for Financial Accounting 7 Conclusion 9 References 9 Introduction This paper critically evaluates the conceptual frameworks in the context of financial accounting theories. The conceptual framework is a system of assumptions, concepts, beliefs and theories and justifies the research. It is developed from the experiential knowledge, existing research, established theories, exploratory research and thought experiments. The experiential knowledge in the form of subjective belief is highly important but is often underestimated. The financial accounting theory functions on the basis of conceptual framework, explains the observed accounting practices and predicts the unobserved practices. The theoretical framework of accounting evolved significantly in the 20th century following the market crash in 1929 and recent financial crisis. The major accounting theories, developed in 20th century are Efficient Market Hypothesis (EMH), fundamental analysis model, CAPM, positive accounting theory and critical perspective model. These theories were criticised by SATTA (Statement of Accounting Theory & Theory Acceptance) giving the reasons why these theories could not gain general acceptance. The main points of criticism were real world complexity, varying requirements of user groups, and failed interpretation of security price behaviour through EMH, costs of adopting accounting standards more than the benefits and limited capacity of users in assimilation and analysis of accounting information. Further, to understand the implications of conceptual framework example of the joint project of IASB and FASB for the convergence of their respective conceptual frameworks is discussed. Whittington (2008) identifies two differing views about the convergence process, Fair Value view and Alternate view and finds that devising a globally converged conceptual framework is difficult because the empirical studies on market efficiency have only tested the observable data and therefore cannot develop and test new reporting standards, so the standard-setters should realize that theories cannot offer an appropriate universal conceptual framework and it will be better to solve specific problems. Conceptual Framework A conceptual framework explains the key factors, variables or constructs and their presumed interrelationships either in a narrative form or graphic form (Miles & Huberman, 1999, p.18). It is primarily a model or conception of what is meant to be studied i.e. the system of assumptions, concept, beliefs, expectations and theories. Its function is to help assess the goals, develop relevant and realistic research questions, select apt methods and identify the validity threats to the conclusion. The conceptual framework also helps in justifying the research. It is like a tentative theory which may or may not be complete. In order to construct a conceptual framework of a study the sources which can be used are: experiential knowledge, existing research and theory, exploratory research and thought experiments (Maxwell, 2005, p.33-37). The experiential knowledge is the most important and neglected source for conceptual framework and bringing it in the research is treated as bias whereas Peshkin (1988) has strongly argued that the researchers should seek subjectivity in a systematic manner rather than in retrospective manner when the data collection and analysis is complete (Peshkin, 1988, p.17). A belief is a subjective condition of knowledge. For example in order to know a proposition ‘P’, one has to believe ‘P’ (Hospers, 1997, p.40). Thus to develop a sound conceptual framework, the researcher has to rely on his/her subjective assessment and previous research works. Financial Accounting Theory The accounting theory provides a set of principles that explains the prevalent practices and predicts unobserved practices. Hence it explains the companies’ choice of accounting method and enables the users to predict those companies’ attributes (Schroeder, Clark & Cathey, 2010, p.1). The ‘theory’ in accounting can have two meanings- positive which explains the ‘what’ and ‘why’ about a thing and normative i.e. a set of invented conventions evolved over time as to how the things should be (Nobes, 1997, p.4). The conceptual framework of accounting theories stems not from accounting literature but from the economics, sociology and behavioural literatures. The accounting profession functions on the basis of a conceptual framework which aids the accounting professionals in communicating the relevant information. This conceptual framework is the foundation of accounting theory. The debate over the need of theoretical framework in accounting began in 1900s when the first attempt to provide the accounting theory was made by W. A. Paton where he expressed his views on fair valuations of assets and liabilities, distributions of income and entity concept. Canning in 1929 developed a conceptual framework for measurement and asset valuation. Following the Great Depression in 1929, GAAP, which was a set of accounting practices emerged and has evolved over time in SAS (Statement of Auditing Standards) (Schroeder, Clark & Cathey, 2010, p.17). In 1958 a committee set up to examine accounting assumptions identified 4 levels for financial accounting development: postulates, research, principles and rules for the principles to be applied in the specific situations. Since then the major accounting theories developed are Efficient Market Hypothesis (EMH), Signalling theory, fundamental analysis model, CAPM, positive accounting theory and critical perspective model. EMH talks about the market efficiency and that the investors cannot earn excess returns by employing fundamental as well as technical analysis. Accountants believe that this theory fails to explain the current accounting practices as the theory holds no correlation between security prices and changed accounting practices, which has been proved false (Schroeder, Clark & Cathey, 2010, p.120). Signalling theory examined the corporate disclosures expecting that the firms’ behaviour through their disclosures provide signal to the market. For the development of accounting theory CAPM is relevant because the researchers have used it to estimate the expected returns on the basis of released accounting information. Positive accounting theories describe the observed phenomena whereas the normative accounting theories explain the required conventions. Critical perspective approach explains the history of accounting to be a complex mix of political, economic and co-incidences, and that the accountants have been unnecessarily influenced by utility-based economics. This theory maintains that the accounting has served to aid only some limited interest groups to the detriment of society. In 1973 SATTA a report on analysis of accounting theories provided the criticisms of the approaches to the theories: 1. It reasoned that the real world complexity could not be related to accounting theories such as the proposition of EMH that the markets are efficient. 2. The difficulty with the desired states i.e. normative standards because different users of accounting information had different requirements which could not be satisfied with uniform standards. 3. The interpretation of security price behaviour such as in EMH in which all the variables were controlled except the ones of interest. 4. The costs of adopting the accounting standard usually exceeded its benefits. 5. A prevailing view that more information provided to the market was better but subsequent studies indicated that users had a limited capacity of analyzing the accounting information (Schroeder, Clark & Cathey, 2010, p.42-44). Conceptual Framework for Financial Accounting FASB and IASB are the two standard-setting bodies which have separately developed the conceptual framework for financial reporting. The IASB is responsible for development and publication of the IFRSs. It works in association with the investors, accountants, analysts, regulators and business leaders to develop and update the reporting standards (IFRS Foundation, 2011). FASB is responsible for issuing the financial accounting standards to the private sector entities in USA. The reporting standards given by FASB are recognized by AICPA and SEC. It aims to establish and improve financial reporting by the corporates for the investors’ interests (Financial Accounting Standards Board, n.d.). FASB was the first independent body to devise a conceptual framework for reporting purposes in 1970s where the inflation accounting problem and decision usefulness were the main issues. This was followed by IASB’s framework. Both of them had many differences with one common feature that both were incomplete. The FASB’s conceptual framework is seen by many researchers as a theory of standard setting and accounting. However there is no existing academic theory that explains the norms of optimally determining the standards. Currently both the bodies are working on a joint project to develop a common conceptual framework on the basis of existing frameworks. Their objectives are convergence of the standards, achieve completeness and improve consistency. The joint project started in 2005 and since then there have been a number of contradictions in the views amongst the IASB and FASB members. Whittington (2008) identifies and discusses the two differing viewpoints- Fair Value View and Alternative View. Both the views seek to serve the investors but the former emphasizes on the forward looking accounting information assuming the accessibility to perfect markets and latter seeks relevant accounting information useful for investors’ valuation models assuming the information asymmetry and imperfect markets. The fair value view has been pinned as theoretically sound but impractical whereas the alternative view as practical but not theoretically viable. For a standard setter a good theory should be logically coherent as well as relevant. However it is difficult to devise a theoretically sound accounting framework in imperfect markets because the empirical studies on market efficiency have only tested the observable data and therefore cannot develop and test new reporting standards. According to Whittington (2008) a better constructive approach for the standard-setters could be the realization that theories cannot offer an appropriate universal conceptual framework and it will be better to work to solve specific problems (Whittington, 2008, p.156-165). Bryer (2004) analyzes the case of Enron and tries to establish reason for accounting failure which he attributes to FASB’s conceptual framework. Enron manipulated its accounts using the subjectivity persistent in the asset-liability framework (Bryer, 2004, p.1). It can be claimed that a theory is logically derived from the facts but this claim cannot be substantiated because the logic is not the only source of changing facts (Chalmers, 1999, p.41). This means that a theory has a universal acceptance and it is based on certain observations which are considered factual however it cannot be said that these observed results will not change. This applies to the previously discussed theories as well as to the common conceptual framework for accounting standards. But the development of conceptual framework and altercation of various accounting theories has served to elevate the relationship between research and practice. Before the development of FASB’s and IASB’s conceptual framework, the normative theory and research had little influence on accounting practice. Imagine where the accounting profession had been if the accounting concepts and standards had not come to exist. Simply by not discussing and developing the conceptual framework and theories, will not help in understanding the complexities of financial system. Conclusion This paper has critically evaluated the conceptual frameworks in the context of financial accounting theories and found that the conceptual framework is a very important part of theory development. The previous theories such as Efficient Market Hypothesis have been criticised for incomplete interpretation of security price behaviour but the importance of CAPM model, normative theories and critical perspective theory stems from the fact that they have served to elevate the relationship between research, practice and education. The conceptual framework convergence process of IASB and FASB has its critics but the both the standard setting bodies aim to increase the comparability of financial disclosures among different countries which serves the investors’ interest. The discussion and development of conceptual frameworks help in understanding and refining the previous theories. This is more helpful in understanding the complexities of financial system. Therefore it can be conclusively said that the conceptual frameworks are important to the development and refinement of the theories. References Bryer, R. (2004). Accounting lessons from Enron: fraud, aggressive accounting or the wrong conceptual framework? [Pdf]. Available at: http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.199.3181&rep=rep1&type=pdf. [Accessed on November 21, 2011]. Chalmers, A.F. (1999). What Is This Thing Called Science? Univ. of Queensland Press. Financial Accounting Standards Board. (No date). FASB Facts About FASB. [Online]. Available at: http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176154526495. [Accessed on November 17, 2011]. Hospers, J. (1997). An Introduction to Philosophical Analysis. Routledge. IFRS Foundation. (2011). About the IFRS Foundation and the IASB. [Online]. Available at: http://www.ifrs.org/The+organisation/IASCF+and+IASB.htm. [Accessed on November 17, 2011]. Maxwell, J.A. (2005). Qualitative research design: an interactive approach. SAGE. Miles, M.B. & Huberman, A.M. (1999). Qualitative data analysis. SAGE. Nobes, C. (1997). Introduction to financial accounting. Cengage Learning EMEA. Peshkin, A. (1988). In Search of Subjectivity-One’s Own. [Pdf]. Available at: http://blogs.ubc.ca/qualresearch/files/2008/02/17.pdf. [Accessed on November 19, 2011]. Schroeder, R.G. Clark, M.W. & Cathey, J.M. (2010). Financial Accounting Theory and Analysis: Text and Cases. John Wiley and Sons. Whittington, G. (2008). Fair Value and the IASB/FASB Conceptual Framework Project: An Alternative View. [Pdf]. Available at: http://onlinelibrary.wiley.com/doi/10.1111/j.1467-6281.2008.00255.x/pdf. [Accessed on November 17, 2011]. Read More