Financial Accounting Theory - Essay Example

Financial Accounting Theory Contents Contents Introduction 2 Conceptual framework 3 Financial Accounting 4 Conceptual Framework for Financial Accounting 5 Conclusion 7 Reference 8 Introduction Conceptual framework is the concepts and ideas which is coherent and organized that justifies a research. A conceptual framework is developed from the existing theories. Based upon this an exploratory research is done and along with the subjective belief on the concerned topic a conceptual framework is made by the researcher. Several theoretical frameworks are made after the financial crisis of 1929 and also after the recent financial crisis. The accounting frameworks are there for wide use of the financial statements of a company. A common framework of accounting would certainly be useful for the stakeholders of the company. But the criticism of the conceptual framework arises as these are not found so useful. The arguments are that the frameworks are not useful as there is lacking of practical evidences. The paper is an attempt to analyze that the conceptual frameworks of financial accounting are really useful or it is just a time wasting activity. Conceptual framework A conceptual framework is made for explaining the factors of the subject and thereby prepares a guideline for making a project. It is a kind of roadmap. The conceptual framework is a set of assumptions about the topic, the concepts, beliefs and theories about the topic. It is guidance to the persons who are associated with certain projects and also it is the guide to the users who are the other stakeholders of the project (Islamic Financial Institutions, n.d., p.1). For developing a conceptual framework experiential knowledge is most necessary to which doesn’t get needed attraction from the researchers. Because of this the conceptual frameworks are not so applicable in the practical field. Peshkin (1988) argued in his research paper that the subjectivity should seek systematically by the researchers rather than retrospectively (Peshkin, 1988, p.17). The function of a conceptual framework is assess the goals of the project, develop the relevant and realistic research questions, select the appropriate methods and at last find the pertinent threat to the conclusion of the research. It is a tentative theory which may or may not be complete. Financial Accounting The existence of accounting theory is because it explains the existing practices and predicts the unobserved practices. The accounting theories also explains that why the firms follow some specific standards and should enable the users to forecast the attributes that may be followed by the firm (Schroeder, Clark & Cathey, 2010, p.1). The accounting theories are basically of two types Normative and positive. The normative theories of accounting are basically subjective and the positive accounting theories are mainly practical and verified enough (Kornai, 2008, p.124-125). The normative theories evolved over time and it shows that how the things should be and positive theories of accounting is more practical as it explain the cause of the event along with the definition of the things. For communicating with relevant information these accounting theories are needed by the accounting professionals and the base of the accounting theories are the conceptual frameworks (Nobes, 1997, p.4). W. A. Paton was the first one to make an accounting theory where he has expressed his views on the valuations of assets and liabilities and distribution of income and entity concepts. Since then the accountants understand the need of a generally accepted principle that will be followed by wide number of companies and their stakeholders. As a result of the great depression in the year 1929 the Generally Accepted Accounting Principle was emerged which was a set of accounting practices (Schroeder, Clark & Cathey, 2010, p.17). The next accounting theories were made by the researchers understanding the deficiencies of the existing framework. Since then some major accounting theories developed by the researchers like efficient market hypothesis (EMH), CAPM model, positive accounting theory and signalling theory are some of those. EMH theory was put forward by Professor Eugene Fama in the year 1970. The Efficient Market Hypothesis suggested the price of a security can’t be predicted because all the participants in the market know the same information, nobody can beat the market. The signalling theory wanted to convey that the disclosures by the corporate in the report would provide signal to the market. The CAPM model is important for the researchers as it is used for expect the return on the basis of the released accounting information. In the critical perspective approach it was explained that the accountants are being influenced by utility based economics unnecessarily and accounting is a complex mix of political, economic and the co incidences. But all the accounting theories are proved as not robust as the stock market price movement show that and it was proved by some researchers also. Conceptual Framework for Financial Accounting International Accounting Standard Board (IASB) and Financial Accounting Standard Board (FASB) are two separate standard setting bodies which have developed the conceptual framework for financial reporting. In association with the users of the financial statements like the business leaders, accountants, regulators and the investors the IASB develop and update the International Financial Reporting Standards (IFRS) (IFRS Foundation, 2011).). The private sector entities of U.S.A. follow the accounting standard set by the FASB. The aim of the reporting is to communicate in an efficient matter with all the stakeholders through the report. The FASB standards are recognized by AICPA and SEC (Financial Accounting Standards Board, 2011). There are many differences in the two accounting standards and these two accounting standards are widely followed by the companies throughout the world. As the investors need to analyze a company or compare between two companies so there is a need to converge the differences, so IASB and FASB have started a new joint project for developing a new conceptual framework on the basis of the existing framework for the convergence of the standards, for improving the consistency and achieve completeness. The statement on Accounting Theory and Theory Acceptance (SATTA) criticized the above mentioned accounting theories (EMH, Signalling Theory etc). These are as follows: It was stated in the report that though the EMH theory is telling about the efficient market concept it is not at all efficient, if this is efficient, the recent news about the market is properly conveyed to the investors then how can anybody make profit from the market. The cost of adopting the accounting standard usually exceeded the benefits. It was also found that the users have a limited capacity of analyzing the accounting information from the studies conducted by the researcher (Schroeder, Clark & Cathey, 2010, p.42-44). Whittington (2008) identifies and discusses the two differing viewpoints- Fair Value View and Alternative View. Fair value view is theoretically sound but it is impractical when the latter seeks relevant accounting information useful for investors’ valuation models assuming the information asymmetry and imperfect markets. For a standard setter a good theory should be logically coherent as well as relevant (Whittington, 2008, p.156-165). In the year 2008 Mr. Richard Laughlin has raised a basic question that whether it is possible for all the entities to follow one specific conceptual framework. He proposed that for achieving this it is required to develop the General Purpose Financial Reporting (GPFR) at first (Laughlin, 2008, p.253-254). In his research paper Bryer (2004) analyzes the case of Enron and he tried to establish the reason of accounting failure which he attributed to FASB’s conceptual framework. As Enron used its accounts using the subjectivity without considering the practical aspects sufficiently so the accounting failure has happened (Bryer, 2004, p.1). As the changing facts always can’t be explained by the logic and the conceptual frameworks are mainly based on theoretical logic, so it can be said that the conceptual frameworks of accounts are not practically applicable fully though it is widely acceptable that a guideline is necessary for understanding the market and the companies’ performance as the companies used to report their financial position by following some certain accounting standards. Conclusion Analyzing the conceptual frameworks of accounting and the practical market situation it can be concluded that though there is the necessity of the conceptual frameworks which are based on the accounting theories there is need of consideration of practical market situation more. Certain accounting theories were made by the researchers and in the past 100 years, but it was found from the researches that they are not totally compatible with the practical market situation. There are two main accounting standards followed by the companies worldwide and these two standard bodies are working on a joint project for converge the differences, so that the new standard would make it easy for the users of the report. From some live example like Enron it was proved that the conceptual frameworks are not entirely robust as the company got bankrupted by following the existing frameworks. So it should be taken in consideration by the framework makers that the projects should be make in such a way that it becomes practically viable, not only theoretically robust otherwise it is just a waste of time. But it is also proved that there is necessity of the conceptual frameworks as these provide a guideline to the accountants and also helpful for the users. Reference 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: December 10, 2011]. Financial Accounting Standards Board. (2011). FASB Facts About FASB. [Online]. Available at: http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176154526495. [Accessed on: December 10, 2011]. 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: December 10, 2011]. Islamic Financial Institutions. (No Date). Conceptual Framework for Financial Reporting by Islamic Financial Institutions. Available at: http://www.aaoifi.com/AAOIFI%20-%20Conceptual%20Framework%20for%20Financial%20Reporting%20(Draft%20for%20Public%20Hearing).pdf. [Accessed on: December 10, 2011]. Kornai, J. (2008). From Socialism to Capitalism. Hungary: Central European University Press. Laughlin, R. (2008). A Conceptual Framework for Accounting for Public-Benefit Entities. [Pdf]. Available at: http://www.cipfa.org/pt/pmm/download/sample_article_PMM_Laughlin_aug2008.pdf. [Accessed on: December 10, 2011]. 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: december 10, 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: December 10, 2011]. Read More