The IASB Conceptual Framework for Financial Reporting - Essay Example

FINANCIAL REPORTING & ANALYSIS- The IASB Conceptual Framework for Financial Reporting Contents Contents 2 Introduction 2 Discussion 3 Understanding of the concepts 3 Illustration of the issues 6 Summary 8 References 8 Introduction The present report is a critical analysis of the IASB conceptual framework for financial reporting. The conceptual framework is relatively a new concept. A conceptual framework for accounting standards was not in use previously and the accounting standard setters usually used to operate without having an accounting standard in place. The accounting standard that they developed was often in response of an accounting scandal that occurred. As such these accounting standards were haphazard in nature. The accounting standards were as such developed as a reactive measure rather than as a proactive approach. This in turn increases the universality of the accounting standards across various platforms. Formation and setting of a conceptual framework for financial reporting increases the robustness of standard setting process, ensures consistency and lends a helping hand in the development of future standards. Each nation prepares a framework which provides the foundation on which accounting standards and reporting of financial information in the country is based upon. This framework is based on several factors such as social, economic and political factors in practical case. In the following report while critically analyzing the IASB conceptual framework of financial reporting the report analyzes the concepts of the framework and then analyzes the issues and criticisms that have surfaced regarding it. Discussion Understanding of the concepts The conceptual framework of financial reporting is a basic concept that deals with reporting financial information is an accurate and standard way. Different nations have developed framework of financial reporting on which all the reporting of financial information in that country is based upon. The objective of any financial reporting is the framework on which the financial reporting is based whereas there are guidelines that identify the boundaries of financial reporting. The main purpose and benefit of using a conceptual framework is that it helps to make the financial reporting uniform and harmonise the overall process of financial reporting (IFRS, 2014). Thus it helps to make the concept of financial reporting uniform and helps the accountants and other users of financial information to easily understand the data presented. The IASB has developed the current conceptual framework for financial reporting in association with FASB (Kabalski, 2009). The main aim with which the IASB has developed this conceptual framework is to enable and help United States of America in adopting IFRS so that ultimately there is a single set of accounting standards that are used globally (Deegan, 2009). Before the IASB and FASB were merged into forming the conceptual framework the accountants found it very difficult to report accounting related information. However this has been resolved since this new conceptual framework has been designed. The starting point of discussion is the fundamental question of why the financial statements are actually prepared. The financial statements are prepared to provide useful information to the various groups of stakeholders (Wilson and Adler, 2013). Now the question arises to what is the definition of useful information. Information may be considered useful if it is of relevance to the stakeholders and is faithful in presentation. Relevance refers to the fact that the users of the information may be able to use the information in order to extract some benefit and make accurate decisions. Faithful in representation means that the accounting and financial statements should actually represent the exact data as it happens and not represent any fabricated information (Mourik and Walton, 2013). The framework considers the nature of the entity which publishes its reports. It represents basic elements from which financial statements are constructed. The conceptual framework designed by IASB deals with financial statement that are general in purpose. These types of financial statements include balance sheet, Pl statement, cash flows etc. The financial statements are prepared by the company for use by a variety of users or rather stakeholders like the customers, investors, lenders, suppliers, government bodies etc. In fact IASB has listed the names of at least 7 different types of stakeholders who use the financial information released by the company (Godfrey, Hodgson, Tarca, Hamilton & Holmes, 2010). Some of the users who use the financial information released by the company may have other sources from where the users can collect information. However for most of the users the financial statements act as the only source of information. Hence the financial statements should be prepared keeping the requirement of these people in mind. Financial statements however from only a part of the entire gamut of financial reporting. A set of all the different types of financial statements forming part of the financial reporting is listed below. Balance sheet Profit and loss or income statement Position that indicates the change in equity level for the period Cash flow statement Notes that either explains the accounting standards and method of information reporting that is followed and other explanatory information Many entities in addition to the above information may also present an analysis of the challenges and opportunity that the company faces. The explanatory note may contain management view on the financial position of the firm or entity, any particular challenge that the company faces and the remedial steps taken by the company. Sometimes the report may also include information regarding the environmental challenges faced by the company. This is especially done by the companies which deal with products that may have a negative impact on the environment. In recognition of deferred tax liability while using conceptual framework any item should be able to satisfy three criteria. These criteria are results from the past events, the economic benefits should be accounted for and thirdly it should have a relevance to the present in order to be considered a liability. However deferred tax does not satisfy one of the criteria. That is the deferred tax does not have any relevance in the present as the company can pay its payable obligations in future. However according to IASB deferred tax liability is to be considered as a liability. Illustration of the issues The financial reporting standard as designed by the IASB has been severely criticized by several scholars in the field on several grounds. One of the points on which the conceptual framework has been criticized is on the basis of using fair value concept while reporting. According to Whittington (2008) there is an ongoing debate on two different views. One is the view that advocates the use of fair value method is implied in the announcements made by IASB. On the contrary there is the alternate view is the view expressed by the critics of the conceptual framework. The fair value view as adopted by the IASB assumes that the markets are relatively perfect. In a situation where markets are relatively perfect the financial reporting should be able to meet the requirements of passive investors and creditors by reporting fair values that have been derived from the prevailing market prices (Walton, 2011). The advocators of the alternate view on the other hand state that the market is relatively imperfect and incomplete. They state that in such a scenario it is required that the financial reporting should also incorporate and meet the monitoring requirements of the shareholders that are present. The financial report in such a scenario should include past transaction and events that are specific to the entity and thus represent the actual challenges and opportunity that the particular entity faces. The researcher concludes that in a real market the search for a one model fits all may be fruitless and the best approach would be to measure the problem and design or choose a method depending on the particular situation. One of the examples that they suggest is using deprival value, which is not defined by IASB at present (Whittington, 2008). Another point of criticism of the framework is the fact that the expenses in the income statements are recognised on the basis of direct association between cost incurred and the earning income. It means that expenses are linked to the revenue in the same transaction. However this does not make any sense. This is because of the time value of money. The expenses that have been incurred in a previous time period cannot be compared with the revenue that has been earned today. Bence and Fry (2004) states that the choice of currency of reporting is one of the first step in preparing a financial report. There are two different options that are available. One is the PPP terms and the other is nominal unit. The unit of currency choice is considered as an important part in the issue of capital maintenance in both the conceptual frameworks. For example comparing current cost accounts could be updated through general inflation index over time. Another criticism in the framework is the fact that the use of the framework had no positive impact in the hyperinflationary economy of Zimbabwe. It would be considered that the framework will consider accounting for changes in price level. This is because of the fact the inflation is a major problem is most of the countries. In this case example of Zimbabwe is considered most often. In case of Zimbabwe its RPI rose by about 300% in 2003. However there is no mention of using Current purchasing power in the model or framework. Another criticism of the framework has been on the basis of measurement of assets, liabilities and declaration of profits as defined in the framework (Carmichael and Graham, 2012). The framework defines various ways by which the entity can measure different important variables. Use of these different variables gives rise to different results. The framework does not specify the particular model that should be adopted in the particular situation and this makes it very difficult for the accountant to choose a particular method. This may in turn also result in inconsistency of the published data. Summary A framework for financial reporting provides broad guidelines which the entity can use to disclose financial information. In earlier times when there was an absence of a framework of financial reporting the accountants used several standards most of which were designed as a counter measure to a particular scandal. The prevalence of so many standards was confusing for all the entities using and designing financial information. Hence in order to avoid this problem a broad conceptual framework has been designed which provide the broad guidelines for representation of financial information. The formation of a uniform framework also helps in maintaining universality and wholesale acceptance of financial information. However there are several problems associated that are using of fair value or alternative value to disclose information. The definition of the particular method used to disclose information, the failure of the model in case of hyperinflationary economies. In conclusion to the above discussion it can be said that although framework is very important and is very useful, much research into its further development is required to be undertaken. References Deegan, C. 2009. Financial accounting theory. New South Wales: McGraw-Hill Education. Whittington, G., 2008. Fair Value and the IASB/FASB Conceptual Framework Project: An Alternative View. ABACUS. 44(2). pp. 139-168. Godfrey, J, Hodgson, A, Tarca A, Hamilton, J & Holmes, S. 2010. Accounting Theory. Queensland: John Wiley & Sons. Bence, D., and Fry, N., 2004. The International Accounting Standards Board’s Search for a General Purpose Accounting Model. Journal of Financial Reporting, Regulation and Governance, 3(1). pp. 1-29. IFRS, 2014. Framework. [Online]. Available at: < http://www.ifrs.org/current-projects/iasb-projects/conceptual-framework/Pages/Conceptual-Framework-Summary.aspx> [Accessed on 14th January 2014]. Kabalski, P., 2009. Comments on the Objective of Financial Reporting in the Proposed New Conceptual Framework. Eurasian Journal of Business and Economics.2(4). pp. 95-111. Danjou, F. 2013. An update on international financial reporting standard. [Online] Available at: < http://www.ifrs.org/Features/Documents/Mise-au-point-concernant-les-normes-IFRS-19-eng-February-2013.pdf> [Accessed on 14th January 2014]. Wilson, R. M.S., and Adler, R. W. 2013. Teaching ifrs. NY: Routledge. Mourik, C. V. and Walton, P. 2013. The routledge companion to accounting, reporting and regulation. NY: Routledge. Walton, P. 2011. An executive guide to ifrs: content, costs and benefits to business. West Sussex: John Wiley and Sons. Carmichael, D. R. and Graham, L. 2012. Accountants Handbook, Financial Accounting and General Topics. NJ: John Wiley and Sons. Read More