Australian Accounting Standards Board Framework - Essay Example

AUSTRALIAN ACCOUNTING STANDARDS BOARD FRAMEWORK with a detailed analysis of the different Measurement Bases.” (word count: 2,485) ABSTRACT The conceptual framework provided for by the Australian Accounting Standards Board (AASB) addresses the preparation and presentation of general purpose financial statements which caters to a wide array of users. Users of financial information include investors, employees, lenders, suppliers and other trade creditors, customers, government and its agencies and the general public. These users are considered stakeholders because their reliance to the reported financial information by the business entity will have a great impact to the decision they will be making. Decision making is a critical process to be made by the entity and its stakeholders because this process can either make or break the entire chain as a whole. Comprehension about the financial information presented is a must, so that a good decision can be made. The financial reports made by the reporting entity should have the attributes of understandability, reliability, relevance and comparability. Measurement is the process of assigning financial values to the elements of the financial statements which provides understandable, relevant, reliable and comparable financial information appropriate for making and assessing decisions about the allocation of scarce resources of the entity. There are several measurement bases provided for by the AASB Conceptual Framework and it include but not limited to; historical cost, value in exchange (fair value), value in use (entity-specific value), net realizable value and present value. The use of any of the measurement bases aforementioned should help the firm prepare and present their financial reports in the most understandable, relevant, reliable and comparable way possible. INTRODUCTION In accordance with the Australian Accounting Standards Board (AASB) Conceptual Framework, the framework caters to general purpose financial statements that a business entity prepares and presents annually (or for interim periods) to meet the common information needs of a wide range of users external to the entity. Hence, the framework does not necessarily apply to special purpose financial reports such as reports to tax authorities, reports to governmental regulatory bodies, prospectuses prepared in connection with securities offerings, and reports prepared in connection with business combinations. The principal classes of users of financial statements are present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the general public. All of these categories of users rely on financial statements to assist them in decision making. The common interest of the users of these financial statements is to know the ability of an enterprise to generate cash and cash equivalents and of the timing and certainty of those future cash flows. The primary responsible for preparing and presenting the entity’s financial statements is the management of the enterprise. The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions. There are four (4) qualitative characteristics that financial statements should possess. These attributes are understandability, relevance, reliability and comparability which help the users of financial information to see the clear picture of the entity’s financial position and performance as well as the cash inflows and outflows. A. MEASUREMENT BASES OF FINANCIAL ACCOUNTING Measurement in financial accounting involves the process of assigning monetary or financial amounts/values to objects transactions and or events at which the elements of the financial statements are to be recognized and reported. The assignment of financial measures (values) on transactions and/or past events is a prerequisite for the recording, summarizing and reporting of those past events/transactions. Accountants should measure the elements of the financial statements at their monetary values on the basis that provides most comprehendible, relevant, reliable and comparable information appropriate for making and evaluating decisions. The management of the entity is primarily responsible in making and generating financial reports to be communicated with its users. Moreover, there are accepted notions in financial accounting measurement. These measurement bases include historical cost, value in exchange (i.e. fair value), value in use (i.e. entity-specific value), net realizable value and present value. Historical cost is the amount at which an economic item is originally recorded in the books of the reporting entity. This is commonly used by most businesses because of its simplicity and ease of use. But there are several drawbacks in the usage of historical cost as a measurement base. First, it is somewhat outdated because it gives no indication of current values since the asset or liability is recorded and carried in the books of the reporting entity in its original cost; it does not record the opportunity costs of the use of older assets which may be recorded at a value based on costs incurred many years ago and it does not measure the loss of value of monetary assets as a result of inflation. Value in exchange, which is also called fair value or market value, is the amount, at which that asset could be bought or sold between knowledgeable and willing parties, in an open market and in an arm’s length transaction. Prices are defined by the mass market’s supply and demand. On the other hand, value in use, which is commonly known as entity specific value, is subjective in nature. It represents the value of an object or transaction to its owner making it a specific value which is specific to each user and use. Therefore, where the economic benefits are derived from use, it is practical to refer an asset as having value in use. But if the benefits arise from sale, the asset is said to have a value in exchange. Net realizable value refers to the net amount that an entity expects to realize from the sale of its assets in the ordinary course of business. This measurement base is common in the valuation of receivables and inventory. Present value is the value on a given date of a series of future payments, discounted to reflect the time value of money and other factors such as investment risk. This is widely used in economics and finance to provide a means of comparison of cash flows at different times. This measurement base gives so much importance on the time value of money. “Your dollar today may be a lot lower than a dollar in the next year.” Choosing a measurement base requires professional judgment so as to make sure what specific measurement base is good for a specific business entity. The measurement base to be used by the entity should be consistent with the qualitative characteristics or attributes of financial information provided for by the AASB Conceptual Framework. These qualitative characteristics are understandability, reliability, relevance and comparability. Understandability is one of the attributes which means that the quality of information presented or communicated can be reasonably comprehended by the principal users of the information. Reliability is the attribute which means that the quality of information presented can be depended upon by the users to represent faithfully without undue error or bias the economic events it purports to show or represent. Relevance is the attribute which means that the information acquired is timely enough to be utilized by the users of information which affects their decision making policies. For information to be relevant, it must assist users in making and assessing decision about the allocation of resources which are scarce and making predictions about future transactions or events and evaluating past events. Comparability is a qualitative characteristic which means that the quality of information can be compared from one period to another and from one entity over the other. This is important so that the entity can assess or evaluate their performance from time to time and from one entity to the other. After assessing or evaluating their performance, they can devise something useful in the future that will improve the condition of the entity. These attributes should help the entity to reliably present their financial statements what it purports to show without bias or undue error. It should also help users of financial information in making timely and relevant decisions. B. PROBLEM OF ADDITIVITY ( DIFFERENT MEASUREMENT BASES) According to William G. Mister, in his Journal of Business Finance and Accounting, the currently accepted set of accounting principles and practices have been formulated such that the length of an accounting period which is a non-economic variable has been incorporated into the accounting system as an independent variable. Accounting reports are, therefore, temporally non-additive - they will not add up over time. Moreover, interim reporting has become increasingly important in recent times. Interim reports for any period other than one year cannot articulate with the annual report unless temporal additivity is required of generally accepted accounting principles. The application of different accounting measurement bases will lead to inconsistency and incomparability especially firms with worldwide operations using different measurement bases for each region. Moreover, it will be difficult to consolidate the financial information since the measurement base used in one region is different from the other. It will also lead to incomparability since different measurement bases are employed thus making each financial report entirely different in substance over the other reports. Say for instance, an entity reporting their financial statements in dollars as their currency can not be directly compared with an entity using other denomination such as pounds, peso and etc. There should be a common denominator between each of these entities so that comparability of financial information can be achieved. The use of different measurement bases also affects the firm’s shares’ prices in the capital market which can also have a great impact on the efficiency of the investment decisions of a firm. Insufficiency in the gathering of financial information will lead to incorrect or poor judgment thus making bad investment decisions for the entity. Making investment decisions is also one of the most critical and challenging processes that an entity has to undergo. There is always an opportunity cost in choosing one alternative over the other when it comes to investment decisions. They also have to consider several factors that might affect this type of decision making. Thorough checking and comparison between the available alternatives is a vital factor in making investment decisions as well. Therefore, firms must see to it that the value of the alternative they have selected is more beneficial and better than the opportunity cost that was forgone. Hence, a measurement base which best fits them will help much regarding this matter. There are a lot of issues that arise when different measurement bases are employed. Say for instance, a parent-subsidiary relationship. If the parent entity uses a measurement base that is different from its subsidiary, a problem on consolidation and aggregation or additivity will arise because it will be difficult for the two entities to consolidate and aggregate information when the elements of their financial statements are applied with different base measures. This will create inconsistency and incomparability to the financial information that the two entities will be reporting to the public. There is no specific provision as to what measurement base is to be used by the firms. There are only available measurement bases provided for by the AASB Conceptual Framework hence, the ability to make professional judgment should be used as a key ingredient by the reporting entity in making decisions as to what measurement base is to be applied. Firms should be keen enough in choosing what measurement bases are to be used for their financial reports because this can have a major impact on the decisions and actions that will be made by the users of their financial information. C. THE STAKEHOLDER’S PERCEPTION There are several different users of financial information relying on an entity’s reported financial data. They are called stakeholders because their reliance to the entity’s reported financial information will greatly affect their decision making process and policies. According to Conrado Valix in his book: Theory of Accounts (2009), the users of financial information and their needs are the following: 1. Investors are the providers of risk capital together with their advisers - this group of users is the one who risk their money in the business enterprise, they are primarily concerned with the risks that are inherent in their investment and the returns provided for by those investments. They need to be produced with the correct information to help them choose whether they should buy, hold or sell. Investors are also interested in information which will enable them to assess whether the entity is capable of dividend payments. 2. Employees are concerned with the information about the profitability and stability of the business enterprise. They are interested in information which will enable them to evaluate the ability of the entity to furnish remuneration, employment opportunities and retirement benefits. 3. Lenders would like to know about the information which enables them to ascertain whether their loans and interest will be paid on maturity. 4. Suppliers and other trade creditors are primarily concerned with the information which will help them determine whether amounts owing to them will be paid when due. 5. Customers are interested with the information about the ability of the entity to continue operations especially when they have a long term engagement with or are dependent on the entity. 6. GOVERMENT AND ITS AGENCIES are concerned with the allocation of resources and therefore the affairs and functions of the entity. These users require information to regulate the activities of the entity, settle taxation policies and as a basis for national income and similar statistics. 7. PUBLIC, entities affect members of the public in varied ways. For instance, entities make considerable amount of contributions to the local economy in different manners including the number of people they want to hire and their patronage to local producers or suppliers. Financial statements may assist the public by providing information about the trends and current developments in the prosperity of the company and the scope of its activities. It is clearly evident that these users of financial information will be greatly affected with their decision making process and policies if they will rely entirely to the entity’s reported financial information. Therefore, the reporting entity must see to it that the financial reports that they are preparing and presenting to these users of information really shows the true financial performance and financial position of the entity in its entirety. D. CONCLUSION/ RECOMMENDATION There are several measurement bases provided for by the AASB Conceptual Framework available for business entities to use. Therefore, it all boils down to the professional judgment of the entity to decide what measurement base to use and what measurement base that would help them prepare and present their financial statements in the most relevant and reliable way they could. Since the financial information they will be communicating will greatly impact the decision making process of their stakeholders. The writer recommends that business enterprises should use a measurement base which most fits it without impairing the understandability, relevance, reliability and comparability of the financial statements. BIBLIOGRAPHY IASB 2009. IASB: The Preparation and Presentation of Financial Statements [Online]. Viewed 03 May 2009. http://www.iasplus.com/standard/framewk.htm. IAS 2: Inventories, paragraph 7 (Net Realizable Value) Carnegie, G., BA 606 Financial Accounting, Lectures 5 & 6 (PowerPoint Presentation) Mister, W., Journal of Business Finance and Accounting: Temporal Additivity [Online] Viewed 03 May 2009.http://www3.interscience.wiley.com/journal/119644852/abstract Valix, Conrado, Theory of Accounts, 2009 Read More