One of the reasons for the current economic crisis was the manipulation of accounting sheets and going around loosely stated standards. This allowed a lot of declining companies continue without investors - the market - realizing how bad these companies were doing. One of the early examples of accounting fraud is Enron Corporation. Enron was showing millions of dollars of profit, but in reality it was losing.
We shall see on the following material how accounting standards have emerged and why. The reasoning behind the need of accounting standards will be clearly identified. It is important to recognize what accounting is and why it is important to a business in order to get a clearer picture of the requirement of a proper base by which its principles and standards are dependent on.
Accounting is the means by which information about an enterprise is communicated, thus it is sometimes called the language of business. Many different users have need for accounting information in order to make important decisions. These users include investors, creditors, management, governmental agencies, labor unions, and other.
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Accounting can be used at two levels; for individual and for the enterprise. Individuals can use accounting information to help control the level of expenditure, to assist in planning future levels of expenditure, to help raise additional finance and to decide the best way to spend their money.
At the level of enterprise, it is used to control the activities of the organization, to plan future activities, to assist in raising finance, to report upon the activities and success of enterprise to interested parties.
Earlier in history, text books show several examples of how accountancy was accused of being inappropriate to deal with financial reporting. It seems that there were not enough standards that would allow proper evaluation of institutes. In the late 1960s, a company was bought for several millions, however in the following year it showed a loss of 9.5million pounds compared to the expected ten million!
The direct effect was an increasing trend of losing confidence towards the finance profession. Accounting was accused to serve best those who are involved in the accounting institutes.
As a result several accounting bodies emerged to try and agree on several general acceptable standards that would minimize the ability of institutes to fraud using accounting. The Financial Reporting Council (FRC) was responsible of overlooking the whole program of initiating solid accounting standards. The Accounting Standard Board (ASB) was the body responsible in creating the required standards. The Financial Reporting Review Panel (FRRP) was responsible about enforcing the application of the standards. Any institute not complying with the standards might be asked to stand upon the panel for investigation.
Although the accounting standards are based on "true and fair" reporting, this is a bit ambiguous. As being true and fair only requires the accountant to follow the accounting principles that best suits his requirement, which may not give an accurate picture of the institute. "Creative Accounting" is a terminology used to describe those accounting practices that look for loops in the accounting standards and use them to present whatever they want to present no matter how far or close it is from the reality.
The development of a "conceptual framework" did take several professional bodies several years of devoted work to develop. "A conceptual framework is a statement of generally accepted theoretical principles that form the frame of reference for a particular field of enquiry" (Ciancanelli et al, 2009).
This frame of reference, or principles, tries to answer several questions such as what needs to be accounted for, how should they be measured, and how should they be communicated to users. As simple as these questions may appear, they actually were a subject of a lot of discussion and disagreement. Setting standards without basing these standards on solid principles was like trying to build a house without a structure.
One example of the problems that incurred in history when a simple question such as: what events should be accounted for, was when companies during the 1980s were incorporating "brand names" and valuing them in the balance sheet. This resulted in increasing the asset value of companies without them accruing real asset!
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In December 1999 the ASB published a "Statement of Principles" (Ciancanelli et al, 2009). This statement of principles comprised of eight chapters each describing clearly a set of principles by which accounted standards can be based on. A good example is the fourth chapter: elements of financial statement. Assets, for example, were defined as "are rights or other access to future economic benefits controlled by an entity as a result of past transactions or events', (Statement of Principles for Financial Accounting, p.51).
These set of principles allowed a more accurate evaluation and description of accounting standards. It was basically the frame work for the accountants to actually agree on a set of standards that would reflect a better picture of the financial position of different institutions.
Accounting statements are one of the most important tools that investors rely on to evaluate the position of a company it might be interested in pumping millions of dollars to invest in. They are also very important for managers to realize the financial position of their company. They are important to employees who might be directly affected by a bad financial position of the company they work for.
Accounting statements must therefore be reliable; reliable in the sense of being a proper reflection of what the company's financial position is. Historically we saw how loose standards allowed for big corporations to show a false financial position for years without being noticed. The effect was a disaster on all stakeholders as well as the economy.
For accounting statements to be reliable they need to be based on solid standards. And for standards to be proper they need to be based on clearly stated principles. These principles allowed for a more unified agreement on the standards and hence an acceptable framework for all accounting bodies to rely on. This, as a result, led to more public confidence to accounting statements which was on the verge at a certain point of time.