Developing a common conceptual framework for financial reporting


A conceptual framework is system of concept and principle in which determined the preparation and presentation of financial statement. This is reflected by Foulk Lynch as he defined conceptual framework as "A coherent system of inter-related objectives and fundamentals that should lead to consistent standards that prescribe the nature, function and limits of financial accounting and financial statements." The idea of conceptual framework is to form a common standard so that financial reporting is consistent and comparable to one another. However, this is not possible to achieve in different capital market where different accounting standard exist where financial statement are prepared based on their regulated standard.

To reduce the differences among the accounting principle used in the different capital market the process of harmonisation introduced by International Accounting Standard Board by late 1970s which then in the 1990s replaced by the concept of convergence; the development of a single set of high quality international accounting standard which is now known as International Financial Reporting Standard (IFRS) that would be used in all countries. According to IASB/IFRS the convergence of accounting standard is not a new phenomenon. The concept of convergence first came into exist in the late 1950s in response to post World War II when economic integration and related increase in cross border capitalization.

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In recent year, the convergence of accounting standard is in much of a focus due to the increasing demand and pressure from financial capital market. As the business gets globalise, the transaction gets complex and investors requires high quality financial information to make capital resource allocation decision. As a result increased demand of high quality financial information by providing much more reliable and consistent information and that has led to major restructuring of IASB an organization that responsible for convergence of global accounting standard.

Recently jointly convergence by the FASB and IASB as part of a joint project to develop a common conceptual framework for financial reporting is the .

The primary objective of this international convergence programme is to develop a common conceptual framework for financial reporting by reducing any differences among accounting standard. The main purpose of creating a common conceptual framework is to protect the public interest by providing high quality financial reporting which is comprehensive, comparable and consistent with one another. So, that user of financial reporting can make economic decision based on it. It will also benefit global economy as a whole as it will win investor and market confidence as well as reduce the administration cost paid to get access to capital markets.

To achieve converged conceptual framework is not straightforward as there are many problems and barriers faced by IASB.

The major problem of IASB to achieve convergence accounting standard is that difference in principles of accounting standard in different nations. The problem of achieving converged conceptual framework will exist till all the disparities between different standard have been eliminated. The one of the problem that highlight achieving international convergence is the debate surrounding whether financial reporting should be rules or principle based. The principles based approach of financial reporting provide a conceptual basis for accountants to follow when reporting and rules based approach requires preparers of financial statement to follow detailed rules. The IASB and IFRS prefers principle based approach as setting their standard where as US accounting standard FASB are rather based on rules approach. IASB believes principles based approach is best for setting standard as it provide broad guidelines to accountants and reduces complexity where financial statement are lengthy, irrelevant and not clear, which does not meet the needs of financial statement users. This is reflected by many views that principles based approach as preferred and commonly used approach for setting standard as guideline. This is supported by ACCA as ''the principle based approach be the way forward" which also supported by many others that principle based approach will limit complexity. (Doherty, 2008). This is further supported by FRC in their report 'Louder than words' stating "our research has convinced us that best route to better reporting and regulation of reporting emphasises principles rather than rules.

The rules based approach received much of a criticism after Enron and WorldCom scandal and US accounting standard realize that it is due to the too much rule driven and complexity which opens the room for creative accounting and manipulation. The US shift from rules based to principle was supported by majority of people and organization. Therefore, US should make move toward principles based approach in setting their accounting standard as without powerful nations participation in convergence process it is difficult to achieve the goal.

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Another problem that IASB highlighted in their exposure draft that there is different view regarding objective of the financial reporting. As IASB clearly state in their exposure draft that the primary objective of financial reporting is to prepare financial report in respect meeting needs of the all financial users. But this is argued by the some people that the financial reporting should be prepared in the perspective of stewardship of the enterprise rather than perspective of shareholder. This is reflected in the ACCA study that the aim of financial reporting should not only focus on capital providers and provide a report of the management's stewardship of the enterprise and a record of the performance and position for them. However, this is argued by Ernst & Young in their comment letter that the financial reporting should be prepared from the perspective of the equity rather than the stewardship management perspective and they request FASB framework on their financial statement that they should pay more attention on entity's performance as users always looks for income statement. Therefore, to meet the objective of financial reporting as mentioned in IASB framework, an entity should prepare their financial report in perspective of all external users and pay more attention to decision usefulness on entity perspective rather than management of enterprise.

There is also have some problem regarding producing high quality financial reporting as there is differences in the exposure draft of conceptual framework and many accounting firms and boards comments letter regarding qualititative characteristics. The qualititative charateristics are attributes of financial reporting to make financial information useful. It determines the usefulness of information that are relevant and relevant which can be distinguishes as fundamental and enhancing qualititative characteristics. The problems arise due to the some of the qualitative characteristic are not explained appropriately in the ED. This highlights in the AJ Mugford report where he believe that it is not fruitful to use qualititative characteristics in order to select what to include and exclude in financial reporting to make it more useful as it does not state clearly in ED. He also believes that there are problems in the trade-off as the ED does not give us details guidance about the situation where trade-off between one qualititative characteristics to one other occurs. Therefore he suggests that it is just a professional judgement to be included in the ED with clear guidance and explanation about the usefulness of trade off. To improve qualititative characteristic of financial reporting there is some suggestion of importance of understandability regarding fundamental and enhancing qualitative characteristics. As Ernst & Young comment letter states that understandability is one of the important factor stated in framework that users have responsibility to understand the information and in order to do so they have a reasonable degree of financial knowledge. They believe that the financial is not useful if it is not understood by the users and therefore they believe that it should be move from enhancing characteristic to fundamental characteristics in order to be useful. It is also suggested by ACCA study that another importance characteristic substance over form is not depicted in ED and they believe that it should be included in the ED as separate characteristic to reflect the changing situations.

Another problems faced by IASB to achieve convergence accounting standard globally is that the measurement and recognition problems where there is debate surrounding whether to use fair value instead of historic cost to measure balance sheet items like assets and liabilities. The problems has arise due to the different method can be used such as historic cost, fair value, replacement cost as they reflect different view of financial statement. The fair value accounting requires assets and liabilities to measure at their current market price to reflect current market condition and benefits decision usefulness for investors; whereas historic cost requires items to be measured based on their original cost which serves benefits to the stewardship for making future decisions. The fair value and historic cost is criticised by many people but fair value seen as preferred method by IASB as the basis for measurement and which has been widely accepted by many corporations.

Although fair value is reliable to financial assets and meets the objective of decision usefulness for financial statement user but it has been criticised by some people as Ryan 2008, suggested that the fair value is less reliable and relevant in terms of measuring non-financial assets as it uses discount cash flow which is more based on judgement and estimates, so it can lead to manipulation. This is reflected by the Ronen 2008, that during inflation many financial institutions found it difficult to use fair value to estimate asset and therefore it proves unreliable.

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The historic cost accounting also been criticised by many people as historic cost serves the benefits to the stewardship and therefore it does not meet the objective of financial reporting that financial statement should meets needs of all external users. Although historic cost more reliable than fair value as it uses actual cost but it is not relevant as Whittington 2008 suggested as historic cost uses original cost when measuring assets and liabilities which may be out of date and only relevant in assessing decision usefulness for stewardship in predicting future cash flows. This is supported by fair value view that historic cost only has interest in past transactions and ignores the current market conditions in which assets value may higher and lower than it suggest. CFA institute has stated the fair value is the most relevant information for financial decision making (CFA, 2007); this is further supported by Bradbury 2008, that fair value is most relevant and reliable measurement objective for traded financial instruments.

Another problem that have impact on achieving global converged accounting standard is non involvement of certain powerful countries that are more developed and have more influential economic power as their actions influence others. For e.g. likes of US adopting international accounting standard will influence those of others to adopt international accounting standard. If these powerful nations adopt international standard; everyone in globally would like to accept it and then it would be much easy to achieve converged accounting standard.

After Enron scandal everyone thought that US FASB will move towards convergence and will adopt IAS but this did not happen as they instead tried to improve GAAP

The convergence of accounting standard is very important in global but there should be appropriate action should be in place to make sure the implementation of the standard. It is not just setting a common accounting standard and then there is no actions taken whether it is followed by everyone. To ensure that convergence accounting standard are effective and used by organisations there should be adequate governance practice and disciplinary procedures in place to make sure there is appropriate implementation and effective controls of these accounting standard. There should also be requirement for effective and efficient audit to provide external reliability for the information prepared by the companies. Also there should be supervision and quality control to make sure companies prepares financial information accordance with the standard and finally it is important that everyone who involves in preparing financial information must act ethically and independently in the best interest of investors.

Achieving of International convergence of accounting standard is also restricted by some of the barriers. Main barrier is the translation of the standard to the different language is an issue that may have an impact on achieving converged accounting standard. As convergence of conceptual framework requires create an common language for standard which financial reporting should be based on, as different country prepares their standard on their own language and there might be some problem of translating the standard which may lead to complexity and will not show the true and fair view of the accounting report.

Political factor of different countries can be barriers in achieving conceptual framework as decisions of nations can lead to situation whether to apply convergence accounting standard

However, they are continuing working towards achieving international convergence of accounting standard although it is not easy due to all these problems and barriers the changing environment. However the progress of achieving convergence accounting standard is high but the objective has not yet been achieved and there is still a long way to go.

Over the past few years IASBs work towards convergence of international accounting standard has been successful as a result today we have a comprehensive, consistent and high quality set of standard but it can be improved further if all these problems and barriers are eliminated its not long before we will have convergence of conceptual framework which will provide common framework and guidelines for all capital nations accounting standard and this will have positive impact on our global economy.

There is many barriers that IASB faced in achieving convergence of accounting standard. The barriers that there is big difference in practices of accounting among different countries. If there sone thing that makes accounting standard difference among various countries, then it would be quite simple to intereprete and understood the report of different countries (Mednick, 1991). But the fact is that the differences in both economic and cultural are so big that it is not making interpretation simple at all even if they comply with the same accounting principles. Accounting standards in various countries specify different needs according to the countries themselves. "Nationalism also generate a threat to harmonization as countries are wary of ceding control of their accounting regulation to outsiders, especially if it is perceived as replacing their own accounting regulations with those of other countries" (Saudagaran, 2001). In addition, the barriers also appear in the situation when the governments of different countries deal with coordinate their own accounting policy to foreign countries' polices, so as to reduce the negative effect from foreign and enlarge the positive externalities. Finally, there also big amount cost involves to adjust the international accounting standard, so some countries are against the convergences due to all these barriers.