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This assignment refers the issues of the qualitative characteristics of financial reporting information. The research mainly explores the debate of IASB and FASB, issuing an Exposure Draft in May 2008 which involves: (i) an improved conceptual framework for financial reporting; and (ii) qualitative characteristics and constraints of Decision-useful financial reporting information. This assignment covers two major areas, which are: (i) financial reporting information that has predictive value or confirmatory value is relevant; and (ii) financial reporting information that is complete, free from material error and neutral is said to be a faithful representation of an economic phenomenon.
The methodology of this study is based on literature review to justify the outcome. The data are collected from books, journals, articles; magazines and internet sources.
The Objectives of Financial Reporting
The objective of financial reporting is aimed to provide useful information to the management in order to make financial and business decisions. It is important that the financial report is provided for entity prospective rather than to follow owner prospective. The objective of financial reporting is used for providing information to attract potential investors; lenders; and related creditors that can build a long term relationship through the business development. Financial reports, therefore, must be able to provide the information in relation to economic resources; the claims of resources; transaction and business activities.
Financial reporting also helps the board to assist for allocating the economic resources in the capital market in order to generate more profitable investment returns. In fact, the general purpose of financial reporting not only useful for the board to plan and advise the financial and business plans. It also aims to protect the wealth of shareholders and public interests. Financial reporting provides the information that is required by the specialised needs (International Accounting Standard Board, 2008)
Financial reporting is aimed to provide information for the stakeholders and the report includes a quantitative measure which identify the performance; the profitability; and the efficiency, etc. Financial reporting can provide the immediate financial information to the capital providers in relation to the economic resources of entity. Capital providers refer to shareholders; lenders; and related creditors, such as: suppliers. Therefore, it is important for the financial reporting highlighting the issues of economic resources of an entity and claims them. Managers and the governing board in an organisation are used financial reporting to analyse the status of the entity business development. Managers and shareholders may have different motives in business development (International Accounting Standard Board, 2008). Managers are more interested in building the size of the organisation. Shareholders are interested on the increasing their wealth and gain their investment returns. Other parties are interested on financial reporting such as suppliers; customers; employees; agencies; and government, etc.
The aim of financial reporting is to provide the information to the capital providers in order for making decision, including resource allocation. Investors may need the financial reporting to protect their investments. Capital providers may need the financial reporting to monitor the situation of the cash flows, such as: dividend; interests; sales; redemption securities and loans. They also like monitoring the cash flows to ensure that the cash flows are in the healthy position. Other users may need financial reporting for their direct and indirect purposes (International Accounting Standard Board, 2008)
Qualitative Characteristics and Constraints of Decision-useful Financial Reporting Information
Financial reporting contains fundamental qualitative characteristic and faithful representation. Fundamental qualitative characteristic is useful when the information from the financial reporting can make different decision by capital providers. Financial reporting provides economic phenomenon for predictive value; and/or confirmatory value. Predictive value is used by the capital providers in order to achieve the expectation of investment returns which normally involve useful input to predictive process. From the economic phenomenon, confirmatory value is about the change past which involves expectation from the past evaluation. If the past evaluation or expectation is different, it may change the possible outcome. However, both predictive and confirmatory values are interrelated. The main aim of the both predictive and confirmatory values is to provide the information that can help the users to justify the organisational ability and business opportunity. It is also useful to help the users to adjust and amend the past expectation in order to have betterment situation of the business development. The information obtains from the financial reporting that must contain faithful representation of the economic phenomenon. The information must be complete; neutral; and error free. However, the information should be able to present in multiplex ways, such as risk transfer which may be qualitative or quantitative measures (International Accounting Standard Board, 2008)
The application of the fundamental qualitative characteristics refers to the intention of using the information to make decisions. Relevance information must be faithful representation applied. However, the fundamental qualitative characteristics; relevance; and faithful representation are link. Moreover, it is believed that enhancing qualitative characteristics can provide more useful information which is comparable; verifiable; time lined; and understandable.
The enhancing qualitative characteristics can generate useful information for decision making. It is an interactive process. The level of one qualitative characteristic may influence the level of maximisation for another qualitative characteristic. Enhancing qualitative characteristics should be able to provide a temporary reduction in period to period consistency in order to build a new financial report standard. Information, therefore, can be relevant; faithful and comparable in the future business development.
The fundamental qualitative characteristics
The fundamental qualitative characteristics may be useful in making decision. However, it may contain useless information. There are several reasons that the fundamental qualitative characteristics are more appropriately identified and sufficiently to be consistently understood.
Financial reporting is used for providing information in order to apply into financial and business plan accurately. Companies recruit internal and external auditor to provide accurate information of their financial reporting in order to generate more profitable business development. Financial reporting is mostly based on the historical records as the fundamental measurement for the future plan. The future business plan involves qualitative characteristics which may include assumptions based on internal and external environment issues for decision making. Qualitative characteristics may be based on the experience through the opinions and views to justify the outcome and making the decisions. Therefore, it may not contain a high level of reliability of information.
Information from the financial reporting must be faithful representation. However, in light of the Lehman failure (Bloom and Schirm, 2010) signifies the insufficient of the fundamental of qualitative characteristics. If the information is misstated or omitted, the information becomes not accurate for decision making. Because of the shareholders and executives have their own interests. Executives may manipulate the accounting figures in order to increase the bottom line figures. Supposing the item should be the expense for the company, executive may instruct the accountant to put as the accrual accounts or current asset accounts. This not only shows an increasing of profits, it also increases the assets for the company. Similarly, if executives record the sale orders in the financial report to deliver the goods or services to the customers. This increases the sales and profits on the financial report. At the same time, the stocks remain high amount. The type of mistake can cost huge disaster in financial reports and may cause huge problems in business (Caylor, 2010). Many giant companies such as Enron (Linthicum, Reitenga and Sanchez, 2010) and Shell (Simensen, 2004) have similar experienced in the past. Furthermore, the financial crisis leads to many people concerning about the governance of IASB and the accounting problems (Sanderson, 2010).
There are different types of accounting standard in the global. The drafting accounting standard can be misleading to the foreign investors (Baker, Biondi and Zheng, 2010). It is also believed that financial report provides cost information. The costs may be based on historical financial data to compute the information. Companies often omit additional costs for their analysis. This creates incorrect financial information for decision making and this may cause losses in business development.
Financial report may limit of its usefulness in business decision making. Because of the predictive value is link to confirmatory value. When financial reporting involves the qualitative characteristics which use estimate figures, the level of reliability of the data may be reduced. This may mislead the stakeholders for making their decisions.
The fundamental qualitative characteristics is not appropriately identified and sufficient because the limitation of financial reporting. The financial reporting may need involving the external environment issues for predictive value. This includes economic conditions; political climate; industry and internal issues.
Financial reporting cannot be curtained the changes in resources in an organisation. For instance, an organisation may assume that credit limit from the lender will be the same in the future business development. However, economic factors such as economy crisis and financial turmoil may change the condition of credit limit from lender. If this is the case, the financial report may not be accurate because of the cash flow problem. If the predictive value is too ambition stating on the financial report, the management may face uncertainty risks in business development. If the management uses this type financial report to make investment decision, they may face serious cash flow problems.
The components of the fundamental qualitative characteristics
The components of the fundamental qualitative characteristics may not be appropriate to be consistently understood. It is because the predictive value is always based on the estimation figures which derive from the confirmatory. However, in reality, business development is always occurring uncertainty risks, especially when there is the change in organisation. Using the confirmatory value may mislead the business operation.
The component of the fundamental of the qualitative characteristics is too broad (Henry and Hotzman, 2010). It is also difficult to be certain that financial reporting adopt relevance and faithful representation which are based on the fundamental qualitative characteristics. If organisation has a new type of project, the component of the fundamental qualitative characteristics may not be accurate information. The information cannot be comparability; verifiability; timelines; and understandability.
Furthermore, drafting financial report is not accurate. The information cannot treat as complete; free from material error and neutral. The result from the drafting financial report may not include the external factors that may change the result significantly.
Conclusion and recommendations
The research mainly explores the debate of IASB and FASB, issuing an Exposure Draft in May 2008 which involves: (i) an improved conceptual framework for financial reporting; and (ii) qualitative characteristics and constraints of Decision-useful financial reporting information. The fundamental qualitative characteristics and the components of the fundamental qualitative characteristics may not be appropriately identified and sufficient to be consistently understood. This is because the different between the confirmatory value and predictive value. The financial report may be influenced by the internal and external environment issues. Drafting financial report cannot be accurate which the information cannot treat as complete; free from material error and neutral.
To be more efficient, it is necessary to monitor the trend of the business development. It needs an effective financial model to monitor the business projects. The actual and forecasted figures should be monitored daily; monthly or half years basis. Projects should be divided into phases. It is necessary for the FASB and IASB to set a international standard to guide the international capital market.