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The most important goal of accounting theory should be to provide a coherent set of logical principles that for the frame of reference for the evaluation and development of sound practices (Alexander et al, p132).
Accounting is a complex process of both monetary transactions and judgements based on recognised accounting principles. When analysing annual financial reports the complexities of accounting are clear; vast amounts of both financial and non-financial information frequently contained in upwards of a hundred pages, with pages of notes to the financial accounts, it is an extremely difficult and time consuming process of disseminating the information into an understandable format for everyday users. A further complication arises when comparing organisations of different countries. Each country has its own regulations and accounting principles and this may distort the information and the way it is presented "accounting as the language of business is practiced differently within varying historical, political, economic and social environments" (Hellmann, Perera and Patel 2010, p1).
The International Accounting Standards Board (IASB) was created to ensure adherence with International Financial Reporting Standards (IFRS) which were compulsory from 2005. The standards were implemented in response to an increasingly globalised economy. One key objective of the organisation is to harmonise both European Accounting Policies and those of the wider community, in particular the United States to overcome issues with accounting policy and cultural differences "by examining fundamental assumptions, the development of the conceptual framework will clarify some existing cultural differences" (Whittington 2008, p497). This is to be achieved through a combination of IFRS issues and through the formulation of a conceptual framework for accounting principles "concepts develop to achieve 'needs' or aims" (Dennis 2008, p263). The framework, initially created in 1989, is now undergoing review and implementation through a joint project between the IASB and the Financial Authorities Standards Board (FASB), a USA based organisation "the IASB's agenda is now aligned with that of the FASB and new standards are being developed on a joint basis" (Whittington 2008, p496).
Content of the IASB Framework
The framework is split into different areas, formulated through analysis of the framework adopted in the United States. The framework is based on principles rather than rules "a principles-based system has more generally stated standards whereas a rules-based system contains detailed specific rules that give less scope for individual judgement in implementation" (Whittington 2008, p497). The reason for this is to enable interpretation of transactions where no standard exists, and to improve the quality of financial reporting "there appears to be broad agreement that accounting standards that are 'principles-based' provide the solution to the problem of poor financial reporting" (Dennis 2008, p261).
Objectives of Financial Statements
The IASB consider that the objective of financial statements is to provide useful information to users to make economic decisions "The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers" (FASB 2008, p.x). The key aspect of this objective is usefulness "considerable resources are invested in financial reporting: if it were not useful, these resources would be wasted. And if financial reporting cannot influence decisions, it would seem that it would serve no purpose" (Lennard 2007, p55). It is thought that until the objectives are clear, a consistent and relevant framework cannot be created; therefore the objectives become the core of the framework. The framework also considers investors as the key users of information as they are the main funding for companies, and therefore have to balance and assess the risks; consequently whilst the objectives are to present information useful to a wide variety of stakeholders, it is primarily aimed at investors. The framework also acknowledges that each aspect of the financial statements is not useful in isolation. To become useful all the different elements of the financial statements must be assessed; income statement, balance sheet, cashflow and the accompanying notes and accounting policies. Without overall consideration the information could be distorted.
Qualitative Characteristics of Financial Statements
Qualitative is "concerned with or depending on quality" (Oxford English Dictionary 1990, p977) and is split into distinct areas "The four principles of qualitative characteristics are understandability, relevance, reliability and comparability" (Alexander, Britton and Jorissen 2009, p141). Each are fundamental to the principles, to ensure the objectives of the framework are met. They are also interlinked together to help the user to gain a more comprehensive overview of the financial position and future potential of an organisation.
Financial statements are growing evermore complex with many consisting of over a hundred pages. This key concept is based on an assumption that the user already possesses a degree of understanding about both business and accounting practices, but is designed to ensure that by careful consideration of the information, a reasonable picture of the business can be formed.
Relevance is concerned with ensuring that the information presented is useful to stakeholders, on occasions this could conflict with reliability. A key example of this conflict is fair value; when valuations are conducted using this method they are not certain and can be subject to volatility however "analysts realise that on some occasions fair values are difficult to ascertain. There is always a trade-off between relevance and reliability but the investment profession believes that relevance is the overriding consideration and aim" (Damant 2002, p6). Relevance is heavily linked to the accounting concept of materiality and statements need to make consideration of any information which is likely to be of material value and as such significantly change the view of the financial position of the company.
Reliability is a key aspect; without this, no useful decisions can be made about the accuracy of the information under review and analysing the information becomes worthless "information has the quality of reliability when it is free from material error and bias" (Alexander, Britton and Jorissen 2009, p142). However as shown in 3.2.2 conflicts can arise between reliability and relevance which poses difficulties within the framework. Accounting information can never be completely accurate because much of the information is subject to judgement and can therefore be distorted or altered dependent on accounting policies. The objective of the framework is to present a faithful representation of the financial position of organisations by providing guidance to identify how and when to measure financial transactions.
Included within this is the concept of substance over form, which is also linked with relevance. In some cases an organisation may not own an asset but may gain economic benefit from its use, substance over form requires the asset and its corresponding liability to be included within the financial statements to ensure users understand the benefit gained. In addition information should be free from bias which is usually confirmed by an independent audit. Auditors are viewed as independent and objective and confirm that the information presented is a true and fair representation of the financial position of a company.
For information to be useful and relevant, it must be presented in a consistent way to enable comparison; historically over a period of years, against other organisations operating within the industry and against companies operating in alternative industries. Only then can a user gain an overall understanding about the position and potential of an organisation. The requirement to compare companies has now become global and therefore difficulties arise in the different accounting policies and principles adopted by different countries "it is hard to imagine that give the enormous volume of cross-border transactions that characterize most multinational companies, that shareholders, creditors and the general investment community can intelligently compare the financial performance across the globe" (Jacob and Madu 2004, p357)
Elements of Financial Statements
This aspect defines three fundamental elements of financial statements; assets, liabilities and equity. It provides key definitions to allow preparers of information to accurately categorise transactions to promote the qualitative characteristics of the framework. Income and expenses are also given definitions together with capital and capital maintenance. All these are vital in ensuring a true and fair view, comparability, reliability and relevance to meet the main objective of usefulness.
Provides definition and information on if and when accounting information should be recognised within the balance sheet and income statement and essentially must meet two specific criteria; "it is probable that any future economic benefit associated with the item will flow to or from the entityâ€¦[and]...the item has a cost or value that can be measured with reliability" (Alexander, Britton and Jorrisen 2009, p151). Within this criteria are two key words; probable and reliability both which require consideration before recognition can occur. Probable is that the transaction "may be expected to happen" (Oxford English Dictionary 1990, p950) but includes a degree of uncertainty. This uncertainty means that an estimate of the financial impact must be sought using the evidence available and judgement based on experience, thus forming a reliable estimate. Recognition applies to assets, liabilities, income and expenses.
Measurement determines how to value items within the financial statements. The framework identifies four methods; historical cost, current cost, realisable or settlement value and present value. All are recognised accounting techniques; historical cost provides for the element at its original cost to the business; current cost is the cost to replace an item or to settle the obligation; realisable value identifies the actual monetary gain which would occur if the item was sold, in contrast settlement value is the monetary cost to discharge the obligation; present value considers future cash inflows or outflows and converts these cashflows into current monetary value. Conflicts relating to measurement, in particular fair value, are apparent between the US and UK "in the US the FASB has been widely criticized for opting to retain the historical cost approach, in the UK the IASB has been widely criticized for trying to adopt a valuation scheme based on fair value" (O'Regan 2006, p59). This issue in itself may jeopardise adoption of the framework by the USA.
Fair Value Accounting
Fair value accounting is a key aspect of the new conceptual framework and one of wide debate and concern. The core principle of fair value is defined as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date" (IASB 2009, p13). Debate centres on whether reliable estimates are possible, and how it is measured in an inactive market. For certain assets and liabilities it is thought to be more accurate than historical cost, which has its own issues "there has been a long debate whether the historical cost accounting procedure is beneficial or detrimental for the informational relevance of the financial statements. Those who are in favour of that method argue that the present value of assets is actually a synthetic estimation of their value" (Dimitropolous and Asterios 2009, p250/251). It is argued that fair value allows balance sheet transparency; and identifying current market values enables consistency across similar products and institutions, allowing more direct comparisons to be made. Criticisms concern the difficulty in determining and validating such valuations.
Furthermore is it suggested that valuations may be subject to manipulation or abuse, and that fair value distorts the profits of a company making interpretation of information difficult for stakeholders "take together, the fair value accounting project of the IASB and the instability of contemporary financial markets suggest that the nature of accounting "facts" is less clear than ever before" (Fraser and Pong 2009, p106-107). Additionally Woods (2004) identifies that "net income before tax may now no longer be a consequence of the bank's economic activity but instead include profit arising purely out of an increase in fair value assets" assets whose true value are yet to be realised.
It also appears that fair value may conflict with the fundamental accounting convention of prudence or conservatism. When increasing valuations in line with market conditions, this could be construed as recognising revenue and profits before they occur. However, down valuing assets using fair value adheres to the principle, as potential losses are recognised as soon as they are identified. Fair value could also be in direct conflict to objectivity, another accounting convention, which determines that information and valuations should be independently verified.
Critical Analysis Of The Framework
The framework defines the key objective of financial statements; to provide useful information to enable users to make economic decisions. However research highlights that some professionals do not believe this goes far enough "the issue is whether decision-usefulness in and by itself provides a sufficient and appropriate focus for the future development of financial reporting" (Lennard 2007, p55). Research identifies another important aspect could be stewardship, which whilst identified in the framework is not classed as a key objective "stewardship information will assist not only in assessing the competence of stewards but also that of integrity" (Lennard 2007, p58). Concerns regarding stewardship are confirmed by Whittington (2008, p499) who identifies the differences between corporate governance in the USA which is capital market driven whereas "in Europe, on the other hand, there are different traditions of corporate governance, relying on more direct controls". This links with issues of cultural differences and whether it is possible to create accounting standards on a global platform. It is suggested that stewardship viewpoints "affects subsequent decisions in the framework and in the standards themselves" (Whittington 2008, p500).
This also raises concerns within the framework with regard to both measurement and reliability "some participants perceive historical cost to be justified as reliable record of past transactions, consistent with stewardship" (Whittington 2008, p501); the IASB appear to be favouring fair value measurements which conflict with historical cost "The joint IASB/FASB project for improving the conceptual framework for financial reporting is directed towards better performance of both functions within the conventional 'accruals' system of accounting through the use of 'fair value'" (Rayman 2007, p211). In addition to the concerns raised in Section 3.5.1 key issues are; firstly that fair value increases are only hypothetical on the measurement date meaning that income is recognised for it occurs; secondly the impact of fair value on the financial statements can distort information for users "the concept of income or profit as value growth can be seriously misleading". An alternative method for disclosing such information is to segregate the value increases to allow users to make their own informed decisions about the usefulness of this information.
4 Critical Analysis Of The Framework (continued)
The IASB framework has clear advantages; standardisation of accounting policies, consistency and comparability across global organisations and economies, and it assists preparers and auditors to account for transactions where no standard exists therefore allowing for the ongoing development of accounting complexities "financial statements should conform to a strictly defined framework: only if this is the case can preparers and users know what is properly included and what excluded" (Lennard 2007, p54). In general it places boundaries on the way preparers can account for transactions helping to prevent manipulation and creative accounting. It also provides an existing and accepted framework for developing economies, in that they do not have to develop their own policies but can thereby adopt widely accepted principles.
Criticisms of the framework suggest however, that it does not consider all countries within its standard setting "the IASB is dominated by what is sometimes referred to as "Anglo-Saxon accounting" i.e. dominance by the English-speaking countries" (Whittington 2008, p496). A view supported by O'Regan (2006, p431) who identifies that "there are far greater social, environmental and cultural issues at stake, particularly in developing countries, where a capital-markets driven agenda is simply unsuitable and unsustainable". Both suggest that the principles may hinder rather than assist developing countries. However in the absence of an appropriate accounting standard, the framework could be beneficial "with often diverse and conflicting needs regarding financial reporting there rarely exists an accounting standard that is acceptable to all parties involved" (Luthardt and Zimmermann 2009, p79), the framework could address this issue.
Another concern is the impact from the joint venture between the FASB and the IASB, fears that convergence "may result in either the continuation of two sets of significantly different standards. Or, perhaps more likely, the domination of IFRS by the U.S." (De Lange and Howieson 2006, p1008). It is wholly different in its approach to that of the US system which is primarily prescriptive as opposed to the framework which is descriptive. This may cause future conflicts and ultimately lengthen the process.
4 Critical Analysis Of The Framework (continued)
The descriptive nature of the framework also allows for an element of interpretation, meaning that comparison of information could still be ambiguous and distorted dependent on how a given principle is understood. This could be further exacerbated by cultural differences across countries however "one way in which IASB can attempt to overcome the possible source of cross-constituency variation is through the conceptual framework, which, in effect, is the IASB's statement about its own accounting culture" (Whittington 2008, p497)
Fundamental accounting conventions in themselves can appear conflicting and this has not been addressed by the framework "existing standards are simultaneously based on conflicting theoretical concepts" (Fox, Grinyer and Russell 2003, p170). This is observed in Sections 3.5 and 3.5.1 above with measurement techniques.
Other issues are that it is already over 20 years old and still not universally adopted. It currently conflicts with aspects of IAS and IFRS which override the framework; therefore it is not a full authoritative document. At present in the UK, for example, there are both the framework and specific International Accounting Standards to consider, making decisions ever more complex and time consuming for accountants and auditors and it will be a lengthy process to review and eliminate conflicts across the two sets of information.
The framework was first introduced in 1989 over 20 years ago and the harmonisation process began even earlier "efforts to achieve a global set of accounting standards began even before 1973 when the International Accounting Standards Committee (IASC), the predecessor to the International Accounting Standards Board, was formed" (Jacob and Madu 2009, p714). In 2010, more than thirty years later, it is still a long way off completion highlighting the difficulty of the task of agreement across countries "for historical and cultural reasons a complete uniformity of accounting practice is probably unrealistic, at least in the short to medium term" (O'Regan 2006, p431); with the USA now involved this could delay completion of the project even further. The USA regulations are far more prescriptive and legislation based than the UK and Europe therefore conflict and disagreements are more likely to arise as the IASB tries to accommodate the requirements of the USA. Progress may however, be assisted by the recent global economic crisis "it is hard to remember any time in recent history when a complete overhaul of our [the USA] accounting system was considered to be one of the cardinal solutions in preventing a complete collapse of the global economy" (Jacob and Madu 2009, p712).
Whilst there are obvious merits in the idea of a coherent and logical framework; industry and organisation comparisons, comparisons across countries and a more consistent and transparent approach towards accounting principles; it does appear to fail in other areas. In theory a coherent logical set of principles and guidelines can only be a positive progression "the increased globalization and integration of economic activity that have taken place in recent years indicate that the financial health of our global capital markets is heavily dependent on transparent, comparable and consistent financial information" (Jacob and Madu 2009, p713); but in reality it may be too complex to fully implement, making accounting more ambiguous than ever before. It can only really work and meet its objectives if and when it becomes the global authoritative and overriding set of principles.