Assessment item 1
Short Critical Essays
Question 1 - 750 words
Financial reports (and the conceptual frameworks on which they are based) can either embrace a ‘decision usefulness’ or ‘stewardship’ function. Define these two terms. Which of these functions has the IASB deemed more important in recent years? Critically evaluate whether the approach adopted by the IASB will lead to the provision of relevant and/or reliable information for all users.
Question 2 - 750 words
Identify the weaknesses of historical cost accounting. Were any of the alternatives to historical cost (CPPA/CoCoA/CCA) successful? In your response you will need to outline your criteria for success.
Question 3 - 750 words
Outline the key building blocks of conceptual frameworks. Conceptual Frameworks are yet to provide significant prescription in relation to measurement issues in accounting. Why do you think this is the case? Would you consider conceptual frameworks to have been successful in achieving their objectives? Justify your response.
This assessment task will assess the following learning outcome/s:
The following points are a general guide for presenting assessment items.
This assignment is based on the discussion regarding the various aspect of financial reporting such as the Conceptual Framework. The two key features, stewardship and decision usefulness has been explored. A comprehensive approach has been adopted for understanding historical cost accounting. In this context, the nature of success of the alternatives has also been discussed. A detailed discussion regarding the building blocks of conceptual framework has been undertaken. The significance of the framework has been explored in relation to the issues of measurement in accounting process. Assessment of the level of success of the objectives has also been incorporated in the discussion.
The theory of accounting on the basis of which testing of the practical problems is carried out is known as conceptual framework in case of financial reporting. The fundamental financing report issues are dealt with in conceptual framework for financial reporting. The issues that are taken into consideration include the objectives along with the users of financial statements. In association with this, the characteristic that designates financial information as useful is also incorporated. Essential elements of financial statements have also been taken into account, which includes liabilities, assets, expenses and income (IFRS, 2017, p.6). Measurement and recognition of the mentioned elements are also present in the proposed conceptual framework.
Assisting the IASB in developing the future IFRSs tends to be the basic purpose of the Conceptual Framework. Besides this, reviewing the existing IFRSs is also considered to be the purpose of CF. Moreover, CF can also provide assistance in preparation of financial statements for the purpose of development of accounting policies responsible for transactions. It also assists in the financial statement preparation of the events that are not being covered by the existing standards. In rare case scenario, conflicts might be encountered related to certain aspects of the CF, which might require revising of IFRS. In such situations, IASB is required to provide a description and explanation of the context of departure (Glautier & Underdown cited in Dandago, 2009, p.93).
Financial reporting requires making decisions regarding investments or undertaking business with an entity. The role of decision usefulness is essential in governing and assisting the decision-making process and is designated to be a vital part of financial reporting standard.
Stewardship functions deal with the protection of interests of the company owner along with the interested parties of the business. The parties involve the investors, shareholders, managers, creditors along with government agencies (IFRS, 2013, p.182). One of the primary functions includes measurement of the available resources of the company. The other function provides for the protection of the equities. Reliability of financial information and standardisation of documents aids in balancing the financial claims (IFRS, 2010, p.49). After the measurement of the resources and striking balance with liabilities, estimation of growth potential poses to be the ultimate functions.
Matthews & Perera (1996, p.9) stated that since the time of antiquity, stewardship accounting had been considered as a part of accounting. Over the period of time, the action of stewardship has been ensured by effective management of resources. It was undertaken by the maintenance of proper accounting records, which reflects the utilisation of available resources. The Joint Stock Companies Act 1844 further incorporated it into the practices adopted for accounting. According to Tilly (1997, p.78), maintenance of accounts and balance sheets are considered to be mandatory along with the preparation for an audit. However, stewardship function has encountered challenges in the past years.
The role played by stewardship involves the boosting of decision usefulness in order to undertake responsible management of the business resources. It creates the required influence for conducting an audit by an independent auditor. Moreover, accurate valuation of the company is undertaken by stewardship since the reliability of information is ensured (IFRS, 2010, p.182). It, in turn, improves the level of reliability regarding decision usefulness in relation to the stakeholders.
Relevance and reliability are two vital qualitative characteristics. Relevance of financial accounting information is such that it creates an impact on the decisions. On the other hand, Reliability refers to the accuracy and fairness of the provided information. Both the aspects are interrelated. Relevance of information has the potential to make a difference in the decisions making process. It is due to the fact that both predictive and confirmatory values are taken into consideration (IFRS, 2018, p.14). Impact of stewardship is evident in the management of integrity to the business and hence providing relevant information is essential along with the maintenance of a level of reliability. Recording of information in an accurate manner is part stewardship function and thus reliability and relevance of information are impacted by it. Moreover, accuracy of financial disclosure is a stewardship function that tends to impact information reliability.
Primary users of general purpose financial reports include owners of the company, financial employees. In case auditing is involved, the auditors are also included. Other users of the report are the shareholders. Stewardship functions, as well as decision usefulness, are applicable to the primary users while application of decision usefulness is extended to stakeholders also. Measurement of current value in relation to historical cost tends to be impacted by decision usefulness since it is vital that the information gathered in accurate, verifiable and reliable.
Normative theory focuses on outlining the ways in which accounting is to be carried out. According to Matthews & Perera (1996, p.64), deductive reasoning is employed in order to proceed in a logically consistent manner. The value of judgement is represented in the process of devising the objective. However, initial criticism had been encountered due to the lack of welfare framework.
Historical cost accounting is the method that takes into account the measure of value. According to IFRS (2010, p.37), the original cost acquired by a business serves as the basis of price of assets present on the balance of the company. For example, land of company headquarter is acquired at $100000; however, the current market value is $20 million. The asset value recorded on the balance sheet remains $100000. According to IFRS (2018), fair value accounting method considers the current market price on the financial statements of a company on the basis of mark-to-market accounting records. It is the price estimated for the assets and liabilities in case the assets are sold, or liabilities are alleviated. The issue in this context is that the market prices tend to fluctuate in an abrupt manner. Besides this, according to IFRS (2013), sufficient as well as relevant information is not provided by the current market price, which tends to pose a difficulty.
The normative alternatives that are available for historical cost accounting include the following.
CPPA or Current Purchasing Power Accounting: The financial statement of historical cost is restated and adjusted. According to Deegan (2014, p.174), the original amount if reflected in terms of current purchasing power that tends to govern general purchasing power.
CCA or Current Cost Accounting: the measurement basis of this accounting method considers value to business aspect. Deegan (2014, p.184) opined that it includes the recoverable amount along with net current replacement cost.
CoCoA or Continuous and Current Accounting System: It is a contemporary accounting method that measures assets and liabilities in terms of the current cash equivalents. Deegan (2014, p.191) stated that emphasis is laid on inclusion of current predictive selling price in the financial statements.
FVA or Fair Value Accounting: Deegan (2014, p.195) opined that the price estimation of assets and liabilities are conducted on the basis of current market value.
The measurement choices available for accounting include historical cost, fair value, current cost, realisable value and value in use (ICAEW, 2006, p.32).
According to IFRS (2010, p.35), measurements of the elements of financial statements have been enlisted below.
Assets: In case future economic benefits are present and measurement of the cost of asset is reliable, assets are recognized in the balance sheet.
Liabilities: Situation in which settling of a present obligation has an outflow of economic benefits results in recognition of liabilities in the financial statement.
Income: Demonstration of an increase in economic benefits leads to the recognition of income. For example, increase in sales of goods or debt waiver.
Expenses: Decrease in economic benefits for the future results in recognition of expenses in financial statements. It has direct association with earnings and cost incurred.
Factors that need to be considered while selection of measurement basis is as follows
According to IFRS (2015a, p.67), the provided information needs to be relevant and needs to demonstrate faithful representation of the purport.
Qualitative characteristics that need to be portrayed include understandable, comparable as well as verifiable nature of information. Initial measurement factors include exchange of similar and different value items, equity claim transactions and internal construction of assets.
CPPA consider general purchasing power while value of individual items is not considered. Moreover, it is conducted on the basis of statistical index which is difficult to choose. According to Deegan (2014, p.201), CCA is unable to figure out the related tax liabilities and hence complete analysis of true costs cannot be conducted. CoCoA is based on the exit price system, which is the cause of reluctance in acceptability of this method. Moreover, due to the mentioned fact, internal value is not considered in the balance sheet. Emphasis is laid on adapting to the environment while the influence of environment is not taken into account. It is due to these reasons that the mentioned accounting methods could not be accepted as standards. In this context, acceptance has been shown towards mixed measurement basis since relevant information cannot always be obtained for all elements of financial statement by single measurement basis. The useful nature of qualitative characteristics and details of cost constraints provides the necessary support for adoption of mixed measurement model in comparison with HCA.
The building blocks of conceptual framework have been incorporated into the discussion, which is as follows.
The initial block of the conceptual framework is financial reporting. The subsequent block is a reporting entity. According to IFRS (2015a, p.4), the establishment of criteria in order to determine the entities that have been considered as reporting entities and is dealt with in SAC 1 of the conceptual framework. It is known as definition of reporting entity. It aids in the preparation of financial reports for general purpose. SAC 2 deals with the objectives which are the third block while SAC 3 is the fourth one. It deals with the qualitative characteristics of financial information. The fifth block includes the details of the elements of a financial report, which is included in SAC 4. The elements are assets, liabilities, income and expense. Along with this, the sixth block is also included in SAC 4. It deals with the recognition criteria of the elements of financial report. The seventh block is concerned with the basis of measurements. According to IFRS (2018a, p.5), it includes the factors of reliability and variability along with comparability. Techniques of measurement comprise the eighth block of the framework while financial position is considered as the ninth block. The factors that are taken into account include adaptation capability, solvency, wealth and financial structure. The tenth block of the framework is performance. Information that needs to be present in this context includes variability and the changes that are encountered in relation to consumption of resources. According to AASB PS5 (2001, p.12), compliance and applicability are considered as twelfth block and thirteenth block respectively. Fourteenth block is concerned with elevation, which compares principle with details. Fifteenth block deals with the research methodology while sixteenth is regarding the requirements essential for audit. Re-transition of policies has been designated the seventeenth block while monitoring of the compliance activities is the eighteenth block. Nineteenth and the final block deals with the prosecution details in case of non-compliance.
The building blocks are connected in relation to consistency and flow of information. Coherency is maintained across the framework by ensuring interrelation of the objectives. The underlying idea behind the outlining of the framework is governed by the normative theory. Since the fundamentals have been provided, it demonstrates the potential to lead to consistent standards. According to Deegan (2014, p.215), the prescriptive style aid in the maintenance of order of development as a logical system is developed. The incorporation of the details regarding the recognition criteria for the elements along with the measurement standards aids in the elimination of inconsistencies.
The objective of IASB Conceptual Framework (CF) is to provide the guidance regarding the order to conduct the procedure of financial reporting. The prescriptive style aids in ensuring the mentioned fact while being governed by the normative theory. Despite the fact that CF has not been accepted as an accounting standard, the framework is found to be used in scenarios where new standards are being set (IFRS, 2018a, p.7). The specificity that has been demonstrated in relation to the measurement basis has addressed the critical issues that are encountered in accounting. The application of measurement basis aids in the prediction of future margins, which is essential for the maintenance of physical capital (IFRS 2015a, 58). Therefore, the information that is being provided poses to be sufficient for the justifications of the cost details. Exact measure of the elements of a financial statement has demonstrated the potential of precise prescription. However, Mitchell (2015, p.4) argued that details provided regarding measurement standard are more inclined to be a general description of the existing practices in measurement. It needed to be more of principles on the basis of which the decisions are supposed to be made.
In order to assess the level of success regarding the achievement of the objectives by Conceptual Framework, various factors such as standard inconsistencies need to be considered. Prior to the development of the Conceptual Framework, there were inconsistencies in the determination process of standards. The logical approach that was incorporated in devising of the framework aided in the elimination of the inconsistencies (Peach, 2015, p.3). In this context, it can be stated that the standards have been set for the recognition criteria of elements along with the measurement basis, which ensures consistency (IFRS, 2018, p.6). Moreover, the prescribed style of the framework aids in a methodological approach. The extended time that was earlier required in order to frame with standards was thereby eliminated. Therefore, it can be concluded that CF has been able to achieve the objectives that had been set significantly.
It can be concluded that decision usefulness and stewardship tend to be crucial aspects of financial reporting standards since information relevance; reliability and maintenance of business integrity depend upon it. Acceptability of CoCoA is hindered due to the fact that the exit price system is taken into consideration while CCA has the inability to provide insight regarding tax liabilities. The building blocks of Conceptual Framework have the potential to ensure logical and consistency in the order of development. The prescriptive nature of the framework has ensured the success of the objectives.