Dsicuss about the Introduction Of A New Conceptual Framework.
The fundamental concepts of accounting are deep rooted in the accounting standards that are prepared using the conceptual framework. There are various problems and limitations that have to be gone through while preparing this conceptual framework. However, all the problems and criticisms are resolved while preparing the framework. So, there are no hurdles while preparing the accounting standard (Bragg, 2016). All the accounting standards that are prepared are based on this framework and there is no individual concept of the different standard setting bodies. Therefore, we can say that it acts as a constitution for preparing accounting standards in financial reporting.
The presence of conceptual framework helps the financial statements to reflect consistency and comparability. It prevents the users of such financial statements using different accounting standard from having different interpretation of the same event or transaction happening in the company (Flood, 2017). The standards that are introduced on the basis of this conceptual framework help the users to carry out time series analysis as well as cross sectional analysis. Time series analysis means comparing the present with the past periods in order to know the growth and financial performance of the company whereas the Cross sectional analysis means comparing the financial statements of the two companies, in order to draw a conclusion about which company is performing better. A conceptual framework accelerates the usefulness of financial reporting given the huge importance of accounting standards in the preparation of the financial statements.
IASB and FASB both jointly have a common conceptual framework that has provided a base in the preparation of the accounting standards (Schroeder, 2014). The framework should be complete and consistent because it is used in the process of making accounting standards that lead to the preparation of financial statements. The financial statements are prepared by the management for the purpose of financial reporting. Financial reporting is a very important part as it involves the process of decision making by various investors, creditors and other persons holding interest in the company.
It is considered very important for IASB and FASB to share a common conceptual framework because it enables the updating, completion, refinement and also convergence between the financial statements prepared under IASB and FASB. However, we cannot say that convergence makes it perfect but there is also a requirement of improvement. It has also proved economical and convenient to prepare the conceptual framework together as it divided the cost and also made it easier to overcome the problems and criticisms together (Scott, 2014). IASB and FASB have to trace out the differences between IPRS and US GAAP and the ways to reduce the difference between them to the extent it is possible.
Now, it will be seen that all the accounting concepts or standards that are used in the process of financial reporting will be revised and the unnecessary be discarded. This will have a very good impact in the long run and also the users of the financial statements will be more confident while taking any decision.
Conceptual framework is guidelines based on which a lot of accounting decisions are made. The relevant authorities have laid down respective standards and guidelines to treat various accounting items. But still there are a few items for which accounting treatment has not been specified. Under such circumstances the conceptual framework comes in use. The accountants and preparers of the financial statements face practical problems while treating few transactions in the books of accounts (Hubig, 2013). Using basic knowledge and assistance of these conceptutual frameworks helps them to treat the item properly in the books of accounts. The conceptual framework are made will a whole of research, they are implement only after they have been ratified by various experts. The hard work is already done on the conceptual framework, because of which while making the standards the authorities consume lesser time. With the help of the base of the conceptual framework, preparation of accounting standards become a lot easier. Conceptual framework on accounting is the base for preparation of standards worldwide. Since the guidelines for preparation of standards are same, accounting for almost all the items are done in a similar way worldwide (Wolk, 2013). This helps the multinational companies maintain consistent books of accounts. It makes accounting a lot simpler.
Therefore we see that conceptual framework not only assists the authorities but it also assists the accounts in solving accounting issues along with the multinational corporations in maintaining proper books of accounts.
Cross cutting issues refers to the multiples issues which are common in a number of tasks, also which are likely to occur again and again. The board aims at resolving these issues which seem to recur. A single or a set of standards cannot alone solve the cross cutting issues, because of which it is necessary to have a conceptual; framework which can cove greater grounds (Rayman, 2009). A cross cutting issue in conceptual framework refers to the issues that affect a number of standards at the same time. This means they are the issues which are commonly faced in implementation or making of multiple standards at the same time. It is important to identify the cross cutting issues so that while the conceptual framework are being formed, these issues can be resolved. Let us take an example in order to understand the cross cutting issue. Let us say there are two standards which require the use of definition ‘Liability’. But due to difference in definition of ‘Liability’ under both the standards the accounting system becomes complex. Other examples of cross cutting issues include Objectives and characteristics, along with measurement and recognition. The board will take into consideration this problem and while framing the framework will find a resolution to this problem (Wahlen, 2012). Therefore we see that cross cutting issues may create obstacles over and over again and hence it is important to resolve these issues.
Historical cost measurement approach is the legal requirement of financial reporting but there are various reasons for why it is criticised. Although historical cost helps us to know the actual cost of acquisition of the asset and helps us to know the financial position of the company during stable prices but it neglects the actual value of the asset when the price level changes which reflects a wrong financial position of the company.
The figures of the assets that are reflected in the financial statements are outdated and therefore do not provide the users of the financial statement a correct and fair view of the future sustainability and cash flows of the company (Zack, 2009). The assets are usually undervalued because of this approach which gives a misleading impression of the company about its ability to carry out its operation at a given level. This approach also hurts the comparability, and this can be resolved only when the balance sheet is reinstated based on the general price level.
If the profits are dependent on the capital, then it would be worthless to compare the totals because the figures of the capital that has been mentioned in the balance sheet do not actually reflect the actual purchasing power of the shareholder (Warren, 2017). As the balance sheet figures are based on the historical cost approach, the profits that are computed are overstated and the ratios computed with the help of these figures will also be overstated.
Account must reflect the economic reality because one of the major objectives of financial reporting is to provide useful information to the users of the financial statements. Therefore, all the information that is provided should be true and reflect the reality of the business because a large number of investors take their decision based on this information (Edwards, 2014). It is not enough to provide only true and fair information to the public, it is equally important to provide relevant information timely. Even if the company conceals certain facts, events or transactions then also it can be said that the financial statements do not reflect economic reality.
The company runs because of the investor’s interest and investment. Therefore, it is the duty of the company to provide them with correct and useful information. If any company tries to manipulate any transaction or event in the financial statements then it is impossible to survive in the long run. In order to make sure that the financial statements are reflecting the economic reality, an accounting concept known as Substance over legal form was introduced (Zyla, 2013). This accounting concept states that not only the legal form but also the economic substance of a particular transaction or event must be reflected in the financial statements to provide true and fair view to the investors. In short, it means that the event or transaction must show the true essence and not the judgement of any person because it would influence and may hurt the decision making. This accounting concept was introduced to increase the reliability of the financial statements.
Economic reality can be measured by various ways. The investors can see or measure the economic reality of the company by the disclosures made by the management in the financial statements. These disclosures include stating the actual liability of the company so that the investors can analyse the future cash flows keeping in mind the current stability of the company (Mattessich, 2016). The investors comes to know about the company’s future plans when the company shares with the investors the projects that it is going to accept in the future and what is the effect that they are thinking it might have on the company as well as the reasons for accepting such project, it must also disclose if there are any contingent claims that a company thinks that may arise and what impact would that contingent claim have on the company, or if there is any change in the accounting rule then the company must report it in its financial statements. There are various decisions that are taken within the company about which the investors do not know (Pratt, 2009). So, the decisions in which there lies interest of the shareholders must be communicated to them so that they can take their decisions accordingly. An investor would be able to know about the growth and performance of the company only by measuring its economic reality which is presented to them in the form of financial statements.
Reliability in accounting means that the financial information of the company should be such that the investors and creditors can look upon for taking any kind of economic decision. The trustworthiness of the financial statements of the company on which the users can rely is known as reliability. (Rosenfield, 2009)
In order to call the financial statements reliable, it must contain the following features:
It is important the companies account for liabilities arising from retiring of an asset and its environmental impact. In order to account for such a liability it is important for the entity to first estimate the fair value of the asset. Fair value of the asset can be easily determines by calculating the present value of the estimated cash flows. In order to determine the amount of provision for environmental liability, the company should estimate the total cost which is expected to arise at the time of retirement of asset (Rogers, 2015). It is difficult to calculate the value of environmental liability due to uncertainties and contingencies subject to their recognition. There is no specific GAAP provided for the accounting of environmental liabilities which makes it more difficult to ascertain the provision amount. Currently the FASB 5 is the only source of information and assistance which help guide on how we can report loss from contingencies. Also FIN 14 helps us estimate the amount of provision. As per FASB 5 a contingency loss is an existing condition which may lead to uncertain gain or loss in the near future (Freeman, 2011). Environmental liability is covered under this definition. It also lays down the timing of recognition of loss. The provision is to be provided for when the loss can be reliably estimated and that they relate to the current period. Therefore the amount of provision should be based on facts and expected future losses and they should be related to the current period.
Recognition of environmental provision requires the huge corporate to reduce the profits by charging millions towards the provision for losses. This would lead to lower market capitalisation and lower shareholders wealth. In order to avoid such circumstances the companies started to defer the recognition of liability by taking the definition of requirement of provision and twisting it as per there requirements (Schnapf, 2011). The preparation of provision clearly states that the fair value of the asset should be clear and calculated. The company’s started claiming that they were unable to calculate the required fair value. In the absence of such fair value the provision could not be calculated. Also in order to make a provision it is important there exists circumstances which may lead to outflow of resources in the future. The companies started to use lack of any present litigations or claims to avoid the making of environmental provisions.
In order to overcome this technical excuse the FASB made changes to the definition and made it clear that, even if the timing and method of settlement is not clear the companies will be required to make the appropriate provision (Case, 2012). They also stated that the companies have the legal obligation to reserve for environmental costs at the time of retirement of the asset. Due to this change in definition by FASB, many companies had to immediately recognise the liability in respect of provision for millions of dollar. Hence the aspects of the requirements which were used as an excuse for recognition were removed.
When we record a liability in connection with future restoration activity, it has effects on the financial statements of the company (Wink, 2011). We will discuss in brief the effects of recognition of liability on the profits of the company and also on the cash flow of the company.
Effects of the liability on the net profit in the current year and future years: when we record a liability in respect of future restoration cost, we must keep in mind that we are debiting the profit and loss account of the company. This will reduce the profits of the company for the current year. But we should also not forget that the provision is made in order to cover the losses of the future. Since a part of loss has been debited in the current year, it means that the company will not have to charge a huge sum of expense in the future. (Dickson, 2017)
Effects of the liability on the cash flow in the current and future years: Since we make a provision for future restoration costs, there is no actual outflow of cash for the company in the current year. However, when the company starts to incur actual expense in the near future in respect of restoration costs the company, the actual cash outflows begin. Therefore there is no effect of provision on cash flows of the company in the current period but there is effect on the cash flows of the company in the future when the actual costs starts incurring.
Recognition of environmental liability is very important for the companies all around the world. Due the increasing importance given to economic development for a long period, recognition of environmental liability had taken a back seat. But now that the economists and the accountants around the world have understood the major importance of recognising environmental liability, rules and regulations in connections with the same are being made and implemented at an alarming the assets (Paul, 2014). The cleanup costs after these assets may be huge and the company may have to bear huge expense if the provision is not made. Thus in order to avoid these huge cleanup costs the company should make required provision for the environmental costs. Also if any provision for the environmental liability is made by the seller, it makes it easier for him to sell the asset. The purchaser is required to carry a proper due diligence in respect of the asset which has an environmental liability attached to it.
It is not easy to estimate the cleanup cost due to various determinants. One cannot reliably estimate the costs associated with cleanup of previously operated property (Kieso, 2014). Also the continuous change in regulations make is more difficult to determine the cleanup costs. Therefore, to resolve this issue the board has laid down that even if the companies report the minimum amount associated with the cleanup, then it would be sufficient for the company.
Therefore we see that it is important that the companies report the environmental liability, even if the amount is minimum.
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