Describe about the Accounting Theory for Accounting Conceptual Framework.
In order to have principle-based standards, there are various reasons for the requirement of conceptual framework. It helps in resolving disputes, if any, as far as the setup of accounting standard is concerned. Conceptual framework helps in setting up of standards which needs to be followed by all the concerns in a unified manner. It provides requisite principles so that it is not required to be recurring in accounting standards. Conceptual framework provides the back support to principle-based standards and that fall in line or in continuation to their pre-defined standards. It also acts a constitution for reporting of financial information and reporting as well as all the references are towards conceptual framework. It ensures that consistency is the key amongst the standards thereby preventing varied conclusions (Godfrey, 2010)
IASB and FASB are two international boards who are responsible for the setup of accounting standards. Both require the support of conceptual framework during its course of development. It is quite essential that IASB and FASB should have a common conceptual framework so as to have modification, update, union and completion between the framework and statements of both respectively. Since, they were developed during the period of 70s and 80s; it is quite natural that they will be subjected to changes and updates as per the changing requirements of accounting. There may be minor differences in their standards but the aim of IASB and FASB is same i.e. transparency, accountability and efficiency which goes in line of conceptual framework (Godfrey, 2010).
Conceptual framework is the backbone of all the accounting standards and thus, is essential for all kinds of concerns. The principles stated in the conceptual framework are drafted in such a manner so that best international practice is followed on a global level. It is a true fact that many concerns, whether mid-size or big corporations are benefited from conceptual framework. The role of conceptual framework can be found in all types of business and thus, I believe that it is equally important for all kinds of parties and there is no kind of disparity for anyone in terms of its principles and guidelines. It can be said that the rules of conceptual framework are stricter for big corporations as compared to those mid-size firms. But, in no way it can be concluded that it is more important for some parties and less for some concerns (Godfrey, 2010).
Cross cutting issue refers to the fact where uncertainty is taken into the account for the cases concerning measurement of assets or liabilities. This involves cases where rules of accounting seem to delay the aim of IASB and FASB. These are such issue which tends to touch the basic guidelines of accounting aspects. Some examples of cross cutting issues one measurement basis for assets and liabilities, considering and applying factors of cost constraint and comparability. Cross-cutting issue is an important aspect in the field of financial framework and is quite a relevant issue for big corporations or company. A strategic outlook is expected to deal with such issues (Iasplus.com, 2016).
Historical cost is used in accounting as to assess the value of a company. It believes in recording the price of an asset on its nominal or the cost incurred in original terms. US GAAP uses this method of accounting as far as the assets are concerned. The fundamental problem with financial statements which follows historical cost as means of measurement under US GAAP is fails to update the value of assets which are subject to change in a significant manner over the period of time. For example, if plant and machinery of a company was purchased for $50,500 and that its value in the market has increased to say, $2, 50,000 as on today, still it will be recorded at $ 50,500 in balance sheet.
It is a true fact that accounting should ensure economic reality and there should be a strong link connecting the accounting standards and financial reports of a company. The boards that are responsible for the framework and development of accounting standards ensures to deliver quality information for investors who are willing to make rational decisions as far as their resources are concerned. If accounting does not reflect economic reality, the whole information would turn misleading for the prospective investors and would also violate the norms of conceptual framework. This is the reason that it is a crucial principle of measurement in accounting as it forms a base for the economic condition of a company. So, the stated principle ensures transparency and develops reliability for its statements (Financial Times, 2016).
As far as the accounting aspect is concerned including the conceptual framework, economic reality can be measured as per the fair value keeping in menthe concept of prudence. Basically, economic reality determines the kind of transaction occurring in business by evaluating an overall commercial scenario. It can be measured by following the best international practise for the concerned organization or company. Principles of conceptual framework and guidelines issued by IASB and FASB, acts as standards for fair practise. An organization can evaluate its economic reality by analyzing its course of work with those standards and judge its level of authenticity. Even, accounting standards also acts as a benchmark for companies in order to judge their economic reality on a global level (Godfrey, 2010).
Reliability in accounting refers to the phenomena where financial information can be confirmed and whether the same is being used by shareholders, creditors, users or investors in a consistent manner. In a simpler manner, reliability refers to the level of authenticity of financial statements based on which the factor of trust is developed by the end users mentioned above of such reports. It is due to the same reason that FASB and IASB are very particular when it comes to reliability of economic statements. Reliability can be measured on the basis of verifying the statements, remaining neutral to the accounting figures and faithfulness towards its disclosures as and when required. It is the most important aspects in conceptual framework and accounting standards authenticated by their respective boards (Godfrey, 2010).
Case Study 3
The provisions of FASB requires corporations and companies to analyze and record a provision in respect to environmental cost of retiring an asset provided that it’s possible to reasonably estimate the component of fair value. Since, it is a guideline from the side of FASB, it creates a mandatory obligation on the companies to follow and implement the same in their financial statements. Generally, fair value of accounting is followed by the companies and if assets are prone to environmental conditions, it is required to create a provision for the same and reflect it in accounting. But, companies are quite sceptic in following the same in their practise of accounting due to their respective apprehensions and financial outlook towards it (Journal of Accountancy, 2016).
In order to defer recognition of a liability, US companies had come up with some aspects of their requirements. They propagated their beliefs that the revenues earned in the business are quite sufficient in offsetting those liabilities and are thus, not required to be shown separately in their reports of financial statements. It was a well known fact that the impact of recognising such kind of liability would be reflected in their figures of revenue due to the concept of double entry. This made them quite sceptic in recognising such kind of liability in their financial statements. The probable tax consequences due to recognition of such kind of liability were also amongst the aspects of requirements to defer recognition of a liability (Godfrey, 2010).
Net profit in the current year as well as of the future years gets affected due to the recognition of liability in relation to future restoration activity effect. These are generally recorded in the form of provisions every year and thus it lowers the profit for all those years in which such provisions are recognised. Since, the provisions are not nominal in nature; it has a huge impact on net profits.
Cash flows deals with the incoming and outgoing of cash in an organization. Since the recognition of liability is in form of provisions, it does not involve the outflow of cash from the company. So, it will have no effect on cash flow till the time such liability materializes in form of cash and lowering the positive cash flow (Godfrey, 2010).
In this global market, it has turned quite crucial to record environmental liabilities and to show its actual aspect in the reports of various organizations. Due to continuous change in environment, some of the assets are prone to it to some extent and it affects its efficiency. So, for depicting fair value it has now turned quite important to recognize such liability in financial statements. Proper disclosures for the same are also quite relevant in order to justify such recognition of liability. The liability for the said purpose should be disclosed in such a manner so that it is able to quantify its effect on financial statements supported by proper reasons and explanations like the nature of assets and its conditions which has led to its recognition (Godfrey, 2010).
References
Financial Times. (2016). Financial data must reflect the economic reality – FT.com. [online] Available at: https://www.ft.com/cms/s/0/fdfd338e-312c-11d9-a595-00000e2511c8.html?ft_site=falcon&desktop=true#axzz4SAP23CoY [Accessed 7 Dec. 2016].
Godfrey, J. (2010). Accounting theory. 1st ed. Milton, Qld.: John Wiley.
Iasplus.com. (2016). Cross-cutting issues – Taking uncertainty into account in the measurement of an asset or liability. [online] Available at: https://www.iasplus.com/en/meeting-notes/iasb/2011/agenda_1102/agenda1603 [Accessed 7 Dec. 2016].
Journal of Accountancy. (2016). Accounting for Asset Retirement Obligations. [online] Available at:https://www.journalofaccountancy.com/issues/2001/dec/accountingforassetretirementobligations.html [Accessed 7 Dec. 2016].
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