Conceptual framework in truest sense represents a well-designed system of objectives and ideas which result in the formation of a reliable set of standards (Barker et. al. 2017). This framework is developed as per the “normative theory” of accounting. There are two basic theories in accounting- The Normative and the Positive theories. Accounting theories in truest sense depicts the usage of correct methods while carrying out the process of accounting. It demonstrates the way how the financial information be measured and disclosed. It also demonstrates how the systems of the organizations and its controls are subject to internal as well as the external factors affecting the business entity. Normative theory is basically based on the concept of recommending what should happen rather than what is actually happening. Thus, normative theories of accounting prescribes a way and the required set of actions to accomplish a specific goal. On the other hand, positive theories describes and demonstrates the prediction relating to activities which are purely based up on actual observations. This theory basically assists in understanding the cause behind the making of complex decisions. Apart from searching the reasons or analyzing the decisions that are made, it assists the management in taking prudent and more informed decisions.
Thus, from the above discussion it is evident that conceptual framework represents a system of objectives and ideas that leads to the establishment of a well-defined set of accounting standards and rules (No 2018). The primary reason and motive behind the development of this well-defined rules is that it forms the framework and basis for setting up of accounting standards, solving any accounting disputes which might crop up in normal functioning and recording of business transactions and also serving as fundamental principles which needs no repetition in accounting standards. The examples of this accounting theory are the agency theory and the contracting theory. For accomplishing the aim of the research, the normative accounting theory encircling the conceptual framework has been used to analyze the accounting effectiveness of the BHP Group.
BHP is one of the largest mining company listed among the top 100 ASX listed companies. It is an Anglo-Australian company dealing in mining of petroleum and other metals since 1885 (Bhp.com 2019). The aim of this research is to critically analyze the effectiveness of BHP to meet the conceptual framework’s obligation. Conceptual framework or the normative theory in accounting has been chosen to critically analyze the effectiveness of BHP is due to its major benefits. Firstly, it provides solutions to specific accounting problems, a guidance to develop a set of accounting rules and also helps in preparation and auditing of financial statements. Secondly, it prevents any political intervention in setting of accounting standards. Finally and most importantly protects the professionalism of accountants and accounting as a whole.
The main aim of the framework is to help the IASB to prepare and revise the IFRS which is based on reliable concepts which in turn will allow the preparers in developing reliant and constant accounting policies. The critical analysis of BHP Group so as to meet the obligations of conceptual framework in accounting can be addressed as follows:
The main users of “general purpose financial reporting” are the shareholders, potential investors, creditors, lenders and many others who are attracted to such financial reporting owing to their need to make prudent decisions relating to buying, holding or selling of securities and debt instruments and many more (Kruglyak and Shvyreva 2018). Their decisions are not only relied upon the present and future cash inflows but also on the management’s actions on utilizing the economic resources of the organization.
Economic resources and claims: Economic resources and claims are of utmost importance for the consumers of financial information to assess not only the financial strength and weaknesses but also the solvency, liquidity and the capability to obtain required financing. These payment and claims requirement assists the users to predict the future cash flows and also how this flow of future cash would be distributed among its claim holders. The economic resources and claims are presented by the organization in the form of balance sheet that finds its place its annual report published every year. BHP Group has abided by this obligation and disclosed all its economic resources as “Consolidated Balance Sheet” as at 30 June 2019 (Bhp.com 2019).
Changes in economic resources: Changes in economic resources mainly occurs from its business operations or any other transactions and events like issuance of debt. Users can easily differentiate the changes through the balance sheet published. The income statement and balance sheet of BHP published in 2019 contains the values of same economic assets with corresponding figures of 2018 and the changes as well as reasons for the change are well illustrated in “notes to the financial statements” available in the annual report. For instance, the balance of Total assets were $100,861 million in 2019 and $111,993 million in 2018.
Accrual accounting based financial performance: All the required information by the users relating to the organization’s economic resources and its variations except the resources which are obtained directly from the investors can be found from the entity’s published income statement (Zhang and Andrew 2014). These information are of great importance to the users in assessing the past and future generation of cash flows. BHP have well disclosed these information in the form of “Consolidated Income Statement” which contains the corresponding figures relating to 2017 as well. For instance, the revenue for 2019 was $44,288 million, $43,129 million in 2018 and $35,740 in 2017.
Reflection of financial performance through past cash flows: The statement of cash flows allows the users to obtain information on how the management has been obtaining and utilizing the cash resources over the years. This statement allows the users to have an insight on the utilization of cash including debt-repayment, borrowings, payments of cash dividends and many more which in turn will facilitate them to measure the capability of the organization to generate future cash inflows. BHP have well disclosed all relevant cash acquiring and utilization transactions through its statement of cash flows as on 30 June 2019 containing relevant corresponding figures from 2017 as well. For instance, the interest paid by BHP in 2019 was $1,346 million, $1,177 million in 2018, and $1,148 million in 2017.
Changes in economic resources resulting out of non-financial performance: Changes in economic resources occurring other than financial performance of the organization is of material importance for the users of financial data (Manes Rossi, Aversano and Christiaens 2014). This includes distribution of cash to shareholders or issuance of equity instruments which are very essential to complete the incomplete picture of the organization’s claims and economic resources. Such information can be found in the statement of changes in equity and BHP has adhered to this obligation towards the users of such financial information by disclosing the changes in equity in prescribed format through their annual report. For instance, dividends paid by BHP to its own shareholders was $11,302 million and $1,205 million to “non-controlling interests.”
This qualitative characteristics helps in identifying the various types of data which are most important for the users and simultaneously applies for both financial information forming the part of the general purpose report along with financial information demonstrated in some different ways (Kruglyak and Shvyreva 2018). Qualitative characteristics states that financial facts are only useful when it is faithfully represented and at the same time relevant. The primary qualitative characteristics are as follows:
Relevance: Relevance is that qualitative characteristics that has the competence of making a transformation to the decision taken by the users of financial information. Thus, relevance states of the capability of financial information that might influence the decisions taken by the users of such financial information owing to presence of either confirmatory value or predictive value or sometimes both. Materiality can be considered as the most important part of relevance and is an entity specific aspect of it. For instance, the profit after tax for 2017 was $6,694 M, $7,744 M in 2018 and $9,520 M in 2019 depicting a constant rise in profit over the years and such financial information have the power to shape the opinion or decision making power of the financial data users.
Faithful representation: Faithful representation is the honest disclosure of economic phenomena in the general purpose financial reports (Thorbecke 2017). The usefulness of the information does not necessarily depend on relevance but also depends upon the faithful representation of such economic and financial information.
Apart from the fundamental qualitative characteristics, the usefulness of information can be enhanced through some more characteristics like variability, comparability, understandability and timeliness. All these qualitative characteristics have been applied by BHP in their financial statements disclosed through annual report on a yearly basis. Here, the independent auditor’s report signed by Michiel Soeting, “Senior Statutory Auditor” KPMG LLP dated 5th September, 2019, signifying an unqualified opinion is a proof of faithful representation by the management of BHP in preparation of financial accounts for the year 2019.
Objective and scope: The main aim and scope of financial statements is to make available various financial information relating to its health to the users of financial information. It provides information relating to the income, expenses, liabilities, assets and equities of the entity which are of prime importance for the users to estimate the future cash flows and taking prudent and effective decisions (Nobes 2014). BHP fulfils the objective and scope as prescribed through published financial statements. For instance, the total equity for the year ended 30th June 2019 is $51,824 million.
Reporting period: All the financial data and facts presented in the form of financial statements are prepared for a definitive period which is mostly a year. Here the financial statements are prepared for the year ended 30th June, 2019.
Adopted perspective: Financial statements are prepared with some underlying assumptions. Thus, it provides all financial information about events and transactions from that perspective. The underlying perspective of BHP is going concern that is continuation of operation in subsequent years. It has a considerable profit margin as discussed above that keep alive the going concern concept.
Reporting entity: The reporting entity is the business entity who formulates the financial statements for the consumers of financial information (Wahlen, Baginski and Bradshaw 2014). It can be a single entity or a combination of more than one entity. Here, the BHP Group is the reporting entity.
Nature of financial statements: A financial statement can be consolidated or unconsolidated. A consolidated financial statements provide more relevant and useful financial statements. BHP Group presents consolidated financial statements of its group as a whole year after year.
Underlying assumptions: According to the IFRS Framework, the underlying assumption of every organization should be going concern that is the presumption of the financial statements is that the organization will continue in near future (van Rensburg, Coetzee and Schmulian 2014). BHP prepares its financial statements as per the underlying assumption of going concern only.
Elements of financial statements: The portraying of financial effects through the financial statements occurs by grouping of financial transactions into broad categories or elements on the basis of their economic characteristics which are as follows:
Elements portraying financial information:
Assets: These are the economic resources in possession of the entity through which future economic benefits are expected to flow in near future. Total assets for 2019 is $100,861 million.
Liabilities: These are the obligations that the entity is liable to pay resulting out of past events and is the reason for which future economic benefits are projected to outflow from the organization. Total liabilities for 2019 is $49,037 million.
Equity: This is the remaining interest in the assets in possession of the organization after meeting all its expenses and obligations. Total equity for 2019 is $51,824 million.
Income: This is the enhancement in economic benefits of the organization resulting out of the sale of goods and services sold. Thus, this is the inflows or enhancement in assets and decrease in liabilities. Total revenue for 2019 is $44,681 million.
Expense: This can be explained as the reduction in economic benefit for the organization resulting in outflow of benefits or reduction in assets volume (Weetman 2019). BHP Group accounted for all these elements in preparation of their financial statements. Total expenses for 2019 is $8,103 million.
Recognition of the elements: Recognition is the incorporation of the identified elements in the income statements and balance sheet as per the prevalent criteria which are reliability in the measurement of cost and the possibility of inflow or outflow of economic benefit to and from the entity.
Asset: It is documented in the balance sheet when there is possible inflow of economic benefits.
Liability: It is documented in in the balance sheet when there is possible future outflow of economic benefits.
Income: It is documented in the income statement when there is a future surge in benefits.
Expenses: It is documented in the income statement when there is a future drop in economic benefits. BHP group has correctly recognized all the above mentioned elements as per the prescribed criteria in their financial statement.
It states of assignment of monetary value upon which the above identified elements are registered and disclosed in their financial statements (Barth 2014). According to the IFRS Framework, there are four recognized measurement bases namely, Historical cost, Current cost, Net realizable value and Present value. However, BHP Group adopted Historical cost through there is no fixed rule for choosing of measurement methods. BHP in their “notes to financial statements” number 11 (pg, 192), clearly mentioned that they record the value of the asset at cost deducted from the impairment charges and accumulated depreciation. Here, they clearly mentioned that “cost” represents the price paid for acquire or build the assets.
Conclusion
Thus from the above study it is evident that conceptual framework portrays a well-designed system of objectives and ideas which result in the formation of a reliable set of standards. BHP Group, which is counted among the top 100 ASX listed companies is being effectively managed and mandatorily abiding by the requirements of the conceptual framework of accounting.
References
Barker, R., Penman, S., Linsmeier, T.J. and Cooper, S., 2017. Moving the conceptual framework forward: Accounting for uncertainty. Contemporary Accounting Research.
Barth, M.E., 2014. Measurement in financial reporting: The need for concepts. Accounting Horizons, 28(2), pp.331-352.
Bauer, A.M., O’Brien, P.C. and Saeed, U., 2014. Reliability makes accounting relevant: a comment on the IASB Conceptual Framework project. Accounting in Europe, 11(2), pp.211-217.
Bhp.com, 2019. Annual Report 2019. [online] Bhp.com. Available at: <https://www.bhp.com/-/media/documents/investors/annual-reports/2019/bhpannualreport2019.pdf> [Accessed 5 May 2020].
Christiaens, J., Vanhee, C., Manes-Rossi, F., Aversano, N. and Van Cauwenberge, P., 2015. The effect of IPSAS on reforming governmental financial reporting: An international comparison. International Review of Administrative Sciences, 81(1), pp.158-177.
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Kruglyak, Z.I. and Shvyreva, O.I., 2018. Improving the Russian regulatory basis for international financial reporting standards-based qualitative characteristics of financial information. Journal of Applied Economic Sciences, 12(8), pp.2325-2338.
Manes Rossi, F., Aversano, N. and Christiaens, J., 2014. IPSASB’s conceptual framework: Coherence with accounting systems in European public administrations. International Journal of Public Administration, 37(8), pp.456-465.
Mora, A. and Walker, M., 2015. The implications of research on accounting conservatism for accounting standard setting. Accounting and Business Research, 45(5), pp.620-650.
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Nobes, C., 2014. International classification of financial reporting. Routledge.
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