1. Explain why principles-based standards require a conceptual framework?
2. Why is it important that the IASB and FASB share a common conceptual framework?
3. It is suggested that several parties can benefit from a conceptual framework. Do you consider that a conceptual framework is more important for some parties than others? Explain your reasoning?
4. What is meant by a ‘cross-cutting’ issue? Suggest some possible examples of cross•cutting issues?
5. What you think is the fundamental problem with financial statements based upon the historic cost measurement principle used under US GAAP?
6. What do you think of the principle’ accounts must reflect economic reality’ as a core principle of measurement in accounting?
7. How would you measure economic reality?
8. What is reliability in accounting?
9. The article states that the US standard setter FASB requires companies to record a provision in relation to environmental costs of retiring an assetif its fair value could be reasonably estimated. How do you think companies would go about estimating such a provision?
10. What aspects of the requirements were used by US companies to defer recognition of a liability?
11. In what ways does the recognition of the liability in relation to future restoration activity affect net profit in the current year and future years; and cash flow in the current and future years?
12. The article refers to changes in disclosure requirements relating to environmental liabilities in many countries around the world. How important is?
In the words of Macve (2015), the conceptual framework could be described as an effort to demonstrate the purpose and nature of accounting. Such type of framework is necessary for principles-based standards, since it lays out a basic structure for the standards. Therefore, with the help of such standard setting and associating the same with a conventional body of objectives and concepts have helped both IASB and FASB in issuing more valuable and reliable standards over time. The framework would help in ensuring that the changes would be within its basic concepts and they would not lead to an inconsistent standard (Zhang & Andrew, 2014).
ACCA has depicted that the availability of a conceptual framework would result in principles-based system, in which the accounting standards are framed from an agreed conceptual bass with specific objectives. In the absence of an effective conceptual framework, the principle-based standards could result in inconsistency for both internal and external users. The internal users consist of the practitioners of accounting, while the external users comprise of the report readers. In addition, absence of conceptual framework could lead to bias on the utilisation of standards and standard settings might misdirect the preparation of financial statements (Saito & Fukui, 2016). Thus, conceptual framework would contribute the future developments of principle-based standards.
The importance of sharing a common conceptual framework for both FASB and IASB is briefly represented as follows:
Beneficial in undertaking economic decisions:
The IASB framework emphasises expediency to different groups of users, particularly the investors providing risk capital. The FASB framework, on the other hand, emphasises efficacy in decision-making on the part of external parties, which lack information related to investment and credit (Cajaiba-Santana, 2014). Thus, adoption of a common framework would help the different accounting users of the organisations in terms of decision-making.
Helpful in evaluating the prospects of cash flow:
Both FASB and IASB frameworks take into account the common interest of the external users of the accounting statements in evaluating the net cash inflows to the organisation. Such evaluation of net cash inflows would help the external users to evaluate the financial position of the organisations. This, in turn, would facilitate the decision-making process of the internal users. In this case, the framework is common and therefore, combining the same into a single framework would enhance the quality of financial reporting of the organisations.
Claims and changes in enterprise resources:
According to the frameworks of IASB and FASB, the above two objectives could be accomplished with the help of information pertaining to organisational resources, their claims and changes. The IASB framework segregates these changes in the form of change in financial position and performance. On the contrary, the FASB framework segregates the changes in the form of comprehensive income and performance along with solvency, liquidity and fund flows (Richardson et al., 2015). However, both the frameworks urge the need for supplementary information and notes. Therefore, the adoption of a single conceptual framework would help the reporting entities and their associated stakeholders in preparing and assessing financial information in an effective manner.
Several parties could be benefitted from a conceptual framework. These parties comprise of the developers of financial reports (accountants), auditors and the external users of the organisation. In this regard, Tracey (2015) stated that the external users include government agencies, employees, customers, investors, lenders, suppliers and financial analysts. The above-stated parties have identical requirements for a conceptual framework and thus, there is no party, which has greater need compared to another. This is because conceptual framework is a method of interconnected goals and fundamentals, which could lead to consistent outcomes.
The preparation of financial reports, reporting, interpretation and evaluation are interconnected with each other. The users of the financial statements make decisions based on the reports prepared along with their detailed analyses. Thus, it needs consistency throughout the phases and such consistency could be accomplished with the help of a conceptual framework.
As commented by Hörisch, Freeman & Schaltegger (2014), cross-cutting issue reflects those areas, which result in conflict between the different standards. One instance associated with the issue of cross-cutting is the fragmentation and internal inconsistency of the conceptual framework. In reality, the prudence and accrual of the going concern and prudence is an example of cross-cutting issue.
However, it is to be noted in accordance with IAS 1, if the operation associated with the concept of accruals is not consistent with prudence, there is greater chance of prevalence of the latter. Despite it is only indirect; the identical prudence override applies consistency and the going concern (Stahl & De Luque, 2014). Therefore, the issues pertaining to cross-cutting need to be addressed, which are probable to offer benefits to the organisations in the short-run. This is because the cross-cutting issues have considerable impact on various agenda projects, which might reduce the business profitability of the organisations to enjoy short-term benefits.
According to Christensen & Nikolaev (2013), historic cost principle is the conventional method of recording costs at the purchase cost. It is based on the assumption that money is a steady measurement unit. Under this method, profit is ascertained by contrasting revenue with the historical asset cost. Hence, in terms of ascertainment of income, the accountants assume that a business is keeping in pace at the time it has managed to recover its initial investment and it has been better, when the business has recovered more than the initial cost. However, the historic cost principle under US GAAP is not adequate for accounting during changes in price level (Shalev, Zhang & Zhang, 2013). Thus, the financial reports developed with the historic cost principle are not free of defects to the degree that:
1.It fails to signify the impact of the changes in price level
2.The disclosure of the assets in the balance sheet statements are made at impracticable values
3.The income statement fails to bear effective charges, especially for the materials consumed (in $) and depreciation
Along with this, the rising rate of inflation has further aggravated the loopholes of the historical cost principle under US GAAP. As a result, there has been under-costing of the products and services, which has led to illusionary paper profit. Due to the inaccurate results of historical cost principle, the US companies following the principle often have to bear higher tax payments, wages and dividends during upward price changes. Thus, the information obtained from the historical cost principle is not adequate due to unrealistic values and distorted reports.
In the words of Palea (2014), the accountants often construct reality, instead of depicting the same. The performance of the organisation and its valuation would be vacant and self-fulfilling tautology. This might be the case, as markets tend to rise due to positive earnings of the firms. This is because of the constant rise in markets, which has resulted in revaluation of assets. However, Liao et al., (2013) argued that there is nothing like truth in accounting, instead, there is stretching of the truth far. Therefore, it is not possible and non-beneficial to depict the reality in a neutral manner.
On the other hand, if the accountants intend to stretch the truth beyond the limit, it might lead to accounting crimes and scandals. Thus, the above-stated principle is an argument associated with relevance. This is because the historical cost principle has been outdated and therefore, it is not pertinent to include it for gauging the economic reality (Qu & Zhang, 2015). It is necessary to consider the markets or projections, which gauge economic reality. This is relevant for effective decision-making. Henceforth, the perceptions could be challenged, since there is only a single system of measurement.
As commented by Fargher & Zhang (2014), economic reality is a slippery concept, which would vary from situation to situation. For instance, valuation relies on the asset attributes, which are measured. These include monetary assets like cash, intangibles that are derived from future cash flows and continued operations and the assets traded in the global markets at market price. Along with this, the change in economic reality is inherent, based on the users demanding the information. In case of investors, the economic reality is associated with future earnings or cash flows. In case of traders, economic reality is the existing selling price of the market, while the same for the manufacturers is the existing purchase price. Finally, in case of the auditors, the historical transactions comprise of economic reality.
In the words of Bischof, Brüggemann & Daske (2014), information could be adjudged as reliable, if a user could rely on the same to be accurate in terms of materiality. In addition, it helps in faithful representation of the information, which it purports to present. Thus, considerable misstatements or omissions in the financial reports might minimise the reliability of information constituted in the same. For instance, a competitor has sued an organisation for damages. If the latter company agrees for a settlement with the competitor, it might negatively influence its financial condition. Thus, non-disclosure of such type of information would result in loss of reliability for the users using the financial reports of the organisation.
The historical costs could be reliable, in case, the mathematical computations are checked. However, the provided case study depicts other interpretations, which include verifiability and precision in contrast to the estimates or market prices (Greenberg et al., 2013). The historical cost accountants interpret verifiability and the market-based accountants interpret reliability for undertaking economic decisions based on individual ontology or global view. Thus, it could be stated that reliability in accounting could be ensured by prudence, faithful representation, completeness, neutrality and “single economic entity concept”.
By taking into account the rising environmental issues and awareness, it has been observed that the global organisations are compelled to consider such issues confronting the individuals and the overall global communities. Hence, it is desirable for the organisations to make particular provisions for identification of these constituents within their business activities. In order to record such activities and present the same effectively to the stakeholders, the accountants of various global organisations need to adopt certain provisions for recording the constituents of environmental liability (Chen, Cho & Patten, 2014).
The provisions formed for environmental liability are associated with the present and future profits and losses of organisations coupled with fair evaluation and finance management of the businesses. The provisions, which are associated with this process, include planning and costing of different processes along with forming provisions based on on-demand performance and guarantees of the organisations (Hallgren & Johansson, 2016). In addition, it has been evaluated that the provisions in this regard are required by taking into account the overall effects of these activities on the profitability of the organisations.
As observed from the case study, the organisations in US are required to follow the standards framed on the part of “US Financial Accounting Board”, which has issued various provisions in 2002 in relation to the realisation of the business environmental liability. In order to comply with this provision, the organisations conducting practices in relations to obligations of asset retirement are needed to set aside environmental liabilities, which are directly related to the eventual asset retirement. Moreover, as per the case study, the environmental liabilities are set aside, in case, the fair asset value could be anticipated effectively. Such formation of provisions has been directed towards the improvement process of environmental liability within the business course. The case study has highlighted that formation and implementation of these policies is necessary for the US firms in developing and establishing their businesses in the nation (Cormier, Lapointe-Antunes & Magnan,
According to the view of Yook et al., (2017), the implementation of measures pertaining to environmental sustainability result in increased cost of the organisation in the initial; phase. Such increased expenses are spent due to enforcement of various measures like reporting of the measures of “corporate social responsibility” in the annual reports of the companies. In addition to this, the shareholders of the organisation are considered as well in relation to the management measures and the activities of “corporate social responsibility”. Since large amount of cost is spent on the enforcement of measures pertaining to environmental sustainability, it is projected that the net income in the present year would reduce due to rise in level of expenditure (Lewis, Walls & Dowell, 2014). On the other hand, Cormier & Magnan (2015) argued that the net income of the organisation would rise, as the goodwill of the organisation is projected to increase sharply in future.
Thus, the completion and implementation of the measures of CSR are considerable in enhancing revenue and profit margin of the organisation due to rise in goodwill value. Coming to the aspects of cash flow statement, it has been evaluated that the initial activities of CSR would raise the expenditure of the organisations, which would move outwards in the beginning. However, the rise of profitability in future would result in favourable movement of cash flow of the organisations in future. Thus, the considerable effects of such practices on cash flow and profit level denote the significance of realisation of environmental liability for the firm.
As advocated by Cho & Patten (2013), environmental liability denotes the obligation on the manufacturers in relation to waste emission in large amount because of the process of manufacturing. Putting differently, it is the amount incurred on the part of an organisation in order to pollute the environment. The rising concerns amongst the various individuals and communities have compelled the management of the organisations to undertake measures for enhancing their performance in relation to environmental sustainability. For enhancing the environmental performance, the policy makers of various firms maintain considerable amount of budget for execution of the measures (Chen, Chen & Patten, 2014).
Along with this, the realisation of environmental liability has been the major CSR source displayed on the part of an organisation. The effective realisation of the process pertaining to environmental liability would help in enhancing the overall goodwill of the firm. Thus, in the current era, it has become mandatory for the business organisations to realise environmental liability within the business processes.
References:
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Cajaiba-Santana, G. (2014). Social innovation: Moving the field forward. A conceptual framework. Technological Forecasting and Social Change, 82, 42-51.
Chen, J. C., Chen, J. C., & Patten, D. M. (2014). Manipulative environmental disclosure: Further analysis of corporate projections of environmental capital spending. Accounting and the Public Interest, 14(1), 87-109.
Chen, J. C., Cho, C. H., & Patten, D. M. (2014). Initiating disclosure of environmental liability information: An empirical analysis of firm choice. Journal of business ethics, 125(4), 681-692.
Cho, C. H., & Patten, D. M. (2013). Green accounting: Reflections from a CSR and environmental disclosure perspective. Critical Perspectives on Accounting, 24(6), 443-447.
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