International Current Development In Accounting Thoughts

Qualitative characteristics in financial information

Discuss about the International Current Development in Accounting Thoughts.

Financial information is regarded as a tool and financial report should contain all information that should be used by all that is professional and nonprofessional as well. However, some of the relevant information should not be excluded from financial reporting because of its difficulty for someone to understand it. Neutrality and representational faithfulness is regarded as qualitative characteristics that should be contained in financial information as identified by conceptual framework (Barker & McGeachin, 2015).

Representational faithfulness exist when there is an agreement between a description and the phenomenon purports to represents. This can be explained with the help of an example, if we assume that inventory items in balance sheet of any company is viewed by external users to represents items intended for sale in business ordinary course. However, inventories consist of machinery for producing inventory; it results in lacking faithful representation. On the other hand, neutrality relates to parties who are potentially affected. Establishments of accounting standards are highly related to neutrality factor. Any financial information faces difficulty in balancing neutrality and representational faithfulness (Bauer et al., 2014).

Financial information is regarded as representationally faithful if it is representing what it purports to represents. Any information cannot be regarded as completely neutral as measurement error is reported in information’s because of many circumstances and events leading to errors. Estimates of good faith sometimes turn out to be too high and sometimes too be too low. Nonetheless, it is expected that such measurement errors can cancel out each other. Accounting discretion available to managers in reporting and making accounting estimates and leading to error of measurement (Beerbaum & Piechocki, 2016).

For example, it is required by managers to estimate the parameters of depreciation, accounts receivable collectability, liability for benefits of postretirements. In this regard, it is quite possible that estimates recognized by managers will be biased for enabling the company in appearing more profitable to external parties or less risky to stakeholders. This is done for their personal gain. It can happen that managers would understate the amount of receivables managers. It would be ultimately uncollectible. This would results in understating amount of bad debt and thereby overstating earnings. Concerning this scenario, it can be regarded financial information cannot be completely neutral (Choi et al., 2013).

The standard setter requires financial information to be representationally faithful, reliable and neutral. Standard setting based on personal conceptual framework leads to different conclusions about identical issues. Rulemaking of the financial information concerning neutrality has come under increasing attack. It is argued by some people that standard setter should not issue pronouncements, which causes undesirable economic effects on company. Process of standard setting must be free from bias or else there would not be credential financial statements. Referring to qualitative characteristic such as Faithful representation would enhance decision usefulness of financial reporting information (Gordon & Street, 2013). If an economic phenomenon is faithfully represented in any financial information, the economic substances of underlying transactions would be easily depicted and it might not be always same as legal form. There can be multiple ways to represent a single economic phenomenon. It can be explained with the help of an example. Risk estimate transferred in an insurance contract would be depicted quantitatively or qualitatively. Moreover, a depiction of single economic phenomenon would represents a multiple economic phenomenon. An item such as plant and equipment in financial statement might represents an aggregate figure of all of plant and equipment of any entity. Attaining faithful representation sometimes are necessary for explicitly disclosing uncertainty degree in reported financial information (Deegan, 2013).

Neutrality and Representational Faithfulness

A financial information that has total freedom from error would imply faithful representation as most of financial reporting measures makes the estimation of several types of judgment of incorporate management. Neutral information makes the reporting of economic activity as faithfully as possible and it does not color the image it is communicating for influencing behavior in any particular direction (Hashim et al., 2015).

Standard setter views that conceptual framework criterion in terms of accounting information qualitative characteristics is better than other bases of measurement. Allocation or methods of measurement are considered reliable if the measures presented results in representational faithfulness that is of lower degree. Faithful representation helps in depiction of any particular transaction that is considered reliable and verifiable. One of the new concept introduced in revised framework is verifiability and the financial information is considered verifiable as it enables independent observers and knowledgeable to reach a consensus of depicting any particular event as faithful transaction. It is regarded by standard setter that information must be representationally faithful within the conceptual framework, as it would provide the users with more relevant financial information (Harmon & Ntseh, 2016).

Historical cost requires all the financial statement to be based on original cost. Financial statements that are prepared under the historical cost accounting suffers from several limitations:

Changes in price level are not considered- Under historical accounting, changes in money value resulting from changes in general level of price are not accounted for. This results in failure of organization to give a fair and true of its state of affairs. The main criticism of this approach is its resultant flaws during inflation. Historical accounting test validity relies on assumption that currency remains stable. This traditional accounting principle records the assets at historical price and such figures are used throughout life of assets. Approach is regarded as faithful representation. Provision for depreciation is not sufficient- under this method, depreciation is not charged at the price at which the assets are acquired, and rather it is charged based on historical cost of fixed assets. For the replacement of assets, provision made by way of depreciation charged on fixed assets are not sufficient (Müller, 2014).

Historical cost accounting is based on certain and fixed inputs and the uncertainty of the initial value decision is eliminated, there arises uncertainty about the true asset value in the future period. This measure of accounting is backward looking and it does not reflect fluctuation in the market or transient volatility not does it considers appreciation over time. This is so because it does not adjust book value of assets.

Valuation done using historical cost accounting sometimes become misleading. This happens when asset impairment reflecting non-temporary credit problems has been inaccurate and when assumptions are violated. The conventional method of accounting does not make any provision for changes in purchasing power (Warren, 2016).

Historical cost accounting are regarded as most popular method of accounting measurement because of its very nature. This approach has the advantage of being less responsive to liquidity shocks; it is not exposed to volatility. It is les dependent on assumptions and is less vulnerable to speculative run up in price of assets. It is because of all these reasons, some of particularly useful information in pricing of asset of going concern are provided using this approach. This approach is considered suitable for purpose of making economic decisions. Election and evaluation of decision rules are affected using historical cost (Whittington, 2014). Many different context involves the application of historical cost such as cost plus contracts and taxable income. This method provides a satisfaction notion in the process of decision-making. Since the past price and requires forecasting of future price, this particular method serve basis of such forecasting.

Standard setting and Faithful representation

Objectivity is one of the main advantage of historical cost accounting and there is no room for manipulation. Any other method of recording accounting transactions would be less objective because the amount to be recorded depends upon individual point of view and it varies from different people. When compared to other method of recording transactions, this method is regarded as cheaper and easier way of evaluation. This is so because, the original cost cannot be amended, it already exist, and it can be easily determined and verified. Therefore, using this approach would requires less estimation in recording data by accountants and becomes easier for auditors for making inspection subsequently (). This method is regarded beyond dispute and is verifiable.

As examined by framework of International accounting standards board, one of the key characteristics of financial reporting is reliability. As compared to other method of accounting such as fair value, historical cost is more reliably determined. This approach gives the assurance that users would not be provided with excess benefits. Assets are subjected to revaluation and this method is compromised by need to restate carrying value of assets in an economy of changing price level.

For the purpose of control, historical cost is considered useful- Accounting objective is seen as the evolving concerning stewardship function of management in conventional accounting. In this context, income is regarded as the main function and managers are required to give accounts to equity holders. For the accountability purpose, past transactions records are considered essential.

Historical cost accounting survives test of time- This approach is capable of surviving test of time. It is believed by most accountants that accounting constitutes a determinant of price, is useful and is regarded as thought pattern of decision makers. It is stated by (Nicoleta & Victor, 2014) that status of accounting today is because of businesspersons and not because of accountant’s desire.

Convention of historical cost is with the goal of Board and accounting purpose charged primarily with reporting past financial transactions of business and accurate recording. Primary purpose of accounting deals with only recoding the past facts and stakeholders for evaluation purpose use financial reports of an organization (Rosa, 2014).

Base measurement should be done using historical cost, as current valuation of manufacturing plant of company seems to be more relevant at original costs. It provides useful cash flow information and valuation is result of exchange between two independent parties. Such agreement on exchange value is highly verifiable and objective.

Measurement of financial information concerns with selection of measurement for liabilities and assets presented on financial position statement. One of the best way for maximizing information for credit and investment decisions is to select measurements for liabilities and assets that faithfully represents wealth of reporting entity. Considering the information that would result in statements selecting particular basis of measurement is done to maximize information for credit and investment decisions (Rivera et al., 2014).

It is believed by the international accounting standard board that investors, other lenders and creditors forms the basis of relevance of particular measurement and the likelihood of assessing how a liability or assets would contribute to future cash flow of reporting entity. The way financial statement users assess the prospects for future net cash flow of reporting entity is affected by the way liabilities and assets would contribute to future cash flow. Such depiction may not provide information useful for assessing future cash flow concepts. Measurement basis selected by IASB comes with number of tentative decisions (Pacter, 2017). For the assessment of decision usefulness of measurement concepts, respondents makes a differentiation between different groups of liabilities and assets. For non-operating and liquid assets, users’ regards market based fair value as the most important measurement concept of decision usefulness. Professional investors do not regard fair value investment as a measurement concept having a homogenous impact on decision usefulness (Nicoleta & Victor, 2014).

Limitations of Historical Cost Accounting

IASB needs to consider the information that will be produce in statement of financial statement while selecting measurement basis. A free choice between two accounting practices is provided by IRFS for non-financial assets. Selection of choice between two accounting policies is analyzed from the perspective of economic cost benefit. When considering the benefit side, fair value is preferred to historical cost accounting. An asset under historical cost accounting is measured at the cost of acquiring it and this provides a reliable basis of measurement. However, there is an obvious disadvantage of this method (Nobes, 2015). If the objective of measuring the assets is to reflect the economic benefit, there is a decline in relevance of historical cost and if there is a change in price subsequent to assets acquisition. It is possible in some cases that the transaction is not taking place at market price and the current economic benefit conferred by asset might not be reflected. Measurement arising from acquisition transactions is not amended by historical costs. As opportunity and piece change and time passes, historical costs losses its relevance. Identical assets having different amounts and of same entity is measured by historical costs. As a result of this, the measurement of economic benefits of assets are not conferred on a comparable or timely basis using this method.

Nonetheless, for fair value, there are several plausible alternatives. The relevant costs and benefits of those alternatives is necessary for making criteria between them. Current value in each regard rather than measuring the historical attribute of assets measures the current value and gain or losses in current value are unrealized and on other hand, the measurement arising from transactions of acquisition of measurement is not amended by historical costs. Economic substance seems to be better captured in fair value and historical cost seemed to be an inappropriate measure. However, the critics of fair value believes that it involves more subjectivity and estimation than some alternative measures (Harmon & Ntseh, 2016).

Under regime of fair value, the assets are recorded at the current transaction price. In literature, IASB has deeply embedded the use of fair value and there is a growing call to use this method in the financial reporting. Conceptual framework is demonstrable for fair value and it will be underpinned in revised framework. As the time passes, auditors, users would be comfortable using the fair value.

The two methods of accounting policies are at the end of the accounting spectrum and historical cost accounting requires regular and partial updating. On the other hand, there is a requirement of updating of all variables in fair value. Historical cost accounting also comes with subjectivity and it becomes more pronounced when an asset are deemed to be impaired and an estimation in value is required to be made. Estimation is based on the future cash flow estimates of management. Due to steep cliff effects, there can be interruption in historical cost stability. For a very long time, the creeping effect of balance sheet may become unseen, as the updates of measurement are comprehensive and less frequent. In this regard, there is a serious convulsion of stability of historical costs. For maintaining relevance of historical; cost, it needs a degree of current measurement and historical costs to some extent is based on fair value. Historical cost accounting comes with several shortcomings and despite of this, IASB has not opted for using fair value in particular or current value in general as a default basis of measurement (Hoffman, 2016).

Nevertheless, it is regarded that for many economic activities using fair value of measurement would not generate relevant information. Reason is that the current market price of assets would not be of primary importance if it were used in combination with other assets for producing any services or goods. It can be concluded that IASB was not wise in expressing general preference for fair value on one hand and historical cost for current measurement on other.

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