1)
Financial reporting is an important part of organization that requires standards in preparations for informed financial decisions. Financial statements need to be prepared using generally accepted accounting principles and theories that form conceptual framework basis. Conceptual Framework refers to a system of objectives and ideas that form basis for development of consistent standards and rules in financial reporting (Weil, Schipper, and Francis, 2013). The Conceptual Framework of 2010 amendments is proposed by the International Accounting Standards Board (IASB).
The Conceptual Framework has several roles in financial accounting and financial reporting. First, the conceptual framework was to assist the IASB in developing future International Financial Reporting Standards (IFRS) and reviewing existing IFRSs (Deegan, 2012). Secondly, the Conceptual Framework of 2010 has a role to assist IASB in promoting rules and standards that set nature, functions, and limits of financial statements and financial accounting. The objective was to harmonize accounting standards, regulations, and procedures that enhance the usefulness of financial reports in making economic decisions (Shortridge, and Smith, 2009). Thirdly, the Conceptual Framework of 2010 was to assist financial preparers in developing accounting policies where a transaction has no existing standards. Another role of Conceptual Framework of 2010 was to assist individual countries in developing their national standards for financial reporting. Lastly, the Conceptual Framework was to assist auditors form opinion on financial statements if they comply with IFRS and users of financial reports in interpreting financial information.
The Conceptual framework of 2010 has lead to several benefits in financial reporting. The benefits have been realized by different stakeholders who have interests in the financial reports of companies. These stakeholders include accounting policy makers, investors/shareholders, management, lending institutions, and auditors. One of the benefits of the Conceptual Framework is that it has offered a guideline to formulating accounting policies. It has enabled countries develop national based accounting standards and companies’ board of management develop policies that enhance consistent financial reporting. Secondly, Conceptual Framework has enabled standardization of accounting standards (Deegan, 2012). It has formed basis within which accounting standards are developed enhancing standard financial reporting. Another benefit of Conceptual Framework of 2010 is that it has improved usability of financial reports. It outlines of foundations to be used for developing standards and generally accepted principles of accounting has enabled financial information users to make better and informed financial decisions. Auditors have also benefited has their work was made easier when giving their opinion on financial statements of a company.
The 2010 Conceptual Framework had gaps that caused problems in the accounting conceptual framework. These problems have lead to Conceptual Framework being criticized and has prompted need for it revision. One of the problems with the 2010 Conceptual Framework is that it was not comprehensive. The conceptual framework did not cover or offered little guidance in some areas such as on measurement, disclosure, presentation, or identification of a reporting entity. Another problem is that some of the Conceptual Framework areas were unclear. For instance, some definitions were not well explained and needed clarification.
The Conceptual Framework 2010 was criticized because it failed to capture some aspects that are important in financial reporting. One of the criticisms was that the Conceptual Framework had some aspects that were out of date. These aspects failed to reflect the IASB current thinking. For instance, the Conceptual Framework stated that liability or asset should be recognized in the financial statements only when they are probable that there is economic resources flow (Langmead, and Soroosh, 2009). This is contrary to IABS that states all assets or liabilities should be recognize whether there is economic resource flow or not because they provide useful; financial information for financial decisions.
2)
(a) We all recognized the importance of financial reporting. According to our group, the objective of general purpose financial reporting is to communicate financial performance of an entity within a specific period of time. Financial reports comprehensively show all transactions that an entity undertook in a certain accounting period and their economic resource flow. This means that financial reports do capture all activities and other decisions that are made by a company. For instance, financial reports show acquisition, expenses, and revenues that are as a result of decisions made by management and actions undertaken by employees. Financial reports also outline profit and earnings per share achieved by a company in a financial year. This is important to investors and future investors of the company. From this argument, financial reporting is a communicator and indicator of performance. This means that financial reports have an ability to communicate decisions and activities undertaken in an organization when accurately transactions are accurately recognized, measured, and recorded Van (Greuning, Scott, and Terblanche, 2011). Therefore, the objective of general purpose financial reporting should be communicating an entity performance through financial performance.
(b) We agree with the board decision to change formal description of the objective of financial reporting to include an explicit reference to stewardship. The stewardship objective recognizes the role that the management has to the performance of an entity. The management makes decisions on how resources are allocated hence determining optimization of investment returns in a company. Efficient allocation of resources means that the company will minimize cost and maximize profit. Efficient allocation enhances financial performance of an organization by ensuring expenses are minimal and revenue is maximized. Secondly, stewardship explicit description by the board enhances management assessment in terms of ability to increase wealth of the company. Styles and qualifications of one organization management are different to another organization that affects performance. This entails that different management team are capable of performing better than others. This therefore means that understanding the management is an important aspect to making decisions either to invest or not to invest. The decision to include explicit description of stewardship by the IASB recognize that financial statements are indictors of management accountability, ability to make economic decision and can be used by investors to make decisions on investment (Zimmerman and Yahya-Zadeh, 2011). Therefore, we agree with the board decision to change the formal description of the objective and include stewardship because it is in line with the board mission of providing useful information to financial information users.
3)
Prudence in accounting is recognizing future losses but not gain. Prudence is an accounting principle that is conservative and aim to underestimate gains and overestimate losses. The ideas of prudence put forward that it safe to overestimate losses and underestimate gains for the purpose of management. The management is able to make better financial decisions when they overestimate spending and losses than when they are underestimated (M?ciuc?, Hlaciuc, and Ursache, 2015). On the other side, the management prefers to underestimate assets and income than overestimate them realize the actual value is below estimate in a future date. Therefore, prudence is an idea of “playing safe” when recording financial amount while anticipating future uncertainty of the actual value.
Asymmetrically prudent leads to understatement of an entity’s income in one accounting period but leads to overstatement in future accounting periods. Asymmetric prudence recognizes losses earlier than gains. This principle put forward that losses are included in the current financial statements while gains are recognized in a future date (Beest, Braam, and Boelens, 2009). The anticipated losses are then recognized early in the current financial year reducing the current income that lead to understatement. The recognition of gains in a future gain after they were earned in a previous accounting period leads to overstatement of an entity’s income in the following year (Weygandt et al., 2010). Therefore, applying asymmetric prudence to record uncertainty leads to understatement of the current financial year income and overstatement of income in the future financial periods.
We agree with the board decision to reintroduce prudence in the Conceptual Framework. Prudence concept will ensure no estimates done on revenues are overestimated or expenses underestimated in financial statements (Kieso, Weygandt, and Warfield, 2010). This means that revenue transactions or assets will be recorded when an entity is certain while expense transactions or liabilities will be recorded when it probable. The concept will ensure profits are not recognized until the transaction is certain. We agree that prudence concept is useful for making decisions that are under uncertain conditions. The prudence concept removes false optimism to users of financial information. The concept ensures that no gains are recognized in the financial statement that the company is not certain and recognize all expenses that are uncertain. This makes the financial information to be very conservative representing the financial pessimistic performance for an entity (Pronobis and Zülch, 2010). Prudence concept therefore considers the aspect of risk when reporting financial information. Risk is important to financial information n users who use on financial statement to make informed decisions (M?ciuc?, Hlaciuc, and Ursache, 2015). Therefore, we agree with the board decision to reintroduce prudence because it considers uncertainty when recording financial information that enable financial information users to be more informed when making financial decisions.
4)
Substance of over form concept is an accounting principle that is used when preparing financial statements by ensuring they are accurate, relevant and complete reality of transactions and events. This means that financial statements shows overall financial realty rather than legal for of an event or transaction. The substance over form principle requires financial statements and disclosures of an entity to reflect underlying accounting transactions. The financial statements should not just comply with legal forms as they appear. The substance over form therefore means that transactions are recorded when they have financial or economic impact to an entity and not necessary when they have legal form. The concept aim is to ensure no information is withheld or introduced in financial statement with legal form without an accounting transaction that can mislead users of financial information (Schroeder, Clark, and Cathey, 2011). For example, a company can create bills and have paperwork for a customer whose products have not been exchange. In this case the paperwork legitimizes the process but the product have not been transacted thereby the transaction cannot be recorded because no accounting transaction has taken place. Another example is where a company can acquire a lease property without legal documents. In this case the transaction will be recognized in the financial statements because there is an accounting transaction (financial realty) that is involved in the event.
We agree with the board on the decisions to state that faithful representation of a transaction represents substance of an economic phenomenon instead of legal form. Faithful presentation ensures all financial realities in an entity are recorded. Legal form can exist in paperwork without affecting an entity financial reality. This means that only faithful representation has economic phenomenon and should be recognized in financial statements. Substance over form principle ensures the conceptual framework capture the economic reality of a transaction instead of legal write-up that can cause misstatements (Power, 2010). The board decision will therefore enhance completeness, accuracy, and relevancy of financial information prepared. The users of financial information will make better informed decisions using financial statement prepared in compliance with IFRS standards. They will be able to get the true financial position of a company before they make a financial decision. Therefore, we agree with substance over form concept being stated by the board because it will enhance the reliability of financial information.
References:
Beest, F.V., Braam, G.J.M. and Boelens, S., 2009. Quality of Financial Reporting: measuring qualitative characteristics.
Deegan, C., 2012. Australian financial accounting. McGraw-Hill Education Australia.
Kieso, D.E., Weygandt, J.J. and Warfield, T.D., 2010. Intermediate accounting: IFRS edition (Vol. 2). John Wiley & Sons.
Langmead, J.M. and Soroosh, J., 2009. International financial reporting standards: The road ahead. The CPA Journal, 79(3), p.16.
M?ciuc?, G., Hlaciuc, E. and Ursache, A., 2015. The role of prudence in financial reporting: IFRS versus Directive 34. Procedia Economics and Finance, 32, pp.738-744.
Pronobis, P. and Zülch, H., 2010. The predictive power of comprehensive income and its individual components under IFRS.
Power, M., 2010. Fair value accounting, financial economics and the transformation of reliability. Accounting and Business Research, 40(3), pp.197-210.
Shortridge, R.T. and Smith, P.A., 2009. Understanding the changes in accounting thought. Research in accounting regulation, 21(1), pp.11-18.
Schroeder, R.G., Clark, M.W. and Cathey, J.M., 2011. Financial accounting theory and analysis: text and cases. John Wiley and Sons.
Van Greuning, H., Scott, D. and Terblanche, S., 2011. International financial reporting standards: a practical guide. World Bank Publications.
Weygandt, J.J., Kimmel, P.D., Kieso, D. and Elias, R.Z., 2010. Accounting principles. Issues in Accounting Education, 25(1), pp.179-180.
Weil, R.L., Schipper, K. and Francis, J., 2013. Financial accounting: an introduction to concepts, methods and uses. Cengage Learning.
Zimmerman, J.L. and Yahya-Zadeh, M., 2011. Accounting for decision making and control. Issues in Accounting Education, 26(1), pp.258-259.
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