Discuss about the The Routledge Companion to Financial Accounting Theory.
Reason for Principles-based standards requiring a conceptual framework
The FASB (Financial Accounting Standards Board) and IASB (International Accounting Standards Board) holds the responsibility of establishing accounting standards for financial accounting and reporting. The FASB and IASB are sharing a common goal for developing accounting standards to be principles-based. The current accounting standards are mainly based on conventions and thus there exist a requirement of financial accounting standards to be based on fundamental accounting concepts and principles. The accounting standards of FASB and IASB are currently based on a set of rules and conventions in order to enhance accuracy and reducing ambiguity in the preparation of financial statements. On the other hand, principles-based accounting standards are based mainly on generally accepted accounting principles (GAAP) that will provide a conceptual basis for accountants in financial reporting. There is a wide debate on the current accounting standards of IASB and FASB to be based on principles based or rules-based (Camfferman and Zeff, 2015).
The current objective of FASB and IASB is to develop conceptual framework for accounting that are principles-based to ensure good financial reporting. The main advantage of principles-based accounting to be used in conceptual framework is that accounting reporting guidelines are practically based to aid accountants for ensuring good reporting. The principles-based accounting standards will help in ensuring that financial statements prepared are reliable and publish consistent information to be used in decision-making. Thus, the conceptual framework of the board should be based on body of principles that guides the accounting and reporting standards (Wolk, 2008).
Importance of IASB and FASB sharing a common conceptual framework
IASB and FASB should share a common conceptual framework for refinement, updating, completing and converging IASB and FASB accounting standards. The conceptual framework of IASB and FASB were established in the 1970’s and 1980’s and therefore requires refinement and updation. The FASB and IASB are recently aiming to converge their accounting standards for overcoming the difficulties that can arise if the decisions are based on different frameworks. The convergence of accounting standards would help in establishing clear and appropriate accounting principles that helps in developing accurate financial statements (Epstein, 2009). The IASB and FASB are presently undertaking a common project for developing an improved conceptual framework that is based on common standards for removing inconsistency in financial reporting. The convergence of IASB and FASB will help in new accounting standards that are based on generally accepted accounting principles in order to enhance reliability and transparency of financial reporting. Also, the convergence will aid in updating the conceptual framework so that financial information presented to the stakeholders is helpful in analysing and examining the financial stability of a firm (Epstein, 2009).
The IASB and FASB have initiated a joint project with the main agenda of converge their accounting standards to remove inconsistency existing in financial accounting reporting standards. The business organisations around the world would gain large benefit from convergence of IASB and FASB accounting standards as there will be less ambiguity in reporting standards to be followed while developing financial statements. The reliability of financial statements developed by businesses around the world would increase in case of following one universally accepted accounting standard. The accounting representations of business organisations around the world will be more complete, neutral and error-free. The faithful representation of the accounting information to the stakeholders would increase with the convergence of IASB and FASB accounting rules and principles (Macve, 2015).
Conceptual Framework is more important to some parties than others
The primary purpose of the conceptual framework is to assist the preparation and presentation of financial reports by business organisations around the world. The International Accounting Standards Board (IASB) have stated that the main purpose of the conceptual framework is to aid IASB in develop accounting standards that will be used by businesses worldwide in accounting and financial reporting. The IASB develop accounting policies from the guidelines of revised conceptual framework that helps in understanding and interpretation of financial statements prepared by businesses across the world. The revised conceptual framework also assists several parties other than IASB in providing better understanding of the accounting policies and standards (Stolowy and Lebas, 2006).
The most important user of the conceptual framework is IASB as it consistently uses its concepts in developing and revisiting accounting standards. However, some parties other than IASB also gain the help of conceptual framework in developing an understanding of the accounting standards and policies. This is because conceptual framework provides a basic understanding and interpretation of the accounting policies used in developing of financial statements. For examples, auditors and regulators uses conceptual framework at the time of decision-making during reviewing the financial statements of business organisations. The IFRS committee also gains the help of conceptual framework guidelines for developing an understanding of the financial statements. Thus, it can be stated that several parties uses conceptual framework guidelines but it is more important to IASB than other parties (Mazhambe, 2014).
Cross-Cutting Issue and its examples
The cross-cutting issue in accounting refers to take into account uncertainty during the measurement of an asset or liability. The uncertainty arises when as asset or liability is assessed by analysing future cash flows or when future cash flows are uncertain. The conceptual framework presents the guidelines on use of cash flow information in order to provide fair value of an asset or liability during preparation of financial reports. The possible example of cross-cutting issue is measuring the unit of account. This refers whether the items should be measured in aggregation or individually. Other example of cross-cutting issue includes accounting of direct acquisition costs as an asset in insurance industry. However, the U.S. has introduced changes about the type of costs to be included as asset and that to be included as expenditure. The accounting of acquisitions costs is a major cross-cutting issue for the insurers as they incur a huge cost in acquiring and originating insurance contracts. Thus, there is high debate over the accounting of acquisition costs so that it can be recovered during cash flows. The most important point of discussion in accounting of acquisition costs its meeting the criteria of an asset (Camfferman and Zeff, 2015).
Fundamental problem with financial statements based upon historic cost measurement principle under US GAAP
Historic cost in accounting refers to the value of an asset based on its initial cost at the time of its purchase. The historic cost of an asset denotes its price on the balance sheet that is entirely based on its nominal or original cost. The method of historic costing is used mainly in generally accepted accounting principles (GAAP). The historic cost method of accounting does not take into account inflated adjusted market value and only record an asset based on its initial purchase price. This method of accounting has been criticised by accountants over a period of time as it does not reflect the present market value of an asset. The main problem with financial statements that are based on historic cost measurement principle under US GAAP is that it does not depict any change in market value of an asset over a period of time. Thus, the financial statements prepared with the use of historic accounting method have a major problem of lack of relevance. The financial statements cannot predict the relevant information about the future growth and profitability of an enterprise though the use of historic cost measurement principle. The investors cannot analyse and examine the real financial condition of an enterprise through the use of historic cost accounting as the assets are valued on past values under this method. Thus, the method of historic cost accounting though being a simplistic accounting method is not very useful as the financial information depicted is not reliable for the end-users (Jones, 2015).
Analysis of principle ‘accounts must reflect economic reality’ as a core principle of measurement in accounting
The financial reporting of business organisations must faithfully present economic reality in order to safeguard the interest of stakeholders. The introduction of a principle-based system will help in developing financial reports that truly present the economic reality of the business transactions. In this context, it is essential that financial statements should be prepared through the use of fair value accounting method rather than historic cost measurement principle. The core principle of measurement in accounting should be based on reflecting economic reality so that financial reports reflect the true financial condition of an organisation to the end-users. The auditors, investors and all the stakeholders can gain clear information about the market reality with the use of such an accounting principle. The use of principle-based accounting standards will truly represent the economics of transaction and thus help in tracking a real interpretation of economic reality. The true and faithful presentation of the economic information through financial reporting would also help in sound judgement taken by management for improving the financial condition of the organisation. Thus, the principle’ accounts must reflect economic reality’ as a core principle of measurement in accounting should be used in order to depict the real economic condition of an organisation through financial reporting (Greenberg, 2013).
Measuring Economic Reality
Economic reality plays a highly important role in establishing of accounting standards and practices. The IASB and FASB are presently sharing a common goal of revising the conceptual framework for updating and revisiting the accounting standards and policies. In this context, the main objective of FASB and IASB is to incorporate the use of principles-based accounting standards in conceptual framework. The establishment of principle-based accounting standards will promote faithful presentation of economic reality in accounting and financial reporting. The economic reality can be measured through the use of fair value accounting method under GAAP by the IASB and FASB (Mazhambe, 2014). The fair value method of accounting reflects the true market value of an asset and thus helps the end-users to develop an in-depth understanding of the economic condition of financial market. The fair value accounting method will provide a clear display of the actual volatility in the market and thus providing a better understanding of the economic transactions to the investors and auditors. The establishment of principles-based accounting standards that incorporates the use of fair value measurement principle would promote transparent disclosure of financial information to the end-users. Also, it would help in developing the confidence of investors in financial reports through the depiction of actual economic condition of an organisation and thus promoting its future growth and profitability (Jones, 2015).
Reliability in Accounting
Reliability in accounting refers to presentation of verified and consistent financial information to the end-users that is free from any error. The reliability principle of accounting states that financial statements should present true, reliable and relevant financial information to the stakeholders of an organisation. The principle in accounting states that only those accounting transactions should be recorded in the accounting system that can be verified completely with the objective evidence. The financial information presented through financial reporting is believed to be materially accurate if it truly represents the economic condition of an organisation. Thus, reliability in accounting usually refers to trustworthiness of the financial statements. The accounting reliability means that financial information presented to the end-users consistently provide the same financial outcomes (Maali and Jaara, 2014). The principal of reliability in accounting is mainly introduced with the objective of reduction of errors and omitting misstatements of financial information presented before the investors and creditors. In addition to this, the principle of reliability in accounting also refers that financial information presented to the end-users can be verified with objective evidence. The most common example of objective evidence includes purchase receipts, cancelled cheques and bank statements. The financial information published in financial reports must be error-free and accurate so that it serves the purpose with which it is has been developed (Maali and Jaara, 2014).
Companies should record a provision in relation to environment costs of retiring an asset as per the US standard setter
The business organisations operating in the U.S. are currently facing environmental legislation for minimising the environmental damage done by the companies. Business operating in the U.S. is expected to maintain environmental compliance for ensuring environment protection. In this context, the US standard setter FASB has adopted a provision in relation to environmental costs of retiring an asset for reserving environmental liabilities if its fair value can be reasonably estimated. The major difficulty faced by the businesses regarding estimating an accounting provision is recognition of environmental liabilities. The environment liabilities presents difficulty in financial reporting due to uncertainties associated with it in the nature of contingencies (Uzochukwu, et al., 2009). The difficulty in assessing a fair market value of the environment liability caused the business organisations to postpone the recognition of their environmental liability. However, later FASB has implemented strict litigation for the business organisations to reserve for environment liabilities even in the condition of uncertainty. For example, an asbestos-contaminated factory is required to have sufficient reserves for covering the environmental damage that can occur due to asbestos. Companies have to incur huge cost for achieving environmental compliance as they have to display millions of dollars in their income statements for covering environment liabilities. Thus, companies have to estimate the provision relating to environment liabilities by taking into account adequate reserves for covering the environment damage (Wolk, 2008).
Requirements for US companies to defer recognition of a liability
The US companies defer their liability in relation to recognition of an environment liability by mothballing a contaminated property. The FASB has issued provisions in the year 2002 for accounting environment liabilities in relation to the retirement of an asset if its market value can be reasonably estimated. The conditional nature of estimating a fair market value of assets being retired from service has caused the businesses to defer their liability indefinitely by taking proper reserves against a contaminated property. The retirement of assets such as manufacturing facilities or parts of facilities in business organisations requires to be taken into account as environment liability. Thus, the main requirement for US companies to defer recognition of a liability is that fair value of a retiring asset should be estimated properly (Stolowy and Lebas, 2006).
Impact of recognition of a liability in relation to future restoration activity on
Net Profit in current and future years
The recognition of an environment liability requires business organisations to take proper reserves for minimising the environmental damage that can occur in the future. Thus, as per the litigation implemented by the FASB business organisations have to incur million of dollars for restoring environmental damage that can occur with the recognition of a liability in future. Thus, net profit for the current year is negatively impacted with huge expenditure of a business corporation in deferring an environment liability. However, the business organisations after taking into account adequate reserves against an environmental liability can minimise the occurrence of a contingency condition. Thus, the future net profit is expected to increase with the implementation of proper measures for restoring environment damage in a business corporation (Wolk, 2008).
Cash flow in the current and future years
As discussed above, the net profit in the current year will decrease with the recognition of an environmental liability as companies have to incur high cost for maintain adequate reserves against the recognised liability. The reduction in net profit is estimated to decrease the present cash flow position of the current year. On the other hand, future cash flows is expected to increase with the rise in net profit in future years.
Importance of companies recognising environment liability and extent of disclosure being liability sufficient
The environment legislation has proliferated at the federal, state and local levels with the increase of environment damage caused by business operations. Businesses worldwide now have to obtain environmental compliance for ensuring environment protection by their operational activities. The companies must recognise their environment liability for addressing the issues relating to environmental protection and thus protecting it from any damage that can occur due to release of hazardous substances into the environment (Rogers, 2005). The recognition of an environmental liability is important so that companies can take into account adequate reserves for covering the environmental damage. It is important for companies to identify environment liability for minimising the occurrence of a future contingency that can negatively impact its sustainability and growth (Uzochukwu, et al., 2009).
The recognition of environment liability will also help business companies to take into consideration the environment hazards associated with its operational activities. Thus, the business companies can take measures in advance that will help in missing the chances of occurrence of environmental hazards and thus ensuring environment protection. The proper accounting of environment liability also help business companies to promote their goodwill in the international market and thus increasing brand awareness. The recognition of an environment liability is not easy due to unknown damage associated with it. The business companies should therefore maintain proper financial reserves for environment liabilities so that environment hazards can be prevented from the occurrence. The FASB has also implemented litigation that business companies should follow in order to safeguard environment protection from their operational activities. In addition to this, the business organisations should also comply with the environmental laws and regulations in order to safeguard from any environment damage. The disclosure about the environment liability is sufficient to an extent for business companies that its fair value is estimated in the income statement of a company (Uzochukwu, et al., 2009).
References
Camfferman, K. and Zeff, S.A. 2015. Aiming for Global Accounting Standards: The International Accounting Standards Board, 2001-2011. OUP Oxford.
Epstein, B.J. 2009. Wiley GAAP 2010: Interpretation and Application of Generally Accepted Accounting Principles. John Wiley & Sons.
Greenberg, M. 2013. Fair Value Accounting, Historical Cost Accounting, and Systemic Risk: Policy Issues and Options for Strengthening Valuation and Reducing Risk. Rand Corporation.
Jones, S. 2015. The Routledge Companion to Financial Accounting Theory. Routledge.
Maali, B. and Jaara, O. 2014. Reality and Accounting: The Case for Interpretive Accounting Research. International Journal of Accounting and Financial Reporting 4(1), 155-168.
Macve, R. 2015. A Conceptual Framework for Financial Accounting and Reporting: Vision, Tool, Or Threat? Routledge.
Mazhambe, Z. 2014. Review of International Accounting Standards Board (IASB) Proposed New Conceptual Framework. Journal of Modern Accounting and Auditing 10 (8), 835-845.
Rogers, G. 2005. Financial Reporting of Environmental Liabilities and Risks after Sarbanes-Oxley. John Wiley & Sons.
Stolowy, H. and Lebas, M. 2006. Financial Accounting and Reporting: A Global Perspective. Cengage Learning EMEA.
Unegbu, A. O. 2014. Theories of Accounting: Evolution & Developments, Income Determination and Diversities in Use. Research Journal of Finance and Accounting 5 (19), 1-15.
Uzochukwu, G. et al. 2009. Proceedings of the 2007 National Conference on Environmental Science and Technology. Springer Science & Business Media.
Whittington, G. 2008. Fair Value and the IASB/FASB Conceptual Framework Project: An Alternative View. ABACUS 44 (2), 139-168.
Wolk, H. I. 2008. Accounting Theory: Conceptual Issues in a Political and Economic Environment. SAGE.
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