Advanced financial accounting - Essay Example

?Advanced Financial Accounting Table of Contents Introduction 3 Development of IASB proposals 4 Criticism and comment on IASB proposal for financial framework 9 Difference of IASB with ASB statements and implication of financial reporting 12 Conclusion 14 Reference 15 Bibliography 17 Introduction With increasing rate of globalisation, it is quite essential to introduce required changes in the accounting practices and standards to incorporate international uniformity. Until mid of 2006, different nations had enjoyed the freedom to use distinctive financial accounting standards that best suits the requirement of their local stakeholders. However, with businesses becoming international, the distinction between domestic and foreign stakeholders should be resolved. This can only be possible if uniformity can be introduced in existing accounting standard. Considering such requirement, International Accounting Standards Board (IASB) and Financial Accounting Standards Boards (FASB) had decided to develop a commonly conceptual framework for financial reporting. These two organisations worked hand in hand to develop the discussion paper. In May 2006, they issued the discussion paper as Preliminary Views on an improved Conceptual Framework for Financial Reporting: The Objective of Financial Reporting and Qualitative Characteristics of Decision-useful Financial Reporting Information. The board (IASB & FASB) asked people to provide their suggestion about the conceptual framework. Initially people resisted this proposal because the approach of UK and US financial standards are different from each other. Both these have a different definitional for stewardship. In the given proposal, the concept of stewardship has given second priority that disturbed the investors’ confidence. Considering the response received from different organisations and people, the board (IASB and FASB). After considering the response received from the investors and other bodies, board has published an improved Conceptual Framework for Financial Reporting in form of exposure draft. This draft covers the objectives as well as the qualitative characteristics of financial reporting information. The final version of both Chapter 1 and 2 was formulated by September 2010 and it got finally published in November 2010. While publishing the final version, board has also published the feedback received on exposure draft. In the given easy, the development of proposal given by IASB will be discussed in further details. The responses received by this proposal will also be discussed so that one can understand how and why people criticised the proposal when it was offered by the board. For better understanding, it will be compared with ASB Statement of Principles (1999) to determine what will be the implication of the changes on different stakeholders in US as well as in UK. Development of IASB proposals After considering the changing global business environment, in October 2004, International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) decided to jointly develop a conceptual framework that will be based on existing IASB framework as well as FASB Conceptual Framework (International Accounting Standards Board-a, 2006, p.8). As per the plan, the project would focus on concepts that are applicable on business entities operating in the private sector. The plan was to expend the proposal to cover other sectors such as ‘not for profit organisation’ operating in the private sector. The project was to be executed in two segments, at first the board was supposed to develop convergence in the conceptual framework and improving areas like “objectives, qualitative characteristics, elements, recognition, and measurement” associated with the framework. In the second half, priority would be given to issues that should yield short term benefit to the board. The board decided to formulate and to present the finding in a summarised manner for further discussion (Deloitte Global Services Limited, 2010, “Background”). The project at first took into consideration the objective of financial reporting. The major question was whether the objective of financial reporting should be to provide financial information to wide range of users or it should concentrate solely on the investors and shareholders. As per the conservative and narrow approach, the financial information should be targeted mainly to the shareholders. However this may not match with the corporate governance framework used in several nations, the board defined that all those who has made investment in a company, bear the financial risk; hence the financial information should be revealed to all wide group of people. The board explained that users of the financial information can be segregated as the one who can demand for financial information and the others who cannot demand from the entity. Hence, some of the entities should prepare GAAP account to fulfil specific requirement of their users. Again, another issue was whether the financial information revealed by an entity should assist the users in decision making process or its aim is just to convey information about past transactions. The board decided that the financial information should assist the users in decision making process. However, such a prime issue raises question about stewardship enjoyed by the entities in several nations. The board decided that the financial information provided in the financial report should not take into account requirement of the management. This is because as and when the management requires, it can demand for it from the entity. However, in the proposal it was accepted that the financial report should reflect management expectations but management commentary will not be reflected. It was also decided that the financial report should provide information to assist the users in analysing the solvency state of the entity. They asked the entities to continue to prepare reports such as XBRL as these reports are excellent analysis tools and the users can derive financial information from them. On the same side the board pointed out that none of these reports can be used as an alternative of general purpose financial reporting. The board members realised that it is quite essential to introduce environmental reporting and social information as a component of the financial report. The information provided under Chapter-1 of the proposal can be summarised below: Investors, creditors, suppliers, employees, customers, governments and regulatory bodies, and members of the public all are users of the financial report. The financial report should reveal information about amount, time and uncertainty associated with future cash flow, the economic resources (assets) and the claim on those resources (liabilities). The concept of stewardship should be a part of overall objective that is providing financial information through the financial report. (Deloitte Global Services Limited, 2010, “Chapter 1: The Objective of Financial Reporting”) The second section of the proposal deals with quantitative characteristic of decision-useful financial reporting information that deals with factors such as “relevance, faithful representation, comparability (including consistency) and understandability” (Deloitte Global Services Limited, 2010, “Chapter 1: The Objective of Financial Reporting”). Each of these characteristics has their own implication on the financial report. As for example the term “relevance” refers that the information should be capable enough to assist the user to make a decision after evaluating the potential effort of past, present and the future transaction on the future cash flow. Or, the users can make required change in their previously done estimate. An information will be considered relevance if it possess timeliness. This means the information is made available before it loses its ability to influence the decision made by the user (Financial Accounting Standards Board of the Financial Accounting Foundation, 2006, p.x). Similarly, “Faithful Representation” means the information reflects real life situation to the users when they make vital decisions related to investment, resource allocation and credit. It is also required that the information should be “verifiable, neutral, and complete”. The qualitative characteristic called “Comparability” will assist the users in making comparison among two sets of economic phenomena. Comparability is also associated with consistency that means sample accounting policy can be used period to period in a single entity or across different entities. Apart from the above mentioned qualities of the financial report, it is quite essential for the financial information to possess “Understandability”. The users who possess some knowledge about financial accounting, economic activities and business should be able to comprehend the meaning of information provided in the financial report. “Materiality” was also included that means, the financial information should not just be relevance but it should be a faithful presentation. For this, the financial information should also possess transparency, but it was not separately mentioned as qualitative characteristic. Again, the benefit of the financial information should justify the cost incurred in developing financial report. The benefit can be identified as better investment, credit and asset allocation decision taken by the users (Financial Accounting Standards Board of the Financial Accounting Foundation, 2006, p.xi). Both materiality and benefits & costs associated with the financial information are the constraints of financial reports. In October 2004, the board published the proposal and asked for review from others. The investors find this proposal difficult to accept and almost unsuitable in the prevailing business environment. Even other committees criticised it. Considering these criticisms, the board revived the proposal and published Exposure Draft (ED) in May 2008. In the “Improved Conceptual Framework for Financial Reporting”, it was mentioned that the proposed framework will not solely deal with general purpose financial reporting; rather the report may include other information such as management commentary, forecasts and press releases. However, which one of these should be used will be informed later by the board after considering the nature of the entity (Wild, 2008, p.4). In the ED, it was clearly mentioned that the board agree for the dual focus that takes into account cash flow generation and managerial stewardship. In ED it was also mentioned that the financial information do requires certain qualitative characteristics as discussed in the proposal of Financial Framework. To acquire the review, the board asked questions like: do you agree with the board’s conclusion? If not, then why? (International Accounting Standards Board, 2008, p.5). The board again revised the Exposure Draft in September 2010 and published the final version in November 2010. Criticism and comment on IASB proposal for financial framework The proposal published for financial framework published in 2006 by joint project of IASB and FASB was criticised by many. The Basel Committee appreciated afford of IASB and FASB for providing a foundation to develop high quality, principle based and converged financial standards for providing financial information to the users. The Basal Committee explained that a principle based nature of the framework will be able to formulate standards that get easily accepted in prevailing business environment. It might be problematic for the entities to accept standards if they are rule based. Thus, the committee expressed their concern over the length and focus maintained in the financial report proposal. Basal Committee suggested the board to revise the draft to address these issues. The Committee also pointed out requirement of a more balance between the qualitative characteristics as well as sub-characteristics of financial report presented in the Chapter 2. Basal Committee said, the discussion paper on the financial reporting framework proposal reflects inconstancy in the financial reporting issues with existing standards. As such inconsistency is unavoidable between the existing standards and the framework; therefore the framework should make require changes. The comments given by the Basal Committee on the discussion paper by IASB and FASB are as follows (Basal Committee on Banking Supervision, 2006, p.1-4). Again, the proposal fails to provide a clear cut objective (FRC, 2006, p.21-22). Comments on Chapter-1 The board should give more prominence to managerial stewardship and it should be considered as a separate objective along with the prospective of assessing cash flow. The committee said that it feel the proposed draft focuses heavily on information use for predicting the cash low after undertaking the sets and liability held by the entity. However, the framework has neglected importance of information that should be used to verify whether the management has fulfilled its steward responsibility (Basal Committee on Banking Supervision, 2006, p.4). The Basal Committee supported inclusion of creditors as the primary users of the financial report because they provide financial resource to the entity. Thus they too have the right to known about financial performance in terms of solvency state and profitability of the entity (Basal Committee on Banking Supervision, 2006, p.4-5) The Committee also identified that the framework does not clearly identified how the guideline would be related to the broad concept of financial reporting. Again, without knowing the boundaries of financial report it would be difficult to determine whether it will be a financial statement or a financial report (Basal Committee on Banking Supervision, 2006, p.5) Comments on Chapter- 2 The Basal Committee raised concern over replacement of ‘reliability’ with ‘faithful representation’. The committee felt that the term, faithful representation is quite vague and there does not have any international consensus over it. They recommended the use of reliability but with a robust definition (Basal Committee on Banking Supervision, 2006, p.5-6). The Committee pointed out requirement of further strengthening of the definition for ‘verifiability’. The frame work failed to explain that that correct application of flawed measurements methods does not results in verifiability. Therefore, while developing the financial report, the entity should include in-depth information about the policies and procedures used in developing the report (Basal Committee on Banking Supervision, 2006, p.6). Professor Rob Bryer of Warwick Business School, UK pointed out certain loopholes in the financial reporting framework proposed jointly by IASB and FASB. He pointed out that the concept of assets and liabilities as potential cash flow does not suites for all those assets which generate cash in an indirect manner in combination of other assets and labour. Therefore, it is quite difficult for the management to determine and measure potential cash flow associated with them. The discussion paper also failed to address how the information regarding entities’ financial position can assist the users to determine the future cash generating ability. The discussion paper provided by the board did not discuss the nature of economic resources in proper depth. Just superficial information is provided with supremacy of future cash flow. Prof. Bryer also raised concern over the issue of stewardship, as in the proposed discussion it has been given the second priority. Rather, cash flow was the prime concern for financial report. Therefore, the economic income approach may reduce the reliability of financial accounting (Bryer, n.d., p.15-16). According to audit company KPMG, negligence of stewardship is a meter of concern. The framework also neglected managerial performance while determining the performance of the entity. Even the investors raised issues regarding stewardship after analysing the proposed framework. All these factors created pressure on the board to introduce required changes so the financial reporting proposal becomes acceptable among the entities as well as the users. Difference of IASB with ASB statements and implication of financial reporting Statement of Principles for Financial Reporting was published by ABS in 1990 with an aim that it will assist companies in preparing and presenting their financial accounts. To bring consistency in the accounting standards, ASB introduced an informal guide to provide frame of reference. It soon turned out as the base for discussion and series of drafts were published in 1990. It described the activities that need to be reported in the financial statement; the aspect of those activities to be highlighted; attributes to be informed in the financial report and the pattern for presenting information in the financial reports. Apart from acting as an input for development accounting standards it is also used for reviewing them. Therefore, it is neither an accounting standard nor it provide guidance for preparing financial statement. This is a main difference between the financial reporting framework provided by IASB and FASB. Some of the FRSs are based on the guideline provided by ASB but alone is not enough because it does not take into account factors like economic condition, legal framework of the local country, cost benefit consideration, market condition, issues specific to the industry and so on (Financial Reporting Council, 2011, “The purpose of the Statement of Principles”). After considering the information available in Chapters 1 and 3 of the ASB Statement of Principles (1999) following points have been pointed out: The prime objective of an entity as per ASB should be stewardship whereas financial reporting frame work considers future cash flow as the prime objective. Both ASB and financial report framework considered large number of people as the “user” of the financial information instead of considering just investors and creditors. In the Chapter 2 that is the reporting entity, a company has been considered as the economic unit that resemble the entity. Therefore, these entities should develop financial report. On the other hand, financial reporting framework is for the private and non-for-profit public companies. The chapter 3 of statement of principles for financial reporting, different terms has been discussed to explain the qualitative characteristic of financial information. The terms discussed are quite similar as defined in Chapter 2 of financial reporting framework. However, ABS provides an elaborated and robust definition as compared to the financial reporting framework (Stein, 2000). Although there is a minor difference between Statement of Principles (SOP) and General Purpose Financial Reporting, but the regulatory bodies should work hand in hand to minimise such gap so that uniformility in the accounting standards can be implemented. In the globalised world these difference can result in hurdles for global economic development by creating confusion and mismatch in the financial information. Conclusion In 2006, both IASB and FASB came together to develop General Purpose Financial Reporting and soon they published the draft to cover the objective and the qualitative characteristic of decision-useful information. Initially it was criticised because of certain loopholes but later on the board worked on it and ask for comment on the ED. After introducing the change as per the response received, in November 2010, the board has given the final version. It can be assured that this framework will be effective enough to converge the accounting standards of IASB and FASB. This will assist the entities who have their operation in different nations and have to face the problem associated with deviation in these financial accounting standards. General purpose financial reputing will be effective in resolving such issues and will make the international financial system much stronger. Reference Basal Committee on Banking Supervision. November 03, 2006. Discussion paper – preliminary view on an improved conceptual framework for financial reporting: the objective of financial reporting and qualitative characteristics of decision-useful financial reporting information. [Pdf]. Available at: http://www.bis.org/bcbs/commentletters/iasb19.pdf [Accessed on January 18, 2010]. Bryer, R. No date. Comments on DISCUSSION PAPER Preliminary Views on an improved Conceptual Framework for Financial Reporting: The Objective of Financial Reporting and Qualitative Characteristics of Decision-useful Financial Reporting Information. Warwick Business School, UK. Deloitte Global Services Limited. 2010. Project Summary. IASB Agenda Project. [Online]. Available at: http://www.iasplus.com/agenda/framework-a.htm [Accessed on January 18, 2010]. Deloitte Touche Tohmatsu. 2006. Release of preliminary views documents on conceptual framework for financial reporting. IAS Plus. [Online]. Available at: http://www.iasplus.com/iasplus/0608framework.pdf [Accessed on January 18, 2010]. Financial Accounting Standards Board of the Financial Accounting Foundation. November 3, 2006. Financial Accounting Series. [Pdf]. Available at: http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175818764152&blobheader=application%2Fpdf [Accessed on January 18, 2010]. FRC. November 02, 2006. Accounting Standards Board. Financial Reporting Council. 2011. Statement of Principles. [Online]. Available at: http://www.frc.org.uk/asb/technical/principles.cfm [Accessed on January 19, 2011]. International Accounting Standards Board-a. 2006. DISCUSSION PAPER: Preliminary Views on an improved Conceptual Framework for Financial Reporting: The Objective of Financial Reporting and Qualitative Characteristics of Decision-useful Financial Reporting Information. Comments to be submitted by 3 November 2006. International Accounting Standards Board. May 2008. EXPOSURE DRAFT OF An improved Conceptual Framework for Financial Reporting: Chapter 1: The Objective of Financial Reporting. Chapter 2: Qualitative Characteristics and Constraints of Decision-useful Financial Reporting Information Comments to be submitted by 29 September 2008. Stein, N. April 01, 2000. The ASB's revised statement of principles for financial reporting - part 1. [Online]. Available at: http://www.accaglobal.com/archive/2888864/28374 [Accessed on January 19, 2011]. Wild, K. September 29, 2008. Exposure Draft of an Improved Conceptual Framework for Financial Reporting: Chapter 1- The Objective of Financial Reporting; Chapter 2- Qualitative Characteristics and Constraints of Decision-useful Financial Reporting Information. [Pdf]. Available at: http://www.iasplus.com/dttletr/0809frameworkch1-2.pdf [Accessed on January 18, 2010]. Bibliography International Accounting Standards Board. September 2010. Conceptual Framework for Financial Reporting 2010. IFRS. Penman, S. H. 2007. Financial reporting quality: is fair value a plus or a minus? Accounting and Business Research Special Issue: International Accounting Policy Forum. pp. 33-44. [Pdf]. Available at: http://www.jps-dir.com/Forum/uploads/12611/Financial_reporting_quality_fair_value.pdf. Read More