Australian Accounting Conceptual Framework Theory - Coursework Example

Australian accounting conceptual framework theory Table of Contents Table of Contents 2 Introduction 3 Conceptual framework of accounting: Definition3 Need for a Conceptual framework 4 Accounting theory 4 Arguments of one over the other 5 Advantages and disadvantages of the theory- 6 Role of accounting theory in developing accounting practices 6 Statements of accounting concepts (SAC) 8 Conclusion 11 Bibliography 14 Introduction An accounting conceptual framework is a system of fundamentals and objectives that are inter-related and lead to the adherence of consistent standards relating to the preparation of financial statements. Simply put, a conceptual framework comprises inter-related concepts which state the purpose, nature and content of the financial reporting. The reasons necessitating the development of a conceptual framework is that it provides the basis for settling accounting disputes. It is important that financial reporting is developed logically and is consistent because it creates confidence among the general public. Financial reporting also referred to as external reporting, provides necessary information to users not having the necessary authority to obtain the relevant information from a business entity. Financial Accounting Standard Board (FASB) of US developed the “first conceptual framework” in accounting. A conceptual framework in accounting leads to better financial reporting and this can provide several benefits to the users of the financial statements, assisting them in making decisions relating to resource allocation (Cathstocx Ltd, n.d.). Conceptual framework of accounting: Definition The conceptual framework basically answers the two questions relating to what one is attempting to do and how this is going to be done. It provides answers related to the purpose of preparation of accounts and decides the suitability of the reports for the required purpose. It also offers ways of making improvements in the accounting practices in order to make them more suitable. Therefore this framework basically revolves around the accounting objectives as well as the methods of preparation of the accounts. This mainly assists in making decisions related to the choice of “accounting practise” and establishes accounting standards (Macwe, 1997, pp. 45). Need for a Conceptual framework An individual recommending a conceptual framework must base his choice on a clear conceptual framework. While deciding on the accounting policy to be followed, an accountant or an auditor or even the company director must ensure that the treatment presents a fair and true view. Like for instance if there is recommendation for the accounting standard relating to “uniform disclosure of leasing commitments” one must have an idea about the consequences of such disclosures and the interests of those served by it. The conceptual framework of FASB is concerned with the calculation and reporting of the assets, equity, liabilities and income components. Accounting theory Accounting is the process by way of which economic information is identified, measured and communicated to enable informed decisions by the users of such information. Accounting theory is a set of principles that provides a framework for the evaluation of an accounting practice and guides in establishing new procedures and practices. There are mainly two types of accounting theories-descriptive or positive and proposal or normative. In the case of latter, researcher suggest an alternative method of accounting. Accounting in terms of fair value and not on historical costs while reporting the financial statements, for making the accounting information useful to the user, falls within the normative theory. In the descriptive theory the researcher studies and describes the prevalent mode of accounting. The descriptive approach is criticised by the supporters of the normative accounting theory. Normative accounting theory justifies ‘what should be’ and not ‘what is’. Given the complexities associated with accounting issues both the methodologies are needed to develop an accounting theory. The descriptive theory tries to justify the accounting practices, and the normative theory tries to justify the accounting practices that need to be adopted (Riahi-Belkaoui, 2004, pp.409). Arguments of one over the other In a normative theory, the aim of the researcher is to develop better ways of accounting. Like an alternative method of making the disclosure that provides more information as compared to the existing ways, for facilitating the decision-making by the users of the financial reports. The descriptive accounting theory is often referred as scientific or theoretical and the objective of the researchers pursuing this type of research is to study the function and existence of accounting in the society. Both the theories revolve around the grasp of the current state of accounting. The normative theory bridges the gap between the details provided by the present accounting system and the information required by the users, by making improvements in the prevalent system. Therefore this theory affirms the requirements of the people who use the accounting related information. On the other hand, the descriptive theory clarifies the meaning of the prevailing accounting system as well as the information given by it (Humphrey, 2007, pp. 283). Advantages and disadvantages of the theory- The three main normative theories are stockholder theory, social contract theory and stakeholder theory. These theories give an incompatible and distinct account of the ethical obligations of the business. Under the stockholder theory, the managers are the agents of the stockholders. They have to manage the resources on the behalf of the stockholders. As per this theory the managers have to follow the instructions of the stockholders. However this theory does not direct the managers to raise business profitability. According to this theory the managers are under the obligation to earn profits by non-deceptive and legal means. The main criticism against this theory is that it overlooks the ethical limitations (Hasnas, 1998). The descriptive theory has the limitation of diverting the theorist from disciplinary effect of fitting the theory into conventional wisdom. Role of accounting theory in developing accounting practices The accounting theory ensures that the accounting practices develop in a logical and consistent way. It acts as the means of developing a conceptual framework. Impressionistic evidence shows that a number of practitioners are inclined towards developing accounting theory. Moreover to carry out the accounting practices a certain level of professional training is required which can be obtained by knowing the currently applied techniques. The learning and understanding of these techniques is aided by the presence of theoretical principles that explain and describe those techniques. It has often been seen that the accountants complain about the shortcomings of the accounting practices i.e. they are not clear or are misleading. The theories forming the basis of the existing practices can serve as a defence in such situations. Therefore the accounting practices must conform to the existing theoretical principles that underlie the accounting practices. Accounting theory explains the prevailing practices that help in developing a better understanding. But the main aim of accounting theory is to provide a set of logical rules that forms the basis of the development and evaluation of sound accounting practices. The IASB framework helps the Board in developing the standards and making a review of the existing standards. Its also brings down the number of alternative treatments of accounting. Besides this, it assists the person in charge of preparing the accounts in dealing with the topics that do not form a subject of a standard (Alexander, et al., 2007, pp.143). Most of the theoretical propositions are based on the ‘historical cost method’ as this method dominates the accounting practice. The concepts like matching and realization principle were based on the rationalization of the historical cost accounting. The materiality concept and conservatism is a rationalization of the deviations from the traditional historical cost accounting. But deriving the theories on the basis of practice suffers from limitations. Firstly it cannot deal with the problems that do not fall within the scope of the current practices. In the practical field of setting accounting standard, it must apply to the accounting for a change in the prices, inflation. The conceptual framework highlights issues that cannot be resolved by referring to the current principles underlying the practice (Whittington, 2007, pp. 370). Statements of accounting concepts (SAC) The Australian conceptual framework issued the following statements of accounting concepts-SAC1, SAC2, SAC3 and SAC4. The SAC1 is related to the “definition of reporting entity”. SAC 2 is about “Objective of General purpose Financial Reporting”, SAC3 is about “Qualitative Characteristics of Financial Information” and SAC4 relates to “Definition and Recognition of the Elements of Financial Statements”. SAC 1- SAC 1 applies to all the reporting entities with regard to the ‘first reporting period’ ending on or after August 31, 1990 and also in the periods of subsequent reporting. The aim of this statement is to describe and explain the concept related to ‘reporting entity’ and set up a benchmark for the quality desired in the financial reporting of such an entity. SAC 1 specifies the circumstances where an entity can be termed as reporting entity. The concepts that are alternative to the reporting entity are legal entity concepts that are used in private sector. There is also a broad concept that is used in the public sector. In private sector there are users in relation to reporting entities that do not have any legislation for the preparation of “general purpose financial statements.”Statements of accounting concepts and accounting standards apply across all the entities that prepare “general purpose financial statements”. Sometimes it is proposed that some of the entities can depart from certain or all these standards while preparing the financial reports. This is termed as differential applicability of Statements of Accounting Concepts and Accounting Standards. The entities that can depart from theses standards are based on the following- Size of entity- The entities that are classified as small, with reference to a benchmark such as turnover, employees, assets etc. Ownership-The privately owned enterprises can be exempted but the public entities cannot deny the maintenance of the standards. Ownership and Size-The private entities that fall in the small size category can depart from the standards. In SAC 1 the requirement for the preparation of the “general purpose financial reports” is related to the users who depend on this report for making allocation decisions. Therefore the above mentioned bases are not followed by the SAC 1. However the reporting entity concept includes the differential reporting concept, whereby certain entities are not recognized as reporting entities and thus are exempted from the preparation of the “general purpose financial reports”. The entities in respect of which the preparation of “general purpose financial statements” is not required are those entities for which it can be assumed that the users, dependent on the information available from the reporting, do not exist. It is most likely that the private sector do not have to prepare the “general purpose financial reports” under SAC 1. This includes the sole traders, privately-held companies, partnerships and trusts whose funds are not subscribed by public. However in certain situations it is desired that the privately owned companies intending to raise funds from the general public prepare the “general purpose financial reports”. In such situations the privately-held company must prepare its reports conforming to all the standards. In the case of public sector all the government departments as well as statutory bodies are required to prepare the financial reports, but the financial characteristics of selected government agencies and authorities means that they are exempted by SAC 1 from the preparation of such reports (Public Sector Accounting Standards Board-a, 1990). SAC 2- The aim of this statement is to set up the objectives of the “general purpose financial reporting” by the entities in the private as well as public sector. It recognizes the users of such reports, their information needs and the information that can serve those needs. The statement does not specify the qualities that must be there in the information, to be able to meet the objective, nature, form and number of financial statements that are to be made. These are the subject matter of the other ‘Statements of Accounting Concepts’. Financial reporting includes the provisions relating to the financial statements and other financial information. The scope of the “general purpose financial reporting” includes financial statements, notes to the financial statements, supplementary information and voluntary information. Financial reports, consisting of financial statements, supplementary schedules, explanatory materials and notes that complement the financial statements, are the means of giving important financial information about an entity to the user. As per this statement the users of the financial statements need the following types of information- performance, financial position, financing & investing and compliance. However the users of these reports can also refer to the other sources for obtaining information. In this statement there is no marked difference between financial reporting and financial reports. It does not even attempt to set the boundaries of “general purpose financial reporting”. Such distinctions are made as per the requirement in other ‘Statements of Accounting Concepts and Accounting Standards’. (Public Sector Accounting Standards Board-b, 1990) Conclusion Accounting theory forms the basic framework of the accounting practice. In business, one often comes across certain events, the treatment of which requires a sound backing of a theoretical framework. The absence of a proper theoretical base can lead to confusion in the treatment of an item. Moreover as all the entities follow a pre-defined set of rules and regulations it becomes easy to compare the statements of two separate entities. The preparation of the financial statements must be based on the objectives of providing important financial information to an external user. This will facilitate the users to take crucial decisions related to resource allocation. Reference Alexander, D. Britton, A. Jorissen, A. (2007). International financial reporting and analysis. Cengage Learning. Cathstocx Ltd. (No Date). Opening issues. Normative theories of accounting 2: The case of conceptual framework projects. Retrieved April 21, 2010 from http://www.download-it.org/free_files/Pages%20from%20Chapter%206%20Normative%20theories%20of%20accounting%202%20-%20%20The%20case%20of%20conceptual%20framework%20projects-bfa91f5d84251d5df53b73ae195aa403.pdf Humphrey, C. (2007). The Real Life Guide to Accounting Research: A Behind the Scenes View of Using Qualitative Research Methods. Elsevier. Hasnas, J. (1998). The normative theories of business ethics: a guide for the perplexed. Retrieved April 21, 2010 from http://web.sau.edu/RichardsRandyL/business_ethics_filing_cabinet_normative_theories_of_business_e.htm Macwe, R. (1997). A conceptual framework for financial accounting and reporting: vision, tool, or threat?. Taylor & Francis. Public Sector Accounting Standards Board-a. (1990). SAC 1 "DEFINITION OF THE REPORTING ENTITY". STATEMENT OF ACCOUNTING CONCEPTS. Retrieved April 21, 2010 from http://www.aasb.com.au/admin/file/content102/c3/SAC1_8-90_2001V.pdf Public Sector Accounting Standards Board-b. (1990). Objective of General Purpose Financial Reporting. STATEMENT OF ACCOUNTING CONCEPTS. . Retrieved April 21, 2010 from http://www.aasb.com.au/admin/file/content102/c3/SAC2_8-90_2001V.pdf Riahi-Belkaoui, A. (2004). Accounting theory. Cengage Learning. Whittington, G. (2007). Profitability, accounting theory and methodology: the selected essays of Geoffrey Whittington. Routledge. Bibliography Vorster, Q. (2007). THE CONCEPTUAL FRAMEWORK, ACCOUNTING PRINCIPLES and what we believe is true. Accounting & Tax Periodicals. pg. 30. Retrieved April 21, 2010 from http://www.up.ac.za/dspace/bitstream/2263/5111/1/Vorster_Conceptual(2007).pdf Gore, R. and Zimmerman, D. (2007) Building the Foundations of Financial Reporting: The Conceptual Framework, The CPA Journal. Retrieved April 21, 2010 from http://www.nysscpa.org/cpajournal/2007/807/essentials/p30.htm Read More