Consistency in Accounting Standards - Essay Example

Consistency in accounting standards Insert Name Course, Class, Semester Institution Instructor Date The framework for the preparation and presentation of financial statements is designed to guide the process of creating novel accounting standards and amending the current ones with the objective of mitigating the inconsistencies that are inherent in the Generally Accepted Accounting Principles (GAAP) globally (Vallisova & Dvorakova, 2011). Research indicates that the proper observation of the framework during the formulation and amendment of accounting principles and standards will eliminate the conflicts that cause distortion in the financial information reported by corporations annually. The framework that is meant to guide accounting practices was approved by the international accounting standards committee on the seventh month of the year 1989. The framework covers a wide scope and explains in detail the relevance of consistency in the standards applied by corporations in the preparation of final statements and reports. This paper seeks to explain the reason why the inconsistencies in the standards of accounting need to be eliminated. According to the framework for the preparation and presentation of financial statements, the financial statements ought to embrace objectivity as many stakeholders rely on them in making decisions. The framework explains that the financial information provided by the statements guides both existing and prospective investors in making economic decisions (Akihiro, 1998). The investors focus on the information and use such information in evaluating the viability of committing their funds to the organizations’ projects. The statements also enable the potential investors to estimate the returns that they should expect from investing their monies in the particular organization. Additionally, from the statements, the existing shareholders are able determine whether or not their monies are gaining favorable returns. It is from such information that the existing shareholder may decide to sell of their shares or acquire some more. Perhaps it is important that we get a clear understanding of the particular inconsistencies before we explain why such irregularities should be eliminated. Most of the inconsistencies in the accounting standards revolve around property. This means that the inconsistencies relate to the valuation, amortization, classification and depreciation of property (ASB, 2004). Land is one of the assets that are particularly difficult to deal with in terms of valuation and depreciation. Different companies handle such fixed assets as land quite differently. For instance, some corporations depreciate their assets on a straight line method whereas others use a reducing balance method. Rationally, if the same asset is depreciated using the two methods, two different residual values will be arrived at. This is because the two methods use two different figures as the useful life of the asset. It is important to understand the concept of residual value. Fundamentally, residual value of an asset is the difference between the cost of the asset and the depreciation figure. It reflects the amount of money that a company can obtain from selling off the asset in its current state. The inconsistency in the depreciation methods accepted by the International Financial Reporting Standards (IFRS) is seen in the different residual figures for the same asset (Ishak et al, 2010). Assuming two companies, A and B each own an identical asset, say a factory plant. If company A, depreciates its plant using the strait line method and company B depreciates its plant using the reducing balance method, the depreciation figures will be different. In the end, since depreciation reduces the anticipated revenue, the two companies will report different profit figures. It is for this reason that the framework for the preparation and presentation of financial statements advocates for the elimination of the inconsistencies. From the case of companies A and B, an investor could be misguided by the profit figures. The going concern concept of accounting provides that a company shall use one accounting method or policy if and only if there is adequate reason to believe that the company will operate as a going concern (Gabinetti, 2012). A going concern is an organization with a perpetual life or one that expects to be in operation beyond the foreseeable future. The inconsistency here comes in where the accounting standards require that the policy used by a particular organization during the time of liquidation or disposition of the company be different. It therefore becomes unclear whether the company should use the same policy or different policies in the event that there is a probability of dissolution within the foreseeable future. The going concern concept of accounting requires that if a different policy is adopted during dissolution, such policy should be disclosed to the shareholders. The treatment of land, according to the various standards is different. This is owing to the fact that different organizations define land differently. According to some corporations, land has a permanent cost. This is because the useful life of land is infinite. However, other companies treat land like all other assets. This is to say that according to such companies, land has a finite useful life. This way the financial statements are likely to indicate different values for assets and liabilities (Finley & Finley, 2010). Again such information does not indicate the true and fair view of the organization’s performance. Rationally, land is one unique asset in the sense that it does not lose value. Even so, this argument depends on the land use in the context of the company. The framework for the preparation of financial statements emphasizes the fact that land should be treated as an asset with a permanent value. Another notable inconsistency in the accounting standards is evident in the recognition of expenses. According to the prudence concept, the expenses are recognized when incurred and not when the money is paid. On the contrary, revenues are recognized when the actual amount of money is paid and not when the revenue transaction is taken down in the books of accounts (Akihiro, 1998). This makes the handling of depreciation difficult. The fact that some companies recognize depreciation as a direct expense makes the contradiction more conspicuous. The framework defines expense as some payment made in anticipation of corresponding revenue. In effect, therefore, revenues and expenses should correspond. Depreciation therefore finds no place in the statement of comprehensive income. The inconsistencies in the estimation and treatment of goodwill are among the irregularities that cause wrong valuation of businesses during the time of acquisitions (Franczyk, 2007). Goodwill, an intangible asset, can be calculated using different methods. Just like in the case of depreciation, goodwill values differ depending on the method adopted in calculation. Goodwill is used during the admission of a new partner or during the time of selling the venture to another party. The framework advocates for the use of one formula universally. This is one of the ways through which the shareholders and partners can get the accurate value for the worth of the firm. The net worth of the firm is the difference between the assets and the liabilities. Goodwill, being one of the assets, is likely to affect the value of the organization. There is need to eliminating the inconsistencies in the accounting standards since they affect the type and accuracy of information availed to the various stakeholders (Norris, 2007). According to the framework, the information reported to the stakeholders should be consistent and accurate all through. This is because the stakeholders use such information in one way or the other. For instance, the framework identifies various stakeholders and how they make use of a company’s financial information. Worth noting is the fact that the stakeholders rely on such information either directly and indirectly. To better comprehend why consistency is necessary, it is imperative to focus on the stakeholders individually. The first stakeholder is the government. The framework mentions that this is one of the most important stakeholders since its relationship with the companies is purely legal. The interest of the government in the profits of a company is linked to taxation purposes. Consistency is therefore paramount since inconsistency will provide wrong figures. Wrong profit figures typically mean that the tax burden will not be accurately estimated. This will amount to a crime referred to as tax evasion. The second stakeholder recognized by the framework is the potential investor. A prospective investor is an individual or an organization that is able and willing to commit funds to the reporting company (Norris, 2011). However, the decision to commit their resources is affected by the financial information generated in relation to the past accounting period. Where a company reports high returns, the investors get motivated to commit funds since they are confident that their money will yield good returns. Inconsistent standards however, may manipulate the results of a company to reflect good returns. In such a case, the investors will be acting on false information to make investment decisions. As such consistency is necessary. The framework describes good accounting information as being reliable and consistent. This is to say that inconsistency makes the accounting information unreliable and inappropriate. Further, inconsistent standards could be used to hinder transparency. The company directors could use the inconsistent standards to report false profits. This can be done with the malicious objective of reducing the company’s tax burden (Beighley, 2008). Additionally, such inconsistent standards can be applied to affect the audit report. As such, inconsistency is a cause of many irregularities and professional misconduct. Inconsistencies can as well be the root cause of unethical conduct among the accounting staff and audit personnel. In conclusion, it is apparent that from the foregoing, the inconsistencies should be eliminated for there to be uniformity in the reporting of financial performance of all organizations. Consistency is a basis for effective decision making. It enhances transparency, proper taxation and efficient valuation of the firm. The users of financial information are such important stakeholders as the employees, the investors, the shareholders, creditors, the government and providers of long term debt finances. The framework for the preparation and presentation of financial information is designed to provide a foundation for the harmonization of principles, regulations and procedures that stakeholders rely on in making financial and economic results. The framework as well emphasizes the need for uniformity in the theories that define the preparation and presentation of financial statements. The scope of the framework lists all the qualities of good financial information and defines financial statements as those reports prepared on a regular basis. Such qualities can only be achieved through consistency in the accounting standards. References Akihiro N. (1998). 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