A judgmental international classification of financial reporting Practices - Essay Example

?INTRODUCTION For many years different organisations, agencies and financial analysts have worked on developing their own conceptual framework however there has been no one common conceptual framework which has been accepted by everyone (Kaplan, & Atkinson, 1998). Considering this situation, in the year 1976 FASB started working to develop a common conceptual framework which could become the basis for accounting standards and resolve different controversies regarding financial reporting (Hines, 1991). Without conceptual framework there have been many issues and problems that have emerged with the passage of time and different people have different opinions on solving the problem (Hines, 1988). Therefore there has been a need for some guiding principles or some kind of structure on the basis of which different decisions can be taken and reporting of financial statements could become reliable and consistent (Zeff, 1972). With regard to this, conceptual framework is helpful because it provides a guideline and a foundation of anything and it can be referred to by people (Nobes, 2006). CONCEPTUAL FRAMEWORK ISSUED BY FASB The following image gives an overview of the conceptual framework issued by FASB. In an ideal world accounting reports that are developed using the suggested conceptual framework would be more useful than other accounting reports which are prepared without using of conceptual framework. This conceptual framework has been divided into three different levels and these levels are as follows: The first level defines the goals and objectives of accounting. The second level of the framework includes the qualitative characteristics that are helpful in making the accounting information valuable and components of financial statements like assets, liabilities etc. Measurements and recognition concepts are included at the third level, which are used in building and applying accounting standards (Kieso, & Weygandt, 2004). (Source: Kieso, & Weygandt, 2004). OBJECTIVES OF ACCOUNTING Before the report analyses whether accounting requires conceptual framework or not, it is important to analyse the main objectives of accounting and then it will be analysed whether the need for conceptual framework fits with accounting or not. Accountancy is an important department in any organisation (Nobes, & Parker, 1985). Considering its importance, there are several objectives of accounting department and these objectives are described below: Preparing Reliable and Consistent Financial Statements Accounting has a major role to play in any organisation (Amaratunga , & Baldry, 2003) because accountants prepare financial statements and records the financial transactions of the company (McCarthy, 1982). These reports and financial statements reflect the proper financial information which is helpful for the stakeholders of the company including investors, employees, shareholders, suppliers, government agencies, customers and potential customers as well as competitors (Ball, & Brown, 1968). The main objective of accounting is to provide information which is useful for the users of financial statements like investors, creditors, and other stakeholders (Chua, 1986). Therefore it is integral that the information provided by the organisation is useful, accurate, authentic, consistent and reliable. Inaccurate information can mislead the users of the financial statements and it could also distort the decisions taken by the management on the basis of financial statements therefore it is important for the organisation to prepare financial statements that follow the principles accepted by others as well (Hogarth, 1993). Thus, a conceptual framework would be required which the accountant can use as a guideline while preparing financial statements to make the financial information consistent and reliable. Keeping Records of all the transactions in a systematic way The other major objective of accounting is to keep records of all the transactions that occur in day to day routine processes in a systematic way (Abdel-Khalik, & Ajinka, 1983) and by making use of these transactions which mainly includes sales invoice or revenues, cost incurred or purchases, expenses, buying and selling of asset etc (Ngangan). By keeping and using all these transactions that occur in a financial period the accountant is able to prepare a financial statement which is helpful for the readers and stakeholders. If there would have been no accounting department, it would have been impossible for an entrepreneur or a business manager to remember all the transactions that occur in day to day life. Therefore accounting helps in keeping a record of all the transaction and helps in reflecting whether the business is able to generate profits or not. However, to have a consistent way to prepare accounting reports and financial statements a conceptual framework would be required by the accountants so that all the information is displayed in a similar pattern and usability of financial statements is made easier. Determines the financial position of the company Financial statements prepared by accountants are helpful in determining the financial position of the company (Briston, 1978). Financial position not only reflects the profitability of the company but it also reflects different areas of costs, revenues, expenses etc (Gerdin, & Englund, 2008) thus these financial statements are helpful for entrepreneurs and managers to take different decisions in order to improve the financial position of the company. Financial position is also helpful for managers to know where they are currently standing and what resources the company has. Therefore financial information presented using financial statements is helpful in taking different decisions and without having a conceptual framework it would have been difficult for the management and entrepreneurs to take decisions. Without conceptual framework these financial statements would not have displayed information in a consistent way therefore it would have made difficult for the users of financial statements to read and understand financial reports as a single format would have not been followed. Helps in decision making Accountants prepare financial statements which are used by not only investors and shareholders to invest in the company but these financial statements are used by the management of the company as well and on the basis of these financial statements several important decisions are taken by the management (Kapadia, 1980). For instance, a company received great response by introducing its product into a different geographic market and it was helpful in increasing the profitability of the company therefore such information would be reflected by the accounting reports as sales from different regions would be displayed and thus management could take decision to introduce the product in more similar regions to improve the overall sales and profitability therefore such important decisions are taken by the management of the organisation with the help of financial statements. Similarly, different decisions are taken by the management by viewing the financial statements for instance; management might take decision to improve profitability that any specific cost which might have increased significantly in comparison to the competitors should be reduced. However, it could only be possible if financial statements of the company in the same pattern as of the competitors and with the help of a common framework it could be possible or it would be difficult for the management to analyse the costs of the company and then analyse the same cost of competitors and take decision. DOES ACCOUNTING NEED CONCEPTUAL FRAMEWORK The four main objectives of accounting are so important and therefore every organisation should have some kind of guideline or rules which they can follow while preparing financial statements and reporting financial position of the company. Whether accounting needs a conceptual framework or not can also be analysed by the following example. For instance, an accountant used to record different daily expenses that occur in routine o and these expenses were deducted from the sales or revenues that the organisation earn to calculate the profitability of the organisation. But what if the accountant also started recording assets purchased by the organisation as expense? If the accountant started recording assets as expenses then the profitability of that particular year would be decreased significantly and even if the organisation might be earning considerable amount of profits would start showing losses in that year, if significant assets are purchased by the organisation. Therefore it is important to have some kind of guidelines and rules and standards that must provide a basic foundation or outline for accountants and they can make use of these guidelines to follow a standard pattern that has been accepted by everyone which should be consistent, reliable and dependable. However, in a generally accepted accounting principle, the accountant was supposed to add the asset in the balance sheet as assets and depreciate the depreciation expense and subtract the expense in the profit and loss statement in order to calculate the profit of that particular accounting period and in this way, the true profitability of that particular year would have been shown. Therefore it reflects that the above mentioned accounting objectives cannot be achieved if there is no conceptual framework or a common structure of financial report because these framework provide a foundation to the accountant and thus the reporting of financial statements would become consistent and reliable as every organisation would be following the same method to represent their financial position and prepare financial reports. WHY THERE IS A NEED FOR A CONCEPTUAL FRAMEWORK There are several reasons about having a conceptual framework and one of the most important reasons is that it would provide a base for financial reporting and with the usage of conceptual framework, the users of financial statements would be able to better understand the financial report as a logical structure would be provided along with rational rules and regulations that would be followed in preparing financial statements (Gray, 1988). Not only this, but it would be helpful in comparing the financial statements with the other firms in the industry thus the users would be able to make use of financial statements of the company in a better way as well by comparing it against the competing firms. If competitors have not used the same pattern then it would have been difficult for the users of financial statement to make go through different financial statements and then analyse these financial statements and then take decisions. However, with a conceptual framework every organisation has a structure to follow which has been helpful for everyone including competitors, management, investors and even employees. The other important reason for having a solid and logical conceptual framework is that it would be helpful in solving different kinds of issues and problems that might be faced as these conceptual frameworks would provide building blocks to people who would be preparing the financial statements. IMPORTANCE OF CONCEPTUAL FRAMEWORK IN ACCOUNTING Conceptual framework is very important because different concepts are taken out from it and therefore conceptual framework is important as it is used by people to establish, interpret and apply different reporting standards (Ruder, 1999). When it comes to accounting, conceptual frameworks is used to relate and apply to accounting standards. Conceptual framework is important as it gives the foundation or building blocks however some have referred the conceptual framework to be similar to constitution for setting accounting standards. In addition to this, the accounting conceptual framework is also used by financial analysts and auditors to resolve any kind of issue or dispute that arise in their day to day life (Perera, 1989). Issues and disputes can be solved by identifying whether the question agrees with the conceptual framework or not and steps should be taken so that the financial reports follow the conceptual framework (Peasnell, 1993). Accounting practices or standards are very much lenient because accounting standards enable some alternative accounting standards or practices to be applied to same situations. Therefore it has been claimed that someone needs to make a judgement regarding the kind of accounting standards to be used and which accounting standards is applicable or not (Hove, 1989). CONCLUSION Conceptual framework is important in defining the way an accountant has to follow in reporting financial statements (Nobes, & Parker, 1985). In addition to this, conceptual framework is important in providing consistency and reliability to the reporting standards (Taylor, & Jones, 1999). Many financial analysts and auditors have raised concerns regarding the differences in accounting standards followed by American and international accounting standards and they have demanded convergence between these two accounting standards (Chandler, 1992). It has been claimed that with use of a logical conceptual framework which is sound, complete and reliable financial reporting can be made more consistent (Gray, Campbell, & Shaw, 1984). RECOMMENDATIONS Subjects like accounting would need conceptual framework because there has to be some kind of basis on which accountants should be reporting and recording the transactions (Watts, & Zimmerman, 1979). As there would be a basis and a structure for accountants, this would allow a single common structure or platform for every organisation and they all would be following the same pattern. Accounting is different from subjects like marketing (Whittington, 2005) in which creativity is more required whereas in accounting traditional steps are to be followed. In marketing, creativity and innovation are required in new product development, in branding, in advertising, in promotional campaigns, in defining target markets and in other marketing activities because for each product or brand, marketing would be different and a marketer would have to think out of the box to make the product successful. As at times marketers have to create the need of the product in order to make the product successful and for this, creativity is more required rather than a conceptual framework. If there is a conceptual framework for marketers which they have to follow, then companies would not be able to differentiate among their competitors as everyone would be following the same patterns however in case of accounting or financial reporting, following one pattern would be helpful for everyone including the management and investors as this would allow the users of the financial statements to read, understand and make better use of financial statements as well as it will be helpful in making the financial reports more consistent and reliable. Therefore it is integral for a subject like accounting to have conceptual framework References Abdel-Khalik, A.R., & Ajinka, B.B. 1983, ‘An evaluation of the everyday accountant and researching his reality’, Accounting Organisation and Society, Vol. 8, No. 4, pp. 375-384. Amaratunga , D, & Baldry, D 2003, ‘A conceptual framework to measure facilities management performance’, Property Management, Vol. 21,no. 2, pp. 171 – 189. 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