International Financial Reporting Standards Definition - Term Paper Example

International Financial Reporting Standards Definition Introduction The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), has ventured on a project to reconstruct the bases of financial accounting by retooling the Conceptual Framework. The Conceptual Framework is similar to a charter for financial reporting, rendering the basis for standards. Had there been no framework, accounting standards would adopt the easier solution for a particular issue. A solution which is coherent with an interconnected theory of accounting would never be the choice. The Conceptual Framework is a crucial factor in the growth of established principles for accounting standards (Gore Richard, 2009). International Financial Reporting Standards (IFRS) are touchstones, explanations and the Framework for the Preparation and Presentation of Financial Statements of corporations. The objectives of financial reporting can be bifurcated into General Objectives, Derived Company Objectives, Derived External User Objectives and Specific Objectives. The general objectives of any financial reporting is to provide the present and possible capitalists, creditors and other users with information which may be useful for them to make lucid investment, credit, and comparable decisions. Derived external user objective provides useful information so that potential investors can calculate the amount and time to make their investment. Through the financial statements the investors, creditors and others can assess the future net cash inflows to the company. The specific objectives are to provide the company about its cash flows, its complete income and the various components of such income and also the company’s economic resources, obligations, and owners’ equity (Nikolai Bazley Jones, 2009). Even though a printed annual report contains data about programs, new products, proposed capital expending etc., this is normally showed in such a way that it is certainly assorted from the regular financial statements (Mautz and Sharaf, 1961, 170-171). The amount of information which has to be presented should help the users to take decisions and form opinions (Flint, 1982, 15). Apparently too much or too little detail may be detrimental (Mautz and Sharaf, 1961, 170). Flint (1982, 15) states that basic queries in financial reporting are ”from which users´ standpoint have the accounts to be considered” and what degree of agreement is to be accepted on the part of those who have to figure notions and take decisions. The conceptual framework The IASB framework keys out the fundamental concept based on which a company can prepare its financial statements under the direction of the international accounting standards. As a result it helps the IASB in mutually developing of new accounting standards and also reviewing of principles already in effect. One of the objectives of any principle setting group is to get uniformity of accounting pattern in the identification, measurement and arrangement of accounting info in issued financial statements. This amended uniformity then encourages comparison and dependability. The structure furnishes counselling on explanations, trims back the amount of permitted accounting treatment options, and thus makes a noteworthy involvement to the goals depicted (Paul Rodgers, 2005). Different theories used in International Financial Reporting Entity theory is based on the notion that the business has a separate existence and personality of its own. It is founded on the equation that 'Assets are equal to Equities' (Liabilities plus Stockholders´ Equity). The core diversity between the liabilities and the stockholders´ equities is that the evaluation of the rights of the creditors are fixed severally of other valuations if the firm is solvent, whereas the rights of the shareholders are assessed by the valuation of assets earlier invested including the valuation of reinvested profits and incidental revaluations. The liabilities are definite responsibilities of the firm, and the assets constitute the rights of the firm to obtain particular goods and services or other gains (Hendriksen, 1982, 455). The enterprise theory is a more extensive construct than the entity theory, but at the same time it is less well defined in its scope and application. The enterprise theory states that accounting may be conceived of as a collective hypothesis of accounting, which means that the firm is believed to be a social establishment controlled for the welfare of many involved groups. This notion of the firm is, according to Hendriksen (1982, 459), most appropriate to the huge modern corporations that has been indebted to reflect on the outcome of its dealings on a variety of groups and on society as a whole. In the proprietary theory the proprietor or owner is at the hub of interest. In the balance sheet arrangement this is declared as follows: 'Assets minus Liabilities are equal to Proprietorship'. The assets are understood to be possessed by the proprietor, and the liabilities are the proprietor’s responsibilities. Revenues are additions in proprietorship and disbursements are reductions. Thus net income falls directly to the owners. The proprietorship is conceived to be the final value of the business to the owners. It is the concept of wealth (Hendriksen, 1982, 453). In the residual equity theory, alterations in asset valuation, alterations in income and in held earnings, and alterations in interest of other equity bearers are all reverberated in the remainder equity of the common stockholders. Thus the balance sheet equation is: 'Assets minus Specific equities are equal to Residual equity'. The outstanding equity point of view is a perception anywhere between the proprietary theory and the entity theory (Hendriksen, 1982, 457). Different users need information- should it be real or fictitious? According to Lorie and Hamilton (1973, 114), the use of security analysis is to discover deviations between the value of a security as fixed by the market and a security's intrinsic value, which means the value which the security ought to have and will have when other capitalists have the same perceptivity and noesis as the analyst. In a well-organized market the price of a surety can be anticipated to estimate its fundamental value because of rivalry among capitalists, that is, the market is well-organized when the exchange value and intrinsic value are equal. Thus on the line of balance, "true and fair" in an enterprise’s outer financial exposure indicates the enterprise’s intrinsic value. Thus the financial reports should contain information which indicates the enterprise’s real and probable profit and degrees of risk such that it is complete so as to enable the decision of the enterprise’s intrinsic value. Therefore it is inevitable that the information policy of any enterprise at any time aims to create proficient capital markets (Lorie and Hamilton 1973, 79-80). According to Paul Rodgers, (2005, p252) regulation of the accounting practice to be used for the preparation of international financial reports for publication, it can be argued that by justifying the model influences every stakeholder group right from the shareholders to the agents who collect taxes and also the governments. Even though the framework is not an IFRS and also does not lay down any specific guidelines on any specific accounting issues like pensions, deferred taxation, but still the framework has a range of influence which is significant. The abstract Framework and the future growth of International financial reporting The IASB puts forth the objects of financial statements and the qualitative characteristics. These are the elements and the component comprised in the financial reports makes them useful. Thus the Framework can be perceived to be the common backbone for the growth of all new accounting touchstones which leads to the uniformity in the preparation of the financial statements (Paul Rodgers, 2005). The objective of the Framework, which is to enable a wide range of users to make economic decisions of the financial operations and the financial position including any changes in such a position of an entity, is difficult to criticise. But it has been observed that the Framework cannot be “all things to all men”. It is in reality planned for general reasoning of financial statements. Thus sometimes such financial statements may not be perfect for specific purposes like reports to be produced for governmental regulatory authorities (Paul Rodgers, 2005). Qualitative features of financial statements (Paul Rodgers, 2005) The features are: 1. Understandability which means that those who possess reasonable knowledge of business and economic activities must be able to understand the basic financial position of a company. 2. The statement should be relevant so that the users can measure the past, present and future events of the company. 3. The statement must be free from any errors or bias. 4. The financial report must be prepared so that comparing of the financial position and trends of a company becomes possible (Paul Rodgers, 2005). Even though all the components are desirable, but still it must be borne in mind that give and take is unavoidable. For instant the use of relevant info for decision to be taken in the future might need the utilisation of less reliable data. Also there are some items like assets, liabilities, income and expenditure which posses a dispute to the practical understanding of these expressions. For example when the term asset is considered, human intellectual capital which is also a kind of asset, arguments are still on the offing as to whether such assets can be recognised or not. The fact that the existence of individuals are not permanent (resignation or change of jobs) might result in the change of control is questioned. This leads to a dilemma with regard to the inclusion of human intellectual capital as an asset of a company (Paul Rodgers, 2005). The value of having accounting standards or not having them IFRS are formulated exclusively for extensive international use. Advocators of IFRS dispute that by following a universal body of international standards, countries can anticipate decreasing the cost of information working and scrutinising to capital market participants (Barth, 2007; 2008). More preparers, exploiters, and auditors of financial reports can be expected to become familiar with one common set of international accounting standards than with several local accounting standards. If the implementation of IFRS is projected to decrease information costs to capital markets, then countries more dependent on foreign capital and trade to value their economic benefits more can be benefited more. But if no international accounting standards are available then foreign capitalists must acquire costs of becoming well-known with domestic accounting practices. Finally these costs will be passed on (at least in part) to the investment-destination country (Karthik Ramanna, Ewa Sletten, 2009). In countries where the value of existing governing institutions is comparatively more, IFRS/IASs adoption is liable to be less appealing. High quality institutions constitute high chance and shifting costs to following international accounting standards. The opportunity costs come up because countries may have to give up the gains of any past and possible future conceptions in local reporting standards specific to their economies (Karthik Ramanna, Ewa Sletten, 2009). IFRS/IASs, are the result of an international political economy balance, and thus cannot be anticipated to endow with reporting standards that are distinctively fitted to any given country’s contexts (Leuz and Wysocki, 2008). But if the local governance institutions of countries are not well developed, the adoption of IFRS/IASs more nuanced. The fact is that prospect and shifting costs in these Countries are smaller, so the option to adopt an outwardly developed body of accounting Standards deliver an advantage. Whereas on the other hand, such countries are prone to undergo corrupted and slow-moving, or incompetent governments that are tolerant to or unable to change (La Porta et al., 1999). Disagreements can take place between reports prepared according to IFRS/IAS and those prepared on the basis of local accounting standards simply due to an alteration in accounting policy or in the method of measurement. Companies are thus forced to manage this alterations so that they are able to distinguish real changes in performance from divergences that come up as new accounting rules were enforced. For instance, IAS 39: Financial Instruments: Recognition and Measurement significantly changes reporting in the financial services industry, whereas IAS 16: Property, Plant and Equipment significantly changes reporting in capital intensive industries, such as manufacturing and utilities. Consequently, when companies try to adopt IFRS/IAS, they are continuously computing and recompiling management and constitutional accounts to measure the possible affect of the new standards (Oracle White Paper Updated July 2008). Management Reporting These disputes also present obstructions to precise and efficient management reporting. Legal reporting must be adjusted with management coverage, and administrators have to realise the affect that IFRS/IASs have on operation management and key performance indicators (KPIs). Advanced statements of performance based on IFRS/IASs have to be reliable with budgets established on the effective GAAP. The tools used for reporting should allow the management to supervise, understand, and report performance based reports on whatever set of standards they select. In a conformity culture, in which good governance is always matched with superior management capacity, nothing less than a complete supervision of performance and risk is satisfactory Finally, some pick apart the present two statement approach since “it creates a risk that one statement will be given a lower profile than the other and, as a result, important information will be overlooked.” (Oracle White Paper Updated July 2008). A discussion on Pro-active Accounting Activities in Europe, 2006. What (if anything) is wrong with the good old income statement? Discussion Paper 2, argued that: Some items of income and expenses are exhibited on a netted basis but it would have been better had they been presented separately. “When this presentation reflects the substance of the transaction or other event, by netting any income with related expenses arising on the same transaction then netted income presentation is preferred”. For instance: “(a) Gains and losses on the disposal of non-current assets, including investments and operating assets, are reported by deducting from the proceeds on disposal the carrying amount of the asset and related selling expenses; and (b) Expenditure related to a provision that is recognised in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets and reimbursed under a contractual arrangements with a third party (for example, a supplier warranty agreement) may be netted against the related reimbursement.” (IAS 1, paragraph 34). But Separate presentation of accounts would restrict the amount of fraud or even concealment of vital facts from the users of the financial statements. There are some who opine that a defect of the current statement(s) of income and expense is that it does not separate earnings into cash flows and accruals. As established in research by Mary E. Barth, Donald P. Cram and Karen K. Nelson, Accruals and the Prediction of Future Cash Flows(November 1999); “each major accrual reflects different information about future cash flows, resulting in different weight in prediction. In contrast, aggregate earnings implicitly place the same weight on each earnings component, masking information relevant to predicting future cash flows. Disaggregating cash flows from aggregate accruals significantly increases predictive ability relative to aggregate earnings, but disaggregating accruals into its major components further significantly increases predictive ability.” Conclusion From the above discussions some questions which come to mind and which are debatable are as follows: i. So how does management adjust its reporting from one set of standards to the next—from multiple, and sometimes local, sets of GAAP to IFRS—without losing control? ii. How can they be certain that results reported one way are consistent and can be reconciled with the numbers reported another way? iii.Do management systems exist that allow complete mastery of performance, or will companies continue to weather unexpected volatility in results? (Oracle White Paper Updated July 2008): It is in the hands of the management of corporations who present their International Financial Reports to take into consideration all the factors which might affect their company investments or may limit capitalists in investing in their companies. It is up to them to check any frauds or errors committed knowingly or unknowingly so that the reputation of the company is intact. There may arise some fundamental questions like the quantity of information and the form of presentation which is required to facilitate users to form notions and take decisions which are proficient to them. It is the task of accounting reports to decrease the enormous mass of elaborate information held in a company´s business papers to handy and comprehensible dimensions. But some companies may try to conceal vital information which may lead to “the summarization and condensation to such an extreme condition that useful comparisons and distinctions are lost or concealed” (IASC, 1989, art. 21). Reference: 1. Barth, M.E. 2007. Research, standard setting, and global financial reporting. Hanover, MA: New Publishers. 2. Barth, M.E. 2008. Global financial reporting: Implications for U.S. Academics. The Accounting Review 83: 1159-1179. 3. Ball, R., S.P. Kothari, and A. Robin. 2000. The effect of international institutional factors on properties of accounting earnings. Journal of Accounting and Economics 29: 1-51. 4. Ball, R., S.P. Kothari, and A. Robin. 2006. International Financial Reporting Standards (IFRS): pros and cons for investors. Accounting & Business Research 36: 5-27. 5. Flint, D. (1982). True and Fair View in Company Accounts. London: The Institute of Chartered Accountants of Scotland: Gee & Co (Publishers) Limited. 6. Gore, Richard (2009). Building the Foundations of Financial Reporting: The Conceptual Framework. CPA Journal, The. FindArticles.com. 08 Sep. http://findarticles.com/p/articles/mi_qa5346/is_200708/ai_n21293130/ 7. Hendriksen, E.S. (1982). Accounting Theory. Homewood, Illinois: Irwin. 8. Karthik Ramanna, Ewa Sletten, (2009). Why do countries adopt International Financial Reporting Standards? Working Paper 09-102 9. Leuz, C. 2003. IAS versus U.S. GAAP: Information asymmetry-based evidence from Germany’s new market. Journal of Accounting Research 41: 445–472. 10. Leuz, C. and P. Wysocki, 2008. Economic consequences of financial reporting and disclosure regulation: A review and suggestions for future research. Working paper, University of Chicago and Massachusetts Institute of Technology. 11. Lorie, J.H. and Hamilton, M.T. (1973). The Stock Market. Theories and Evidence. London: Richard D. Irwin, Inc. 12. Mautz, R.K. and Sharaf, H.A. (1961). The Philosophy of Auditing: Sarasota, Florida: American Accounting Association. 13. Mary E. Barth, Donald P. Cram and Karen K. Nelson, Accruals and the Prediction of Future Cash Flows(November 1999). 14. Managing the Transition to International Financial Reporting Standards An Oracle White Paper Updated July 2008 http://www.oracle.com/appserver/business-intelligence/hyperion-financial-performance-management/docs/manage-transition-to-ifrs-whitepaper.pdf 15. Nikolai Bazley Jones (2009). Financial Reporting: Its Conceptual Framework Intermediate Accounting, 11th edition. 16. Paul Rodgers, 2005. CIMA Exam Practice Kit Financial Analysis: Publisher Elsevier. ISBN0750683732, 9780750683739. 17. Watts, R.L. 2003. Conservatism in Accounting Part I: Explanations and Implications. Accounting Horizons 17: 207-221. Read More