Conceptual Framework and Standard Setting - Finance Essay Example

Conceptual Framework and Standard Setting

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The debate on setting standards and faithfulness in financial reporting is not new. FASB and IASB have before passed their own conceptual frameworks. The incongruence of various aspects of treatment of financial items in the individual conceptual frameworks led to the desire for a joint conceptual framework. The recognition of the value derived by various stakeholders from the financial information of these the creditors and investors stand out from the rest emphasizes the need for faithful reporting. Ideally, the paper discusses how the inconsistency in standards is blow to the value of financial statements. This explains why qualitative characteristics of financial statements occupy a significant portion of standards setting. The theme of faithfulness of financial statements in financial reporting is highly emphasized. The paper also significantly covers the objectives of financial reporting. Moreover, some criticisms on the joint conceptual framework on financial reporting are covered. Ultimately, the segment on implications, the importance of uniformity of standards guarding the financial reporting gets further emphasis.

Introduction

Financial reporting plays an important role in offering financial information on an entity for use by the current and potential equity investors and creditors amongst other stakeholders in making economic decisions. Improvement of conceptual framework and standard setting is important to ensure the returns reported in financial reports are credible to the stakeholders (Barth, 2007b). The treatment of different items in financial statements forms a subject of debate. On this note, the move towards dealing with inconsistency in treatment of some financial elements aims at improving the value of financial statements. The qualitative characteristics of financial statements thus form a critical feature in the subject of conceptual framework. The need to ensure uniformity in financial standards derives from the desire for faithfulness in financial reporting (Villmann, 2008). The literature review examines extensively the theme of conceptual framework in accounting.

Literature review

The issue of financial reporting and standard setting in relation to the faithfulness of financial representation is an issue that arouses lots of debate. There are both costs and benefits that the enactments of new standards accompany. For instance, if a standard is set that requires a firm to disclose what previously confidential information was may cost the firm dearly (Barth, 2007a). In determining the desirability of accounting standard, it is important to list the social preferences that may accompany a new standard. This includes, measuring the weight and the benefits of the standard on capital providers and the costs open other participants. Barth (2007a) argues that the accounting and standard setting for value relevance research ought to be relevant to standard setting. The main influences in setting standards are to alter the form and the contents of financial statements. In this case, one aspect of the content of financial statement is passing a judgment on whether a potential cash flow item fulfills the definition of getting included in a financial statement (Villmann, 2008).

Accordingly, the ambiguity of treatment of some elements of financial statements is one of the drives towards the joint conceptual framework project between IASB and FASB. It makes sense to unify accounting treatments that are prone to misinterpretations. For instance, the project replaced reliability with faithful representation because the former was highly misunderstood (Eccles & Andrew, 2005). Faithful representation was reached given it captured the same meaning that reliability intended. Analysts see the IASB and FASB joint project on conceptual framework as a move that emphasizes the value of balance sheet over the income statement (Benston et al 2007).

Many stakeholders utilize financial reports in variety of uses that differ from each other. Each of the stakeholders derives certain information from the financial statements. The accounting standards setting bodies including Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) are always on the forefront of ensuring that the adoption of improved conceptual framework. Wendall (2003) suggests an approach of ensuring that a firm and its auditors to analyze whether a suggested accounting standard is consistent with underlying principle. Although it is not possible to satisfy all these stakeholders, financial statements ought at least to satisfy the needs of majority of stakeholders (Page, 2005). In order to achieve this, standards needs to be set that are consistent with principles valued by constituent users of financial statements (Harrington & Mousalli, 2005). Benston et al (2007) concur that the aim of joint FASB and IASB conceptual framework project is grounding accounting standards on consistent principles. Consistency is a virtue of ensuring that faithfulness in financial reporting is upheld all the times. According to the FASB (2006), conceptual framework becomes consistent when principles are founded on fundamental concepts rather than on collection of conventions. In the same vein, the body of standards that apply in financial reporting in enhancing the fundamental concepts, conceptual framework need be must have sound, comprehensive and possess internal consistency (Benston et al, 2007). Creditors and investors mostly utilize financial information. A credible conceptual framework is vital in communicating information about an entity’s economic resources, claims to the resources among other events and transactions that characterize the financial operations of an entity (Eccles & Andrew, 2005). The qualitative distinctiveness plays a part in making financial information credible. The evolving business needs are a challenge. In order to keep up, the regulatory processes deserve continuous improvements to keep up with the changes.

Qualitative characteristics in financial reporting normally distinguish useful financial reporting information from information that is less useful and misleading (Gallery & Natalie, 2004). In this case, for financial information reserve consideration as useful and credible; it must satisfy two fundamental characteristics; it ought be first, relevant and secondly offer faithful representation (Benston et al, 2007). Relevance in financial information possesses capability of influencing decision making due to the predictive or confirmatory value feature that accompany relevance. A very important aspect of relevance of financial reporting is the timeliness (Kirk, 1991). Timeliness refers to availing the information to decision makers while valid to influence the decision makers (Berth, 2007a). Stale information is irrelevant. On the other hand, faithful representation of financial information is important due to its assurance that the information is neutral and without material errors (Page, 1999). Information is normally considered material if its omission or misstatement by far effect may influence the decision making process. Financial information that is relevant and faithfully represented enhances usefulness of making decisions.

In order to ensure sound financial reporting, the body of standards ought to get whole and applications of the standards basis on sound, comprehensive and consistent conceptual framework (Benston et al 2007). The ethical consideration in accounting resonates around presenting correct financial information to the stakeholders. The responsibility of the standard setting bodies like FASB and IASB is enhancing consistency in financial reporting. Barth (2007) observes that the consistency is a pipe dream when different frameworks are applied. The essence of streamlining conceptual framework revolves around enhancing uniformity in presenting both non-financial components of business reports and key indicators of performance (Harrington & Mousalli, 2005).

Looking at the big picture in considering global or national economy, FASB and IASB mandate resonates ensuring the efficient operation of the economies by developing high quality financial reporting standards. The needs of the widespread users of financial information are only realizable with relevant standards in place (Whittington, 2008). This is why the financial reporting ought to disclose reliable information. Reliability here refers to the faithfulness which accounting information represents what it asserts to represent (Kirk, 1991). In this case, the information must be verifiable by independent measurers and ought to possess elements of neutrality in respect to particular groups. One of the reasons that have guided the move towards the consideration of revision of the conceptual framework by both the FASB and IASB is the need to uniformity in financial reporting (Barth, 2007b). Financial reporting thus deserves qualitative aspect of comparability. This means that in the process of reporting financial information in different places or organizations, similar items must receive same treatment while different items must receive different treatment (Barth, 2007a). This pertains to consistency in treatment of similar items. This is the guiding principle that is driving the IASB and FASB to considering developing a single conceptual framework in standard setting. Previously, both the IASB and FASB had different conceptual frameworks (Whittington, 2008).

However, the joint IASB and FASB conceptual framework project has a number of criticisms. First, analysts believe the project lays more emphasis on the investment role of accounting while paying little attention on the vital stewardship role that management plays for owners (Benston et al 2007).  Secondly, FASB standards are advisably not effective when based on conceptual framework only. In this case, concepts like ‘relevance’ and ‘consistency’ are broad in gauging a specific standard (Kirk, 1991). The varied interpretation may jeopardize the theme of faithfulness in financial reporting. Therefore, a more thorough field-performance-testing model would better apply before applying untested standards on real accounting (Page, 1999). Analysts suggest that firms need more flexibility in choosing their reporting choices allowing market forces influence in setting accounting standards. Moreover, industry players observe that although the standards aim at producing neutral numbers, the management’s obvious upward bias in financial reporting may derail this noble goal (Benston et al 2007). The standards in pipedream possess no aspect of conservativeness. Thus, conservative standards can only assure neutrality in accounting numbers.

The objectives of financial reporting

Financial reporting aims achieve a variety of objectives. First, it provides useful information to assist in making rational investment and credit decisions (Page, 1999). This applies for creditors and existing and potential investors. Secondly, financial reporting aims to enlighten existing and current investors and creditors about the amount, timing and the uncertainty of future cash flows (Whittington, 2008). Moreover, financial reporting provides information on the operating performance of a firm during the period in question (Gallery & Natalie, 2004). Certainly, the financial reporting provides information on how the stewardship of management is responsible to the owners. It is important that financial reporting is consistent with financial reporting objectives. The objectives of financial reporting are ensuring that beneficiaries of financial statements receive relevant and neutral financial information for making economic decisions (Barth, 2007a). For instance, when material errors are committed while doing a financial reporting this could have a serious implication on the decisions made by both potential and current investors not forgetting the creditors. The faithful representation of financial statements gains relevance when the implications of erroneous financial information get into consideration (Villmann, 2008).

Conclusion and Implications

The joint conceptual framework of IASB and FASB represents a positive move towards preventing inconsistencies. It is therefore important to assess whether a suggested accounting standard is consistent with underlying principle. As observed, there are costs and benefits that accompany changing of standards. Ideally, the main criteria in considering changing standards related to the form and the content of financial statement (Barth, 2007a). Creation of harmony in treatment of financial statement elements is a drive towards conceptual framework and standards setting that enhance faithfulness in financial reporting. As known widely, financial statements are utilized mostly by investors and creditors among other stakeholders. Although sometimes it becomes impossible to satisfy all of them, the financial statement information must satisfy the majority. That is why qualitative characteristics of financial reporting come in.

Analysts have forwarded various criticisms on the reliability of the conceptual framework including its focus on the role of accounting in investment ignoring the stewardship of management to owners. The other criticism revolves around conceptual framework lacking conservative standards thus their inadequacy of resulting to neutral accounting numbers. It is the duty of stakeholders highlighting these weaknesses to the standard setting bodies. The duty of minimizing these weaknesses lies with standard setters. All these represent efforts of ensuring financial reporting must be both relevant and have faithful representation. Moreover, consistency is very important. Additionally, comparability marks a vital element in financial reporting. Finally, standards set ought to be consistent with the underlying accounting principles. This is because it makes no sense in setting standards that contradict the underlying principles.

References

Barth, M (2007a) Research, standard setting, and global financial reporting, Boston: Now Publishers

Barth, E.M (2007b) Standard-setting Measurement Issues and the Relevance of Research, Accounting and Business Research, 37(3) 7-16

Benston, G.J et al (2007) The FASB’s Conceptual Framework for Reporting: A Critical Analysis, Accounting Horizons, 21(2) 229-238

Eccles, T & Andrew, H (2005) Financial Statements and Corporate Accounts: The Conceptual Framework, Property Management, 23(5) 374-388

Gallery, G & Natalie, G (2004) Applying Conceptual Framework Principles to Superannuation Fund Accounting, Abacus 40(1) 1-21

Harrington, C & Mousalli, S (2005) The Accounting Profession: Looking Ahead, Journal of Accountancy 200(4) 43-72

Kirk, D.J (1991) Completeness and Representational Faithfulness of Financial Statements, Accounting Horizons, 5(4) 135-142

Page, M (1999) The Conceptual Underwear of Financial Reporting, Accounting, Auditing & Accountability Journal, 12(4) 489-489

Page, M (2005) The Search for a Conceptual Framework: Quest for a Holy Grail, or Hunting a Snark? Accounting, Auditing & Accountability Journal, 18(4) 565-577

Wendall, P.J (2003) FASB Proposal on Principles-based Standard Setting, SEC Accounting Report, 29(3) 6-7

Whittington, G (2008) Fair value and the IASB/FASB conceptual framework project: An alternative view, Abacus 44(2) 139-168

Villmann, R. I (2008) Pay Attention, CA Magazine 141(5) 45-47

 

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