Introduction
The primary purpose of the conceptual framework is to provide guidance to the firm in developing new accounting standards. Choosing an acceptable accounting method, the amount and type of information being disclosed and the format in which information should be presented involves determining which alternative provide the most useful information for decision making purposes. FASB has developed qualitative characteristic of accounting information that distinguish better (more useful) information from inferior(less useful). The qualitative characteristic help to provide answer to the question, what characteristic of accounting information make it useful for decision making (fridson, 2002).
In the exposure draft relevance and faithful representation have been described as the two fundamental qualitative characteristics while verifiability, comparability, understandability and timeliness are described as enhancing qualitative characteristics. Cost and materiality are referred to as the major constraint in financial reporting.
In comparing and contrasting the existing framework and the exposure draft then each characteristic will be considered at a time.
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Relevance
Relevance means that the accounting information is capable of making a difference in decision. If certain information has no bearing on a decision it is irrelevant to that decision. To be relevant information must either confirm or change the decision maker expectation. Relevant information helps the user make prediction about the ultimate outcome of past, present and future event. It also help user confirm or correct prior expectation. In the existing frameworks both FASB and IASB have a similar definition of relevance with just a single difference. IASB consider relevant information as that which influences users decision and help them to evaluate past, present and future event while FASB define relevant information as information capable of making a difference in decision making. Therefore the above two definition differs on whether the accounting information should actually make a difference in decision making or capable of making a difference (Jon & bill, 2008).
The exposure draft continues to use relevant as a fundamental qualitative characteristic. In the exposure draft accounting information is considered relevant when it is capable of making a difference in decision making. Therefore both the existing frameworks and exposure draft have a similar definition of relevant information but the exposure draft deviate a bit from IASB definition in that it describe relevant information as that which is capable of making a difference while IASB define relevant information as that which actually makes a difference. In the exposure draft relevance is assessed in relation to a decision unlike in the existing framework where relevance is assessed to a particular decision maker.
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FASB refers to feedback value and predictive value as component of relevance while IASB identifies confirmatory value and predictive value as component of relevance. Both the feed back value and confirmatory value have the same meaning. for the purposes of adopting a common term the exposure draft have used the word confirmatory value therefore replacing the term feed back value used in FASB framework.
Faithful representation and reliability
The existing framework define reliability as a fundamental qualitative characteristic of financial reporting however the term reliability has not been Cleary defined leading to misunderstanding. Reliability means that a user can depend on or have confidence in the information. Accounting information is considered reliable when it actually represent what it is intended to represent, is reasonably free from error and can be verified. Verifiability, neutrality and representational faithfulness are defined as component of reliability in the existing framework. Representational faithfulness means that there is agreement between a financial measure on description and underlying economic phenomenon being measured or described. There must be freedom from bias and completeness such that nothing material is left out (George, 2006).
To eliminate confusion on definition of reliability the exposure draft has replaced the word reliability with faithful representation as it encompasses the key qualities that the existing framework included as component of reliability.
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IASB referred to substance over form as one of the component of reliability however in the exposure draft substance over form is not identified as one of the component of faithful representation as it would be redundant.
Neutrality and conservatism
Neutrality means that accounting information should be neutral and unbiased with respect to the impact of the information on user’s behaviour. Accounting information should not be biased in an effort to attain a predetermined result or to cause user to behave in a particular way. The existing framework describe conservatism or prudence as a desirable quality in financial reporting while in the exposure draft conservatism is not included as one of the desirable qualities in financial reporting (Pelham, 2006).
Empirical measure of faithful representation
The existing framework try to quantify faithful representation however the exposure draft does not attempt to quantify faithful representation or its component (porwal, 2008).
Comparability
Information that can be measured and reported in a similar manner for difference enterprise is considered comparable. In the existing framework comparability is given the same weight as faithful representation and relevance although it is indicated that comparability should not be over emphasized at the expense of faithful representation and relevance. In the current exposure draft comparability is described as an enhancing qualitative characteristic and logically follows faithful representation and relevance.
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Verifiability
Verifiability is demonstrated when independent measures using the same measurement method obtain similar result. Verifiability therefore increases the assurance that accounting measures represent what they are intended to measure. Verifiability is not included as an explicit component of reliability in the existing framework and in the exposure draft it is described as an enhancing qualitative characteristic.
Constraints on financial reporting
The existing framework and the exposure draft consider both materiality and cost as pervasive constraints on financial reporting.
Impact of the changes on the occurrence of creative accounting
Though the current exposure draft is a good document it is doubtful whether it will prevent the occurrence of creative accounting like those witnessed in US during the last decade involving Enron, world com and others. Key characteristic in the exposure draft are also found in the existing framework and in case those qualities were not effective in preventing cases of fraud perpetrated by directors in Enron and other firms the minor changes made in the exposure draft will not prevent occurrence of creative accounting. the exposure draft seem to clarify some matters which were in conflict in the existing draft but does not introduce new characteristic therefore no major change to prevent occurrence of creative accounting. Most cases of creative accounting are perpetrated by high level management and directors of a company. Since this is an intentional misrepresentation of accounting information then perpetrator will succeed no matter what the changes introduced in the current exposure draft.
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In Enron case directors created offshore entities which in real world were not there and were used by management to inflate/increase the company profit which led to share price increasing in the stock market. The management then sold their shares thereby generating large profit at the expense of the financial health of the company. Therefore occurrence of creative accounting is more related to integrity among management and the issue of governance rather than laid down standard and qualitative characteristic on financial reporting. Where management and staff are honest and good governance is upheld in the company then issue of creative accounting and fraud cannot result in the organization (Rao, 2008).
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Reference:
Fridson, M. S., & Alvarez, F. (2002). Financial statement analysis A practitioner’s guide.
New York: John Wiley & Sons.
George J. (2006) Worldwide financial reporting: the development and future of
accounting standards, Oxford University Press.
Jon A. and Bill D. (2008) Financial accounting standards: explanation and analysis,
University of Virginia.
Porwal, L. (2008). Accounting Theory: An Introduction, McGraw-Hill.
Pelham, G. (2004) The FASB Conceptual Framework Project, Manchester University
Press.
Rao, V. (2008). Corporate Management, Governance, and Ethics Best Practices, John
Wiley and Sons.
