Accounting Theory Developing Financial Reporting

Question: Describe about the Accounting Theory for Developing Financial Reporting. Answer: Introduction Accounting standards are important to develop a common accounting framework to be followed by the users of accounting system. There are different measurements of cost like historical cost, fair market value, current cost and net realizable value. These measurements of cost will be analyzed in detail through explain the usefulness of other cost measurement methods to historical method. Conceptual framework is most important part of the accounting and there are certain users whoa re benefited from this conceptual framework. Also there will be discussion on the financial reports and how it impacts the decision. Usefulness of Alternative Measurement Systems to Historical Cost Historical cost is the method used to measure the value and it is used in accounting to know the price of assets and liabilities. According to this method assets owned by the organization have to be recorded at original cost or nominal cost as and when acquired by the organization (Menicucci, 2014). There are mainly three alternatives to the measurement of values in accounting as against the historical cost. Fair Market Value Method: Fair market value concept is one the popular method to value the assets and liabilities and can be used easily as against the historical cost concept. According to fair market value method, value of assets refers to value on which assets and liabilities can be purchase and sell in the open market. Fair market value is truly based on the market price of assets whereas historical cost is based on the past transactions (Amount paid when assets are brought). It is more relevant to use the fair market when accounting for assets as it provides the current market information and also keep check on the impact on inflation of assets value through accounting them (Pratt, 2010). Investors and creditors are much benefited from the fair market value concept as assets are recorded at market value that provides clearer picture of performance of the organization. Hence, this method provides more transparency to the users of financial reports. Organization exposure to risk a nd inflation can be evaluated through applying the fair market value concept. There are some dissenters who argue that accounting information presented in the market value financial statements cant be trusted and are unreliable as it is not based on the arms length price. Due to this issue, there is huge exposure to manipulation of accounts by the management and such information cannot be used in financial decision (Pratt, 2010). Market value of assets and liabilities are generally based on the subjective estimates of the managers. Sometimes fair market value of assets cant be ascertained as it is not readily available in the market therefore for such assets historical approach or fair market estimation by the manager is followed. Fair market value method is more beneficial to the investors as only this method provide current and inflated price of assets (Pratt, 2010). So it can be said that this method is the best alternative to historical cost method. Net realizable value: It refers to the estimated selling price of the assets in the ordinary course of business less the cost incurred to make the sale. As against the cost measurement bases of assets (Historical cost and Current Cost), net realizable value means actual benefit derived from an asset. There are certain assets where fair estimation of cost or historical cost proves to be volatile and there is required to follow the concept of net realizable value (Stolowy Lebas, 2006). Net realizable means lower of fair value and recoverable cost. Net realizable value is only accepted in some cases because it is strictly opposed in some cases where acceptance of net realizable value is not possible. The general reason net realizable is rejected as it results in unrealistic low values of the productive assets like plant and equipments. Net realizable value differs from the fair market value by the amount of transaction cost reduced to arrive at net realizable value and also the extent of cost of completion that differs from the market value of assets (Stolowy Lebas, 2006). Therefore, it can be said that net realizable value concept can be more beneficial in few cases where historical and fair market value concepts are not useful. Current Cost - Reproduction Cost and Replacement Cost: Reproduction cost of assets refers to the economic cost that will incur if exiting asset is replaced with an identical one. Replacement cost refers to the economic current acquisition cost that will incur to replace the exiting asset with the asset of equivalent productivity capacity or service potential (Bonham, 2008). As defined reproduction cost differs from the historical cost as it puts concerns on the most recent economical cost of assets whereas historical cost takes only the cost incurred at time of acquisition. Replacement cost is more reliable and take all aspects of accounting while estimating the replacement value of assets. Replacement value is based on the productivity capacity or the service potential of an asset not on the cost incurred to replace the exiting asset with new one (Bonham, 2008). So, current cost concept can be used as against the historical cost and it is beneficial in various situations as per the need of the organization to present the financial reports. Potential Beneficiaries from the Development of a Conceptual Framework Conceptual framework of accounting was set by the International Accounting board with mutual concern with other accounting boards. This framework sets out the concepts that define the preparation and presentation of financial statements for the external users. This framework is so designed that it mainly helps the readers and preparers of financial reports. The main purpose of common conceptual framework is to eliminate the various issues caused while preparing the financial reports as there are many differences in presentation of financial reports at country level and at international level (Alexander Archer, 2008). Therefore, IAB has come in front to solve this issue through preparing the common framework to present the financial reports that help preparers to prepare only one financial report for the origin country as well as for international level. Investors who tend to invest in the multi national companies pursue difficulties in understanding the financial reports before such framework has been made due to difference in accounting standards and presentation style of statements (Greuning Koen, 2001). Conceptual framework assists the accounting standard board in promoting harmonization of regulations, accounting standards and procedures relating to the preparation and presentation of financial statements through providing the basis in reduction of number of alternative accounting treatments followed by Accounting Boards (Weygandt, Kieso, Kimmel, 2010). This common conceptual framework helps auditors to provide their opinion on the true and fair picture of the financial statements in easier way. Through issue of common accounting standards to followed by the all accounting boards it is possible for auditors to expertise their knowledge in their interest field and get a chance to use such knowledge national as well as international level. There are certain users of the financial reports and they require having a common platform through which such financial reports can be reviewed and common opinion can be made. It is only possible through producing such a contrast yet common accounting framework at international level. This conceptual framework consists of guidelines and principles that have to be followed while framing the accounting standards (Greuning Koen, 2001). The IFRS framework defined by the IAB serves as the guiding principle to the accounting board in developing the future IFRSs and to solve the accounting issues that does not confirms with the new International Accounting Standards. Investors need to know the risk associated with their investment in various organizations and how much return they can earn through such investment. The only way to determine the risk and return associated with the investment is to analysis the financial statements, but lack of common financial statements it is not possible to evaluate the company performance with ease. Investors need financial information that guides them whether they should buy, hold or sell. Also, investors are eager to know the capacity of the organization to distribute the dividends and how much (Alexander Archer, 2008). The general purpose financial report does not provide all information therefore IFRS Framework has been framed to avoid such problems faced by the investors. The IFRS has noted that parties like prudential and market regulators find general purpose financial statements useful. On the other hand Board considered that objectives of financial reporting and general purpose financial statements are not consistent and it requires developing a common framework that governs all the accounting standards followed while preparing the financial statements (Macve, 2015). To the contrary, persons associated in preparing the financial reports complain on the requirement to prepare two different financial reports, one as per home country Accounting Board and other according to International Accounting Board. There are certain differences between IFRS and other followed Accounting Standards. Among such differences there are some issues that significantly violate the requirements at international level (Macve, 2015). All such issues have been proposed in the conceptual framework and necessary steps have been taken to overcome such issues. Conceptual framework proposes the common principles and guidelines that need to be take care of while framing the accounting standards. After such changes, it has been noticed that mostly countries have same accounting standards as given by IAB. Accountants find it easy to learn these common accounting standards and apply while preparing the financial statements (Weygandt, Kieso, Kimmel, 2010). So, it can be conclude that conceptual framework helps certain people through solving their common issues but it is true that investors and accountants are much benefited from preparation common conceptual framework. Decision Usefulness and / or Stewardship as objectives of financial reporting Decision usefulness: It refers to the method or approach used while making the financial statements and it lays emphasis on the theory of investors decision making as to infer the type and nature of information required by the investors (Kieso, Weygandt Warfield, 2010). This theory refers to the single person decision theory. The single person decision theory provides how the rational individual makes optimal decisions while having the uncertainty. This theory requires the decision maker to have set of acts from which one have to select on the basis bayes theory model. The optimal decision refers to the decision that increases the decision maker expected utility that is based on the probabilities of the states of nature. There are pre and post probabilities of states of nature that decision maker conceive while making the final decision and these probabilities are tested using the bayes theorem. Information system has wide role in decision making process as all major decisions are t aken through incorporating financial information generated by the information system (Staubus, 2013). Stewardship function of financial reporting: Stewardship is the wide concept and it is widely accepted all over the world. Basically Stewardship is taken from the word Steward. It means person who undertakes responsibility to manage the affairs of an estate hold by his employer, one who mange the financial affairs of others property and one who is appointed on the behalf of anther to take care of. IASB framework has discussed the stewardship or accountability in its Para 14. It clearly says that financial statements must show the results derived from accountability/stewardship of management (Alexander Jorissen, 2007). Owners of the organization has the right to check on the accountability of management in order to help investors to economic decision on whether to buy, sell or hold their investment. Basically stewardship function of financial reporting is linked to the agency theory as owners assign the stewardship of the company to the responsible management. They want from manageme nt to fulfill the owners objective, apply strategies to make proper use of resources and to check the misappropriation of the company assets. Stewardship is most important in the financial reporting as it considers the relation of agent-principal and tend to benefit both parties (Britton Alexander, 2004). According to stewardship function management has to report credibly to the owners of the company and must be held responsible of every wrong decision taken against the welfare of company. Stewardship is not limited to the value of assets and liabilities but it focuses on whole business model. Stewardship lays emphasis on the long term considerations, value of reporting the past transactions and events, and completeness, reliability and transparency of reporting. Stewardship can be use interchangeable with the accountability as both means acting for welfare of owners. However accountability can be used in wide context as compare to stewardship and in modern period stewardship seems to be replaced by the accountability. Among stewardship and decision usefulness functions, stewardship has been accepted as the main objective of general purpose financial accounting. Stewardship function set vast and clearer picture of reliability, completeness and transparency of financial reports to their owners. IASB has mentioned that stewardship / accountability it is most important objective of financial reporting and it is considered as separate objective of financial reporting (Alexander Jorissen, 2007). Stewardship / accountability is related with the agency theory and it has broader view than resource allocation because it focus on both past performance of the organization and how organization will perform in future (Britton Alexander, 2004). Conclusion Financial reporting is the most important part of management function and there need to consider its important aspects to have proper financial reporting. Conceptual framework plays a significant role in financial reporting and it benefits people at large mainly investors and preparers of financial reports. References Alexander, D. Jorissen, A. (2007). International Financial Reporting and Analysis. Cengage Learning EMEA. Alexander, D., Archer, S. (2008). International Accounting/Financial Reporting Standards Guide. CCH. Bonham, M. (2008). International GAAP 2008: generally accepted accounting practice under international financial reporting standards. Wiley. Britton, A. Alexander, D. (2004). Financial Reporting. Cengage Learning EMEA. Greuning, H. Koen, M. (2001). International Accounting Standards: A Practical Guide Other World Bank Bks. World Bank Publications. Kieso, D., Weygandt, J. Warfield, T. (2010). Intermediate Accounting: IFRS Edition. John Wiley Sons. Macve, R. (2015). A Conceptual Framework for Financial Accounting and Reporting. Routledge. Menicucci, E. (2014). 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