Acc518 : Current Developments In Assessment Answers

1. Financial reports (and the conceptual frameworks on which they are based) can either embrace a ‘decision usefulness’ or ‘stewardship’ function. Define these two terms. Which of these functions has the IASB deemed more important in recent years? Critically evaluate whether the approach adopted by the IASB will lead to the provision of relevant and/or reliable information for all users.

2. Identify the weaknesses of historical cost accounting. Were any of the alternatives to historical cost (CPPA/CoCoA/CCA) successful? In your response you will need to outline your criteria for success.

3. Outline the key building blocks of conceptual frameworks. Conceptual Frameworks are yet to provide significant prescription in relation to measurement issues in accounting. Why do you think this is the case? Would you consider conceptual frameworks to have been successful in achieving their objectives? Justify your response.

1. Decision Usefulness

Under the current conceptual framework, the IASB and FASB have recognised decision usefulness as its principal objective. The concept deals with providing useful information to the potential investors, creditors and others for making investment related decisions. The objective identifies the intention to meet the needs of those users who cannot access the sufficient information about the company for the purpose of their decision making (Staubus, 2013). However, the same is not articulated by the board but the main aim for this joint venture is to eliminate the problem of information asymmetry. As per IASB, it is the aim of financial reporting to facilitate the data to the capital investors which is useful for their decision making related to the efficient allocation of their resources. In other words, it is a concept that allows the companies to provide better information in their financial statements for the decision makers (Bebbington, Gray& Laughlin, 2001). 

Stewardship

It is basically an ethical term in accounting which counts for the responsibility of the management towards managing the business and providing relevant information to the shareholders about the resource allocation through financial reporting. Stewardship function of accounting is much more than decision usefulness and is a manner in which government agencies can be kept satisfied. It is the responsibility of accountants to be familiar with the parties involved in a business transaction and provide them with the reliable data in order to conduct the business in a fair and ethical way (Burton &Jermakowicz, 2015). 

According to the recent conceptual framework, there are two objectives one is decision usefulness and other is stewardship. However, there was a debate on the matter that which function is considered to be more important by IASB. Many experts argued on this and everyone has different perspectives. Since 2006, the primary goal of financial reporting was decision usefulness. However, later on the board decides to give more importance to the second objective that is stewardship which favoured many European constituents. According to recent conceptual framework exposure draft 2015, the prominence of stewardship has increased along with the overall objective of reporting. Now, it is required to report on the ability of management to generate an appropriate return on the resources used in the business. In ED 2015, it is mentioned that disclosing about the management’s efficiency and effectiveness is considered as a help for the users for assessing management’s stewardship. The objective is also combined with the view point of stakeholders with a fact that non capital investors are also interested in knowing about the governance of the company and discharge of management’s duties (American Accounting Association's Financial Accounting Standards Committee. 2007).

The approach adopted by IASB lead to provisions of relevant information as stewardship helps to increase the content of decision usefulness by imposing duty on the management for taking care of the business professionally. This will result in a reliable outcome of financial reporting. In addition, the function raises the need for auditing of financial statements by the independent auditor which makes the data more reliable. It also helps in correct evaluation of the corporation by recording correct information as well as protecting the interest of parties related to the business by offering them the reliable and relevant information. The function of stewardship not only showcases the responsibility of management but also highlights the duties of regulators, lenders, investors and many others. This lead to a high level of financial accuracy as the function allows government to look for accurate documentation of the company’s data in order to analyse the future growth of its stocks and take suitable decisions. Being linked with stakeholder theory, stewardship also diminishes the agency problems by attracting more investors towards the organization. As and when the agency issues reduces, better financial decisions about the business can be taken which eventually increase the concept of decision usefulness (Cordery& Sinclair, 2016).

Furthermore, the decision usefulness of financial reporting vary as per the degree of management’s stewardship. According to Gassen, the financial statements are useful for taking decisions only when the information presented in it is reliable and accessible to the decision makers. Such availability of data is directly related to the concept of stewardship of managers. If the management of the company provide fair and relevant details to the users, then the function of decision usefulness will increase. It also helps in establishing an integrity between the business and its managers (Gassen, 2007). However, there are many arguments against the relationship of these two functions and as per some experts they are considered as separate objectives of reporting. Nevertheless, it is clear that the function of stewardship influences decision usefulness directly and indirectly and that is why more importance is been given to this objective as per the recent conceptual framework issued by IASB (Gjesdal, 1981).

2. Under historical cost accounting concept, the assets in the balance sheet are shown at their historical prices i.e. the prices paid at time of acquiring them. Though the concept is easy to understand but it has its own weaknesses. They are as follows:

• The concept is fixed which means the recording and reporting is done on the basis of original cost which cannot be changed. Hence, it does not take into account the inflation and fluctuation in prices. As a result, at time of inflation the current price of asset is way different from its original cost. So, it is worthless to record assets on their acquisition value as it does not reflect the true and fair value of them.
• Another weakness is that under this method, the company fails to reflect the true and fair view of its position and performance in financial aspect as the correct and exact value of assets are not shown. They are recorded at the price on which they are acquired which proves to be unrealistic values for fixed assets. This makes a difference between the balance sheet value of assets and their true value. As a result, an unreliable and unfair view is been presented by firm’s statement of financial position (Van Greuning& Koen, 2001). 
• Historical cost accounting also lead to insufficient and inappropriate provision for depreciation. It basically deals with making funds for the replacement of fixed assets. Under this concept, the depreciation is charged on the original cost of asset, instead of its acquisition cost. Therefore, the provision which is charged is not sufficient for the fixed assets replacement.
• The major disadvantage of this concept is that it reflects unrealistic profit in the financial statements of the company. The income statement does not show the true profit as the revenues are recorded at current prices where the expenses are shown at historical costs. Thus, it can lead to overstatement of profit at time of inflation (Rao, 2011).

Due to such limitations, some alternatives were there for the historical cost concept which prove to be successful to a great extent. Current purchasing power accounting (CPPA) was one of the alternative framed on the base that when the price rise, if the company distributes its unadjusted profit based on historical cost, then its real value will reduce in real terms. In other words, the firm could distribute part of its capital. The concept was relied on calculation of some indices which makes it easier and less costly. At time of applying this method, all the adjustments are done at the end and all the non-monetary assets are recognized as those assets whose value will change over the period of inflation. It is also assumed that the purchasing power of the entity will not change as a result of holding non-monetary assets (Kamal, 2004). Another alternative was Current Cost Accounting (CCA), based on actual valuations rather than adjusted historical cost. This option has gained more acceptance and Bell and Edward decides to reject HCA and CPPA in order to support this alternative. It distinguishes between the profits generated from trading and gains derived from holding an asset. The assessment is based on replacement costs; through which operating profit is been calculated and holding gains are excluded from the calculation (Arora, 2002). Apart from these two, Continuously Contemporary Accounting (CoCoA) which states that the purchasing power of money does not remain constant and continues to change accordingly. Providing the dynamic environment in which business operates, the realizable value of the firm is the amount of its current cash and cash equivalent. It is considered as a substitute of HCA and it measures the assets and liabilities at their current cash price. As per this alternative, the firms should acquire those assets which are suitable for the environment and the financial statements of the company should reflect the current predictive selling price of the assets and the profit is calculated as variation in the adaptive capital of the firm during the financial year (Kirkman, 2014). 

CPPA proved to be very successful as it restated the financial statements according to the changes in GPP. The adjusted statements replicate the original amounts as current purchasing power and the method transforms various historical measures into CPP. It also facilitates the identification of gains and losses because of the holding of monetary items. By making the comparative study easier, the method helps the management to take appropriate decisions on the basis of reliable financial information. It allow the managers to form suitable policies and procedures and is of great importance to the stakeholders. However, the CPPA approach was later on criticized by the companies because it includes the application of retail price index. In virtue of this, CCA was introduced which takes into account the replacement cost of the assets to value them.

3. A system of integrated goals and fundamentals which enables the companies to lead to the consistent standards is known as conceptual framework. The development of the framework must be in accordance with the necessary “building blocks such as” Relevance, predictive value, confirmatory value, Faithful representation. The relevant financial information is useful in making the decisions. In order to make a certain difference the data has other building blocks such as the predictive information and the confirmatory value or the combination of the both. The revised framework carries the notion of the materiality as the key driver of the relevance. On the other hand the faithful representation was earlier utilised in place of the reliability. Other feature is the timeliness which is again the vital block of the conceptual framework. There is always a conflict between the timeliness and the relevance of the information as both the blocks are necessary and appropriate at their place. Henceforth, there is always a constant trade-off between the timeliness and the components of the relevance (Macve, 2015)

The objectives of the IASB are to provide the financial data about the company to the potential investors so that they can make the decisions. The investors seek information with respect to their evaluation of management’s stewardship and with the timing and uncertainty of future cash inflows to the company.

The conceptual framework is yet to provide the prescription in relation to the issues regarding the measurement in the accounting because of the fact that the standards keep on updating as per the new guidelines and the provisions. The measurement of a specific item is selected with the purpose of maximizing the information about the reporting firm which has prospects for its future cash inflows. The prediction is subject to the ability to truly represent cash flows at cost that will be adjusted by the benefits. However, neither historical cost accounting nor fair value method clearly explains the measurement methods that should be considered. Therefore, such terms should not be included in the chapter.

For example historical cost is the first measurement base that was discussed. Its accounting remains unchanged and according to the framework it presents the carrying amount of non-financial assets held at their historical cost. Financial items held at the original cost will no longer will be recoverable. Whereas, the one held at historical cost will require changes such as payments and interest. The main reason of the development of the conceptual framework was to assist the IASB board and for the purpose of the development of the IFRS and the updating of the existing IFRS. Framework may also help in preparation of the financial statements in order to develop the accounting policies and for the transactions which are not falling under the umbrella of the existing standards (Sage Publications, 2018).

When there is no standard, the management must employ its own perspectives in developing the accounting policy. The information is being used by the primary users to measure the entity’s position and the future cash flows of the business. Conceptual framework allows a sensible and translucent discussion in the discipline. This methodology is helpful in the clarification of the issues, development of the taxonomies. The more advanced and the futuristic framework is necessary in order to establish a body of the knowledge and the diversified policy and the recommendations. The FASB's system was, generally created three decades back. From that point onwards, business and money related exercises have turned out to be progressively complex. As a result, the standards issued in present era are more complex as compare to the framework which was originally developed. Consequently, some updating of the system might be both attractive and important to power it to keep on contributing towards the FASB's answers for future issues. Subsequent to playing out an extensive audit of the structure, the Board chose to add a venture to its motivation to address introduction and estimation ideas. Reason provided was that those zones were insufficient and could give noteworthy advantages in tending to present and future budgetary revealing issues. The absence of ideas in these regions has prompted conflicting choices in the introduction and estimation prerequisites in GAAP. The board is also working on the development of the framework for the purpose of the disclosure. The project is focused on improving the effectiveness of disclosures made in notes to financial statements through a clear and effective communication of the relevant data to the users (FASB, 2018).

References:

American Accounting Association's Financial Accounting Standards Committee. (2007). The FASB's conceptual framework for financial reporting: A critical analysis. Accounting Horizons, 21(2), 229-238.

Arora, J. S. (2002). Price-Level Accounting. New Delhi: Deep and Deep Publications.

Bebbington, J., Gray, R., & Laughlin, R. (2001). Financial accounting: practice and principles. London: Cengage Learning EMEA.

Burton, G. F., &Jermakowicz, E. K. (2015). International Financial Reporting Standards: A Framework-Based Perspective. New York: Routledge.

Cordery, C. J., & Sinclair, R. (2016). Decision-Usefulness and Stewardship As Conceptual Framework Objectives: Continuing Challenges.

FASB, (2018).The conceptual Framework. Retrieved from https://www.sagepub.com/sites/default/files/upm-binaries/49880_ch_7.pdf

Gassen, J. (2007). Are stewardship and decision usefulness complementary of conflicting objectives of financial accounting?

Gjesdal, F. (1981). Accounting for stewardship. Journal of Accounting Research, 19(1), 208-231.

Kamal, G. (2004). Contemporary Auditing. New Delhi: Tata McGraw Hill Publishing.

Kirkman, P. (2014). Accounting Under Inflationary Conditions (RLE Accounting). Abingdon: Routledge.

Macve, R. (2015). A Conceptual Framework for Financial Accounting and Reporting: Vision, Tool, Or Threat?. California: Routledge.

Rao, P. M. (2011). Financial Statement Analysis and Reporting. New Delhi: PHI Learning Private Limited.

Sage Publications, (2018). The FASB’s conceptual framework. Retrieved from https://www.fasb.org/jsp/FASB/Page/BridgePage&cid=1176168367774#section_4

Staubus, G. J. (2013). The decision usefulness theory of accounting: A limited history. New York: Routledge.

Van Greuning, H., & Koen, M. (2001). International accounting standards: a practical guide. USA: World Bank Publications.