Conceptual Frameworks for Financial Accounting

Questions: 1. Explain why principles-based standards require a conceptual framework? 2. Why is it important that the IASB and FASB share a common conceptual framework? 3. It is suggested that several parties can benefit from a conceptual framework. Do you consider that a conceptual framework is more important for some parties than others? Explain your reasoning? 4. What is meant by a 'cross-cutting' issue? Suggest some possible examples of cross cutting issues? 5. What you think is the fundamental problem with financial statements based upon the historic cost measurement principle used under US GAAP? 6. What do you think of the principle' accounts must reflect economic reality' as a core principle of measurement in accounting? 7.How would you measure economic reality? 8What is reliability in accounting? 9. The article states that the US standard setter FASB requires companies to record a provision in relation to environmental costs of retiring an asset ('to reserve environmental liabilities') if its fair value could be reasonably estimated. How do you think companies would go about estimating such a provision?10. What aspects of the requirements were used by US companies to defer recognition of a liability? 11. In what ways does the recognition of the liability in relation to future restoration activity affect net profit in the current year and future years; and cash flow in the current and future years? 12. The article refers to changes in disclosure requirements relating to environmental liabilities in many countries around the world. How important is it that companies recognise the liability? To what extent is disclosure about the liability sufficient? Answers: 1. Requirement of conceptual framework The movement towards accounting standards based on the principles is a step towards union between IASB standards and FASB standards. However, the immediate requirement is to comply with the Surbanes-Oxley bill that needs to be based on the principle-based standards of accounting. Standards based on principle are relevant as economically that offer high level of comparison between firms with regard to future cash flow prediction or performance evaluation. The objectives of the standards based on principle require a clear definition under the conceptual framework with regard to the determination of trade-offs among the reliability and relevance and the way in which these will affect the comparability. Some improvements are required in the conceptual framework to recognise and measure the expense and revenue approach as it is a crucial part of the mix. In addition, conceptual framework is required to maintain the clarifications in the report and examine the accounting based on principle to identify the possible divergence between the objectives of the users and the prediction of future cash flows against the performance of the companies. 2. Importance of Common Conceptual Framework for FASB and IASB A common goal of IASB and FASB is their standards to be formed as per the principles. To comply with principles-based, a set of standards shall be followed in elementary concepts. For accounting standards on various problems to result in logical reporting and financial accounting, the elementary concepts required to establish a framework that is comprehensive and internally reliable. Without the supervision assisted by an agreed-upon framework, set standard finishes up with concepts formed by individual member of the standard-setting committee. Another familiar goal of IASB and FASB is for convergence of their standards. The Boards are accomplishing various projects that are targeted for attaining short-term objectives on particular problems, as well as various key projects that are handled either jointly or in coordination with each other. Moreover, the Boards are planning to line up their future outlines more closely with each other in order to attain convergence in future standards. The standards of two Boards will face difficulties in converging their standards if their Board forms decisions on different framework. 3. Importance of Conceptual Framework for various Parties A conceptual framework objective assists in the recognition of the targets and the objectives of preparing annual statements. It also assists in the selection of transactions and identification of the requirement of recording these transactions. The direct beneficiaries of these are IASB and the FASB. These frameworks offers the establishment of set standards, moreover, it offers them the impression through which the accounting tools can be utilized for solving presentation and reporting concerns. On the contrary, conceptual framework offers the board various reasons while selecting the substitutes based on value. The conceptual framework does not supply answer to every query. However, it assist in eradicating some of the conflicting options from the list. 4. Cross-cutting issues: Cross-cutting problems are stated as the topic that have a significant impact on all the operations in a particular ground and therefore special attention must be given. Like gender and environment, cross-cutting issues are crucial to all aspects of development. Mainstreaming of cross cutting issues states that all the initiatives for development must have a positive impact on issues like environment and gender equality. Examples: Some possible examples of cross cutting issues are gender education, peace and value education, standardization of culture, environmental sustainability. 5. Problems with historical cost Historical cost is the measure of worth used in determination of price of an asset existing in the balance sheet is based on the assets original or nominal cost at the time of purchase. This method is used for the assets under the GAAP (generally accepted accounting principles). Problems with historical cost method are as follows: Unrealistic valuation of fixed assets: Under the historical cost method, fixed asset are transacted and presented in the balance sheet at the price for which they were purchased. Alteration in the prices is not taken into consideration. Unrealistic profit: Statement of revenue prepared under unrealistic profit method does not show the actual profit as the earnings are recorded based on the present value whereas the expenditures are recorded at historical value. During the inflation period, profits are overstated. Fair value of financial position is not revealed: Balance sheet includes non-monetary as well as monetary items. Non-monetary items like land, building are shown at historical value whereas monetary items lie cash, creditors, debtors are shown at current value. Therefore, non-monetary items are understated during the period of inflation and balance sheet does not present fair value for the financial position. 6. Accounts must reflect economic reality In accounting, it is normally considered that the accounting must reveal economic and corporate realities. It is very clear that in accounting that it is very crucial to show the real imoact on the economy rather than simply painting the picture of reality. Consequences of real economy arises when the users of financial statements changes their actions or opinions due to the alteration in in the standard of accounting or the method of accounting that has been used in preparing the financial statements. The performance of the firm will also be changed in some extend that what is shown in the financial statements. For examples, due to the changes in accounting, the following things can take place, people start purchasing in less quantities, investing less. Moreover, nothing will be same as before, some people will be in better position and some will be in worst position. Therefore, it is very crucial that the accounts must reflect economic reality. 7. Measurement of economic reality Although most of the apprehension about reliability is connected with the measure of fair value, most of the measures are not clearly followed in the industry. However, much reliance is shown for such measures, at present, the accounting statements are substituted with the processes that are considered reliable. Moreover, in the given study it is stressed that the existing business procedures, the liabilities and assets estimate are based upon evaluation. These evaluations are normally inclusive of the useful life of the fixed assets, selling ability for the stocks, collections of receivable, life of useful equipment, cash flows to be created from the investments and lawsuit in the environment (Pearce, Barbier and Markandya 2013). 8. Reliability in accounting: Accounting reliability refers to whether the financial data can be confirmed and utilized on continuous basis by the creditors and investors with the same outcomes. Generally, reliability states the trustworthiness of the financial reports. If decision makers cannot rely on the financial statements, financial reporting will be proved useless. Due to this reason, the FASB is worried with the reliability of information contained in the financial statement (Manfredi et al.2015). As per the FASB, three attributes that must be followed in preparing the financial statement to be reliable are: Neutrality: To present the information in reliable way, it must be neutral. Financial statements that of the company management that are somewhat biased are expected to report increased profit and are not likely to report the unfavourable events. Neutrality implies that management must prepare completely unbiased statements. Verifiability: Financial statements are regarded as verifiable when it gives same results through using different independent measures. For example, third parties and auditors can evaluate and measure the financial statement and get the same result. Representational faithfulness: It states that the statements must reveal the reality or actual incidences taken place during the year. 9. Provision of Environmental Liability With consideration to the increased worries and awareness about environment, it is been stressed that the companies around the world are pressurised to account for the issues related to environment that are faced by the common public in the society. Thus, it is very important that the companies should make definite provisions for recognition of environmental liability in the carrying procedure of business. Some provisions are there to record and present these transactions in effective way that can be useful for the shareholders. Therefore the accountants are required to adop some principles for recording the environmental liability. Few provisions that are included in the procedure are costing and planning for various activities with providing for provisions based on the on-demand performance and guarantees offered by the businessconcern. Moreover, it is identified that provisions in this regard are required to be made with consideration to the overall effect that these activities ha ve on the overall performance of the company (Evangelinos, Nikolaou and Leal Filho 2015). 10.Requirement of Liability Recognition It is emphasized in the given case that the organizations from United States are forced to abide by the standards developed by US Financial Accounting Standard Board that issued various provisions in 2002 with regard to identification of environmental obligation in the business. As per the provision, the corporations who were following the obligations related to asset retirement were obliged to reserve environmental obligations that are connected with the ultimate retirement of an property. Further, the environmental obligations are retained if the fair value of the property can be calculated in appropriate way. The expansion of these requirements is led towards the development of the procedure of environmental obligation within the business procedure. It has also been identified that through the case study is important for the companies in the US for the establishment and development of their business in their country (Csikszentmihalyi and Larson 2014). 11. The Effect of Recognition of Liability The execution of environmental sustainability results into overall increase in the cost of the organization at the primary stage. The increased amount of expenses is incurred for undertaking various measures. For example, reporting about the CSR in the yearly statements of the company along with considering the shareholders of the company into assurance with regard to the methiods adopted by the management with regard to CSR activities. It is further noticed that high expenses is incurred for the execution of environmental sustainability, thus, it is likely that the profit in the current year will decrease as an outcome of rise in expenditure. However, it is very much likely that the total profit of the company will increase as the overall goodwill of the company is expected to increase in the coming years due to the rise in the CSR methods adopted by firm. The implementation and execution of the CSR measures is important in increasing the profitability and sales of the company due t o overall rise in the goodwill. With the assessment of cash flow, it has been assessed that primarily CSR activities will affect the the cash flow of the company to move outwards. However, as the profitability will start rising, cash flow will be in favour of the company (Arena, Conte and Melacini 2015). 12. Importance of Disclosure of Environmental Liability Environmental liability states the liability on the producers with regard to release of large amount of waste from the manufacturing procedures. It is the outlay of cost that is expensed by the company for polluting surroundings. The rising worries among the people of the society have pressurized the management of various businesses to take efficient measures to progress their activities in environmental sustainability. The policy makers of various companies to implement measures to develop environmental performance uphold considerable amount of budget. With consideration of the rising in the significance of environmental concerns, the substance for the organizations to identify environmental obligation has gained importance in the present times. Thus, it has become very important for the companies to identify environmental obligations within their procedures (Glasson,Therivel and Chadwick 2013). 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The International Journal of Life Cycle Assessment, 20(3), 389-404. Pearce, D., Barbier, E., and Markandya, A. (2013). Sustainable development: economics and environment in the Third World. Routledge.