Accounting Assignment On Financial Reporting Conceptual Framework

Question

Task:
You are required to answer the following through this accounting assignment:

1. The IASB Conceptual Framework states that the fundamental qualitative characteristics of useful information are relevance and representation faithfulness. Must both of these qualitative characteristics be satisfied before particular information is included within a financial report?

   Explain your answer

2. The FASB and IASB (2005, p. 12) state:
   The long-standing unresolved controversy about which measurement attribute to adopt, particularly between historical – price and current measures- and the unresolved puzzle of unit of account are likely to make measurement one of the most challenging parts of this project.

   Provide an explanation of why measurement will be one of the most ‘challenging’ components of the conceptual framework being developed by the IASB.

Answer

Accounting Assignment Part 1
Qualitative Characteristics of Financial Information: Relevance and Faithful Representation
The financial reporting conceptual framework was first introduced in the year 1989 by the International Accounting Standards Board (IASB) and thereafter it had undergone certain revisions majorly in 2010 and 2018. The purpose of the framework is to support ISAB in their process of developing and making revisions in the international financial reporting standards so as to makers of accounting standards to develop accounting policies of consistent nature for such areas which are not considered in any particular standard and also to facilitate all the users of IFRSs in understanding and interpreting the same. In 2010, the chapter regarding the qualitative characteristics of useful information in the financial report was included in the conceptual framework to give clarification on the necessary qualities of information contained in financial reports. In 2018 when the revisions of conceptual framework were made, this chapter did not get fundamentally revised but only few clarifications of the wordings used in the chapter were given (Burlaud, 2013).

For years, the major concern that remained with the accounting regulators is the poor quality of financial information of financial reporting done by the entities. Financial reporting is one principal means to communicate the results of financial performance of an entity during a particular period with the outsiders who are associated with such reporting entity in one or the other way. The intended users of financial reports need to evaluate the economic performance of the reporting entity in order to take informed decisions at their end. Since, financial reports of the company serves as the basis of various significant and important decision making it is of utmost importance that such reports only covers relevant and reliable information. In the absence of information being relevant and faithfully represented, it might lead to incorrect decision making wherein the users might have to bear heavy losses. However, the corporate scandals related to financial reporting have caused serious concerns among accounting regulators. Therefore, the need of defining the qualitative characteristics of useful financial information was felt by board so as to bring some standardization in terms of quality.

IASB has incorporated an entire chapter in its conceptual framework that discusses the qualitative characteristics of financial information. Under this chapter relevance and faithful representation have been prescribed as the fundamental characteristics of financial information. These fundamental qualities are then coupled with various other enhancing characteristics such as verifiability, understandability, comparability and timeliness of the information contained in financial reports. Relevance is defined as the information’s ability to make difference in the intended user’s decisions. Relevant information is what that is helpful to the users to make informed economic decision. Financial information is called as relevant or useful when it has two features. One is Predictive Value that can help the user in making predictions and anticipations of the future results and the other one is Confirmatory Value that enables the readers to confirm their predictions made at earlier stage (IASB, 2018). Relevant information must cover financial as well non-financial information related to reporting entity.

Faithful representation which is also referred as reliability that is the degree to which the information contained therein the financial report reflects the true picture of resources owned by reporting entity, its obligatory claims and the transactions and events that have been occurred in the given period. Reliable information or the information that is faithfully represented has primarily three basic features: Complete, Neutral and Error Free. Completeness is achieved when full or adequate disclosure of overall information that is necessary is made. Neutrality is achieved that information is fairly disclosed without any biasness. Error free information is the information that has no errors or omissions. The conceptual framework provides clarification on the concern regarding measurement uncertainties that are defined in faithful representation terms. A faithful representation does not necessarily means that information would be accurate in all the aspects. Rather the use of estimation is necessary to prepare the financial information and does not lead to weakening of such information usefulness (Mbobo & Ekpo, 2016). The framework of financial reporting as prescribed by IASB strikes an adequate balance between relevance and faithful representation so as to standardize the definition of useful information. As far as explanations are given, information that has more uncertainty shall be replaced with the information with lesser uncertainty of estimations.

From the above discussion on the importance of both the qualitative features of useful information it is easy to make out that none of two can serve the purpose of information usefulness in alone (Novak, 2012). A faithful representation of something irrelevant and the relevant information being presented unfaithfully are both not going to do justice to the purpose of financial reporting. Hence, IASB’s conceptual framework does not challenge the compatibility of both the qualities. The objective of financial reporting is to communicate the financial results of the reporting entity to the stakeholders to enable them to make informed decisions. If the financial reporting is not undertaken by the business entities it might cause huge losses to the stakeholders of the company. To ensure the sound quality and transparency of financial reporting IASB has designed the conceptual framework. Thus adherence to whatever prescribed in the conceptual framework is necessary for all the reporting entities. Considering the criticality of quality of financial information, reporting entity must prepare its financial statements that are supported by all the qualitative attributes of information as prescribed by IASB. The financial information must therefore essentially posses both relevance and reliability (i.e. faithful representation) to prove its usefulness to the intended users of reporting entity.

Part 2
Why measurement will be one of the most ‘challenging’ components of the conceptual framework being developed by the IASB.
IASB has defined measurement as the phenomenon to determine the monetary value at which different elements of the financial statements are recognized and shown in the statement of financial position and the statement of income. Measurement is one among the most underdeveloped area of the conceptual framework as prescribed by both FASB and IASB. IASB discusses alternatives to measure the monetary value but it does not select any one of them. (IASB, 2013). Secondly, IASB contains various attributes of measurement. The list of attributes covers historical cost method, current cost method, gross or net realizable value method, current market value, fair value and the present value of cash flows expected in future. The use of different attributes is going to be continued in the future however there is no guidance on making a choice among the given measurement attributes. The framework therefore could be said as lacking entirely developed concepts of measurement. Better concepts of measurement shall be required to address the initial as well as subsequent measurement processes. The major most challenge in the measurement area is to decide as to which attributes shall be selected and used for subsequent measurements. The measurement at subsequent stages includes stances like impairment or revaluation or depreciation. Such issues give rise to the concerns regarding classification of incomes and losses in the income statement and the statement of changes in equity. A related concern whether the criteria of recognition and de-recognition would differ on the basis of selected measurement attribute. Another important issue related to measurement is ‘unit of account’ as to whether items in the financial statements shall be grouped at certain extent of aggregation or disaggregation instead of measuring them individually. Difference accounting units causes differences in the measures of impairment in case when the measurement attribute selected is historical cost (No, A.S., 2018). This happens when the unit of account is a large asset group then impairment of one asset out of the group might be countered by appreciating the other asset in the same group. Further, different unit of account might also cause difference in fair value measures in the case when the price per item is higher of per unit price for similar asset group (FASB, 2005).

The measurement aspect is financial reporting has always been controversial due to the fact that important concepts such as net income or net assets have uncertain meanings in the framework. The measurement criterion in financial reporting is truly a subjective matter of judgment and use of conventions (Filipova, 2017). The transactions which become the part of financial reporting may be affected by various problems of subjectivity, judgment or use of conventions if one of the measuring techniques is being used however the same transactions might have to face another basic of problems of measurement if another technique of measurement is used. Such transactions and events could not be prevented from the problems of subjectivity as far as measurement is considered. International financial reporting standards and other standards involves measurement of different items on different basses. However, it is necessary to measure all the items of a statement be it balance sheet or the income statement on a single basis so that total of all the items reflects a clearer picture. Eliminating such type of inconsistencies out of measurement methods must override the basic objective of financial reporting due to various reasons (Draft, 2015). There are certain items to which one basis proves strength and other proves its weakness. For instance, fair value method of measuring and recognizing an item has a weakness for the items that do not have any active market and at the same time historical method of measurement might prove weakness for those items which have zero historical value. Example of such items is financial instruments. Therefore selection of one basis of measurement might prove useful for certain items but for some of the items it the same basis does not serve. Further, the choice and selection of single basis of measurement may lead to higher degree of variability or inconsistency of reliability of measurements. Therefore consistency could not be achieved if single basis is not selected for measurement purpose of certain items.

Though the conceptual framework establishes certain fundamental qualitative characteristics of financial information and it also narrow downs the possibilities of deviations but it is not sufficient to achieve the agreement on a single measurement basis and also it does not guide on how to choose differential measurement basis in differing situation (Benston, Carmichael, Demski, Dharan, Jamal, Laux, Rajgopal & Vrana, 2007). From the above discussion it can be concluded that the issue of measurement is controversial and hence it is difficult to be resolved. The project of developing the conceptual framework with adequate measurement components will require resources and inputs from the board to a significant extent. Therefore, the measurement aspect is said to be most challenging for IASB to include in conceptual framework. However, it is important to note that once the measurement aspect of financial reporting gets resolved it will help in resolving further various accounting standard issues by providing them refined and updated framework with consistent principles that will serve the decision useful purpose of financial reporting.

References:
Benston, G.J., Carmichael, D., Demski, J., Dharan, B., Jamal, K., Laux, R., Rajgopal, S. and Vrana, G., 2007. The FASB’s conceptual framework for financial reporting: A critical analysis. Accounting Horizons, 21(2), pp.229-238.

Burlaud, A., 2013. [Online]. Should Financial Statements Represent Fairly or be Relevant? Available at: https://halshs.archives-ouvertes.fr/halshs-00873959/document. Accessed on: 24.04.2020.

Draft, E., 2015. Conceptual Framework for Financial Reporting. 2015-05-01)[2015-07-20]. http://kjs. mof. gov. cn/zhengwuxinxi/gongzuotongzhi/201506 P.

FASB. (2005). Online. Revisiting the Concepts. Available at: https://webcache.googleusercontent.com/search?q=cache:mTykwJFtMR8J:https://www.fasb.org/cs/BlobServer%3Fblobcol%3Durldata%26blobtable%3DMungoBlobs%26blobkey%3Did%26blobwhere%3D1175818825710%26blobheader%3Dapplication%252Fpdf+&cd=1&hl=en&ct=clnk&gl=in Accessed on: 24.04.2020.

Filipova, F., 2017. The Problem of Measurement in the Revised Conceptual Framework of IFRS. In 7th International Conference On Application Of Information And Communication Technology And Statistics In Economy And Education (ICAICTSEE–2017), November 3-4 th (pp. 1-6).IFRS(2020). Some challenges in measurement bases for financial reporting

IASB. (2013). Conceptual framework — Measurements and elements of financial statements (IASB only). Available at: https://www.iasplus.com/en/meeting-notes/iasb/2013/march/cf Accessed on: 24.04.2020.

IASB. (2018). Conceptual Framework for Financial Reporting 2018. Available at: https://www.iasplus.com/en/standards/other/framework. Accessed on: 24.04.2020.

Mbobo, M.E. and Ekpo, N.B., 2016. Operationalising the qualitative characteristics of financial reporting. Accounting assignment International Journal of Finance and Accounting, 5(4), pp.184-192.

No, A.S., 2018. Conceptual framework for financial reporting. Norwalk, CT: FASB.

Novak, A., 2012. Qualitative characteristics of useful financial information in conceptual framework. In Quality, innovation, future: Proceedings of the 31st international conference on organizational science development (pp. 802-813).