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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.

This assessment task will assess the following learning outcome/s:

  • be able to critically evaluate attempts to develop and apply a conceptual framework.
  • be able to critically appraise the objectives of accounting and relate them to the various concepts of accounting discussed in earlier subjects.
  • be able to analyse the possible usefulness of alternative measurement systems to historical cost.

The Decision Usefulness and Stewardship Functions of Financial Reports

1. Financial reports are mainly prepared on the basis of conceptual framework, which help in depicting the transactions that has been conducted by the company during the fiscal year. there are two different types of information, which can be embraced by the organisation in representing their transactions in the annual report. Moreover, there are two different method such as decision usefulness and stewardship, which can be used by the organisation in depicting their transaction in the annual report. Decision usefulness provides investors creditors, shareholders and banks with adequate information regarding the current financial performance of the organisation. In addition, the decision usefulness factor in financial report portrays the financial information, which is required by the shareholder to make adequate investment decisions and project the current trajectory of the organisation. Hence, under the factor the financial report depicts useful information, which enhances comparability, verifiability, timeliness and understandability. In this context, Pelger (2016) stated that annual report allows the organisation to present their actual financial position, which allows shareholders to understand their progress. On the other hand, Gebhardt, Mora & Wagenhofer (2014) argued that companies not following the conceptual framework is restricting the investors to understand their current financial performance.

The second method of annual report representation is Stewardship, which allows the organisation to formulate their annual report and represent their current financial performance. In addition, stewardship is the primary information, which is used by users for understanding the current resources of the organisation. Moreover, it also helps in detecting the level of net cash flow, which will be generated by the entity in near future. Thus, it helps in detecting the management’s decision for effectively utilising the available resources of the organisation. The method helps in detecting efficiency of the management in utilising the current resources presented to them. Moreover, the financial report also helps in detecting management’s efficiency in utilising its available resources. In this context, Williams & Ravenscroft (2015) stated that values depicted in the annual report allows the investors to understand company’s current financial performance, while support them to make adequate investment decision.

However, from the evaluation of IASB standard, Stewardship is deemed more significant for the preparation of the annual report. In addition, from the evaluation it could be detected that the organisation needs to focus more on stewardship method, while preparing the annual report and adequately depict their financial performance. On the other hand, Luke (2016) criticises that IASB has changed its current conceptual framework after the scandal of Enron and WorldCom to reduce the loopholes and unethical measures, which can be taken by the organisation. Hence, IASB with the implementation of Stewardship to ensures that management understands the responsibility, which act accordingly and ethically. The reduction in the scandals that has been found after Enron and WorldCom indicates the effectiveness of the Stewardship method, which has been used by the organisation for presenting their financial position during the fiscal year. In this context, MARTIN & Osma (2018) stated that companies by utilising the IASB method maximise the level of information that could be presented in the annual report, while minimises the occurrence of frauds and accounting mishaps.

Weaknesses of Historical Cost Accounting and Alternatives (CPPA/CoCoA/CCA)

The steps taken by IASB regarding the alteration in the presentation of the annual report is by adopting stewardship method in representing the annual report of the company. In addition, during the exposure draft in 2015 the IASB reintroduced the Stewardship method of evaluation for increasing the reliability and minimise the extent of unethical measures that could be adopted by organisation. Moreover, the steps taken by the IASB has been fruitful, as there has been no such accounting scandal since Enron and WorldCom, which indicates the positive attributes used by the board. The information that organisation needs to portray in the annual report has been helpful in understanding their current finical performance and their solvency condition. This insight has allowed the investors to increase their current observation capability and make investment, which could generate higher returns from investment. on the other hand, Luke (2016) argued that the measures used by IASB has not been so successful, as in 2007 the financial crisis depicted the problems that led was present in the financial reports of organisation. However, IASB has been developing and evolving the conceptual framework to minimise the presence of accounting loopholes and maximise the ethical information that is presented by the organisation. According to Miller & Oldroyd (2018), investors rely on the current accounting standards imposed by IASB, as it improves the condition of annual reports.

2. Historical Cost Accounting is one of the major accounting techniques, which has been used by the organisation over the period of time. This method has many limitations in the current economic environment, which are depicted as follows.

  • The major limitation situated with the Historical Cost Accounting is the non-consideration of price level changes, as it fails to give fair and true view of financial affairs of the organisation.
  • The second limitation of the method is the ignorance of inflation factors, which needs to be considered, while preparing the annual report. This non-accommodation reflects on the income statement, which occurs as over-stated and unrealistic profits.
  • The third limitation is the outdated Monterey figures, which are used in the accounting method, which nullifies the significance of the financial report and the value of assets. The Historical Cost Accounting method only reflects the values of the assets, when they were acquired, while ignoring the market values of the assets. This results in abnormal gains and loss, when the assets are being sold by the organisation.
  • Furthermore, the Historical Cost Accounting does not allow the organisation and shareholders to compare the actual performance over the period of different fiscal years. in addition, the actual growth obtained by the company is not detected by the Historical Cost Accounting method. On the contrary, Ellul et al., (2015) argued that with fair valuation method organisations are able to depict the actual financial value, which helps the investors to take adequate investment decisions.
  • The Historical Cost Accounting method also does not match the current revenues and cost, which has been inducted by the organisation during the fiscal year. This does not allow the organisation to understand the current finical performance, as it does not understand the current financial performance during the fiscal year.
  • Lastly, the Historical Cost Accounting method mainly uses the mixed holding gains and operating gains, which will not depict the actual operating income that has been generated by the organisation. Hence, for detecting the accurate and fair operating profit relevant segregation of the holding gains and operating gains needs to be conducted by the organisation (Taplin, Yuan & Brown, 2014).

There are different alternatives to Historical Cost Accounting, which are readily used by the organisation for depicting their financial position in the annual report. In addition, from the evaluation Constant Purchasing Power Accounting and Continuously Contemporary Accounting measure are considered the alternatives for the Historical Cost Accounting method, which are not actively used by the organisation (Ho, 2018). Furthermore, with the help of Constant Purchasing Power Accounting organisations are able to use the price index system, which re-instates historical figures at current purchasing power. Hence, organisation is able to successfully use the recognizing method, where adequate price level is changed. Moreover, inflation factor is also used in Constant Purchasing Power Accounting for detecting the current valuation of organisations asset. Furthermore, the accounting concept also supports comparability, which depicts the actual financial position of the company. The method directly allows the organisation to distinguish between profits for understanding the actual financial position of the company. However, the use of historical method is much better option for the organisation it reduces the complexity in their accounts preparation.

Key Building Blocks of Conceptual Frameworks

However, there are some limitation to Constant Purchasing Power Accounting system, which are depicted as follows.

  • The method only considers general purchasing power, while it does not change in value of individual terms.
  • Moreover, the accounting measure is based on statistical index, which is not appropriate for individual firms.
  • In addition, there is difficulty, which is faced by the organisation to detecting the right price for the index.
  • The changes presented in the current method is not adequate, where the basic principle of historical cost accounting remains same under Constant Purchasing Power Accounting. Hence, it fails to remove the defects of Historical Cost Accounting, which the organisation needs to remove during the preparation of the annual report (McKinnon & Ohno, 2016).

Constant Purchasing Power Accounting system does not adequately support the evaluating theories, which are used as criteria for acceptance. The implication of the system is adequate, while the major problem occurs in its logical criteria and the assumption, which is reducing the significance of the accounting system.

Thera are certain advantages of the second alternative method, which is Continuously Contemporary Accounting method. The method directly allows the organisation to measure its assets and liabilities at the current cash price. Moreover, the method directly uses current selling price of existing assets to determine the actual financial position of the organisation. The method is successful in recognising different price level changes that has been conducted during the fiscal year. Moreover, it also uses inflation factor for understanding the current financial condition of the assets. Hence, up-to date figures of fixed assets in the financial statement is adequately presented. Lastly, adequate depreciation cost is used in the method for depicting the actual financial position of the organisation (Gaffikin, 2014).

However, there are certain limitation to Continuously Contemporary Accounting are depicted as follows.

  • The values of certain assets are not determined with the help of market price
  • The difference between the cost assets and new market value is mainly used for understanding the net profit.
  • Lastly, the difference in value of assets mainly varies due to the characterises of the organisation.

Continuously Contemporary Accounting also does not support the evaluating theories fully, as it lacks predictability, acceptability and logical reason in preparing the financial report. Hence, the system will not help in supporting the financial accounting that is needed to be prepared by the organisation.

Lastly, Current Cost Accounting method allows the organisation to value the assets are their fair market value. The method directly helps in depicting the accurate financial position of the organisation by using fair market values. However, the major lamination of the method is the determination of the actual fair values, as it might alter due to perspective of the accountant. Despite the drawbacks of the Historical Cost Accounting method it is much better option in comparisons to other accounting methods currently presented to the organisation (Parker & Fleischman, 2017). The Current Cost Accounting method is not helpful in preparing the annual report, which could depict accurate financial performance of the organisation.

3. Conceptual Frameworks is mainly considered as the interrelated objectives and fundamentals, which are used by the organisation, while preparing the annual report. In addition, the objectives listed in the conceptual framework mainly depicts the purpose and goals of financial reporting, which needs to be maintained by the organisation. The defined rules and regulation that is portrayed in the conceptual framework allows the organisation to adequality represent their current financial position in the annual report. the concept depicted in the conceptual framework acts as a guidance for selecting the different level of transaction, events and circumstances which can be accounted in the financial report. The alternative methods are depicted in the conceptual framework, which helps in recognising and measuring the summarised report. In this context, Zhang & Andrew (2014) stated that with the help of conceptual Framework organisations are able to identify the current financial position and evaluate their assets in accordance with the regulatory guidance. On the other hand, Cheng et al., (2014) argued that loopholes in the regulatory guidance relatively increases the chances of unethical measures taken by the management to formulate their financial report and present highly inflated performance.

Why Conceptual Frameworks Are Yet to Provide Significant Prescription in Relation to Measurement Issues in Accounting

With the help of conceptual framework FASB is able solve a report financial accounting problem that was previously faced by organisations while creating their financial report. the conceptual Framework adequately provides a set of common premises as a basis of discussion for the organisation and depicts the terminology which could be used during the preparation of financial report. In addition, the conceptual Framework also limits the area of judgement and discretion, which arises during the preparation of the report. The FASB Conceptual framework helps in understanding the financial accounting standards and contributes to the development of the financial report. FASB is a Foundation that changes and alters the accounting standard for establishment an adequate accounting system which could support the financial activities of the organisation. Dinnie (2015) mentioned that the aim of FASB is to identify accounting standards, which could increase the efficiency and usefulness of the information that is presented in the annual report of the organisation.

The conception framework does not affect the practices of the organisation directly but allows the accountant to formulate the accurate annual report as per the standards (Schaltegger & Burritt, 2017). There is still conflict between the Generally Accepted Accounting Principles and the conceptual framework, which increases discrepancy during the preparation of the annual report. For example, the current conceptual Framework allows the Museum collection to be listed in the Assets of the organisation, while the GAAP does not recognise these assets as a standard financial statement instrument.  this relatively increases the discrepancy between the financial framework and the accounting standard of GAAP. Conceptual Framework is relatively improving and evolving over the years to identify different issues that is haunting the accounting system. This improvement is relatively taking time, which the financial issues are not being reduced with the help of conceptual framework.  the description see between the accounting standard and the conceptual Framework is also a major factor behind the non-deduction of accounting issues. Simnett & Huggins (2015) mentioned that accounting standards have certain loopholes which are constantly being utilised by organisation to fulfil their wrong deeds, which is not reduced by the current conceptual framework. The reduction in discrepancy between the accounting standards and the construction Framework would eventually help reduce the accounting issues that has been arising since time immemorial.

Conceptual Framework has been successful in supporting the objectives of ethical accounting system, as it helps in influencing the securities to develop new accounting standards which could improve the current financial projections of the organisation. Hence, with the help of conceptual Framework organisations are able to portray the actual financial position without using any kind of unethical measures to formulate their annual report (Henderson et al., 2015).

Evaluation of the Success of Conceptual Frameworks in Achieving Their Objectives

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