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Case Study: Accounting Theory Add in library

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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?

8. What is reliability in accounting?
 
 

Answers:

(1). 

  • The term principle based standards refers to the standards which are based on certain principles which are set by some experts with the help of their conceptual understanding of standards.
  • If standard setters lack conceptual understanding, they will end up setting a principle based on personal understanding, which may result in difficulties in formation of principle based standards.
  • Conceptual understanding is the base to work in any field. If there is no conceptual understanding, even if the principles are set for that particular job, the person working might end up being just a robot and doing what is written in principle having no understanding of what he/she is doing. 

(2).

  • International Accounting Standard Board and the US Financial Accounting Standard Board have determined a set of rules and regulation to be followed by the business organizations to be followed by the organizations so as to render the financial statements a true and correct nature of the items represented in the financial statements.
  • It is important for the IASB and FASB to be on the same degree of accountability so as to maintain the degree of confidentiality of varied number of users who rely on the financial statements to share a common view.
  • Also by following the same framework it would help the companies to avoid confusion regarding the policies followed by the company and thus rendering the same view to users who view the financial statements.
  • Thus for an organization it is relatively very important so as to disclose the same view in terms of different financial statements prepared according to the different Standard Boards.

(3).

  • The financial items in the statements are totally based on the principles followed by the experts.
  • The experts follow principles which are based on different accounting policies and thus they rely more on the accounting principles and decision followed by the company from different times so as to render the company a more true and correct nature of the financial statements rendered to the different users.
  • Critics of fair value generally believe that reliability should be the one of the major pillars on which the financial statements are prepared.
  • Some critics also interpret reliability as having a meaning that differs in at least certain respects from how that term is defined in the FASB's Conceptual Framework. Some critics equate reliability with precision, and others view it principally in terms of verifiability. Thus, the use of conceptual framework is more important to some parties than other.

(4).

  • A Cross cutting issue is an issue or topic which can seriously affect the business of the concerned enterprise.
  • In other words, many situations or issues, which are going to affect the operating of the business, are cross cutting issues.
  • For example, entry of a new competitor who is dealing in similar products, the management will try and find out to get an edge in the competition. This is cross cutting issue for management.
  • Another example of an cross cutting issue is, change in policies or amendment in any law which significantly affects the working of the business enterprise. In such circumstances, the management has to discuss and plan their activities in order to cope with the requirements of such changes in law and policies.
  • The cross – cutting issues need to be discussed and solved in the manner which will not affect the working of the business enterprise. If not taken seriously, this may adversely affect the working of the business and can even affect the profits of the business enterprise significantly. 
 

(5).

  • Fair value accounting refers to the accounting of events and trasnactions at an actual value given up for the acquisition of asset or for repayment of liability.
  • Thus it forms one of the dominant charecteristic on which the base of financial statements of an enterprise are prepared and therefore gets a curve more than the historic cost.
  • Advocates of fair value accounting say it would give users of financial statements a far clearer picture of the economic state of a company. The question mainly deals over reliability of the values of the assets and liability of an organization.
  • Historic cost of measurement of assets and liabilities means the actual cost or value for which an asset or liability was acquired by the organization while performing its routine operations.
  • But in the present day scenarios taking an asset or liability at its historic cost does generally not present the true and fair view of an enterprise. By presenting financial items at historic cost an enterprise shows a past or old value at it is now and therefore may change the views of the viewers of the financial statements. Thus presenting assets or liabilities at historic cost can cause a fundamental problem. 

(6). 

  • Accounts are prepared with conceptual framework so as to make the information reliable for the stakeholders. Economic reliability means reliability of information of figures and values presented by the enterprise on which the various financial statements are prepared.
  • For an enterprise it is very important aspect so as to present the financial information in a reliable and effective manner so as to make the users who depend on the financial statements have an upright view of the financial statements.
  • Thus it is a core principle of measurement in accounts and therefore for an enterprise it’s of utmost important so as to make its accounts and thereafter its financial statements reliable. Showing financial statements in a reliable manner not only helps the customers but also other stakeholders viz. creditors, investors and government so to judge the financial position of an enterprise. 

(7). 

  • The term economic reality refers to actual situation in the market or economy, rather than shown picture or rigid principles of economy which sometimes depict economic position which is different from economic reality.
  • For example, due to some accounting estimates and principles, the company may end up creating excess provision for expense which will not depict the economic reality.
  • Another example is accrual concept of accounting. Following this principle, we recognize income as and when it is accrued. Thus, in current year balance sheet shows profits. But in next financial year, the company comes to know that the buyer/debtor become bankrupt and is unable to pay due to this, instead of profits, the company may end up bearing losses.
  • Thus, economic reality as on previous years differs from as to what is shown to shareholder and other users of financial statements.  
 

(8). 

  • Accounting refers to the act of recording transactions and other financial information in a systematic and chronological manner.
  • It forms the basis for preparation of financial statements. Thus it is very important that accounts prepared for an enterprise are reliable.
  • The reliability in accounting refers to the trust that management and the other users of financial information build on the financial information which is derived from the accounting system.
  • Such reliability can be build up by using latest and accurate accounting system, audit of financials derived from accounting system and managements control on the users of accounting system.
  • A reliability in accounting in simple terms can be defined as to have assurance on the process of accounting, i.e. proper debit and credit are recorded and under proper head of revenue or capital nature.
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