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Discuss About The Eurasian Journal Of Business And Economics.

Improving the Quality of Financial Information for Users decision making by the adoption of Enhancing Qualitative Characteristics

The present report is developed for providing an understanding of the significance for disclosing decision-useful information to the users of financial statements. It is essential for business entities to comply with standard accounting policies and practices for providing information that is worthy of decision-making. The businesses need to disclose high quality financial information for protecting the interest of the end-users so that they are provided with true and fair depiction of the financial performance of an entity. In this context, this report is developed for providing a discussion of the enhancing qualitative characteristics that are stated by the conceptual framework of IASB for improving the quality of information. Also, it provides a critical discussion of the primary factors that should be considered for determining whether an entity is a reported entity. It also discusses the limitations of historical cost as a measurement base in developing decision-useful information. At last, it has provided a comparison of the standards of AASB 15 ‘Revenue from contracts with customers’ with the accounting standards of AASB 18 developed for measuring and recognition of revenue.

IASB (International Accounting Standards Board) has developed the conceptual framework of accounting that presents guidelines to the accountants for development and presentation of financial statements. The framework has stated fundamental and enhancing qualitative characteristics of financial information to make it useful for decision-making. The fundamental characteristics of financial information are relevance and faithful presentation of information. In addition to this, the enhancing qualitative characteristics of financial information are comparability, verifiability, timeliness and understandability (Kabalski, 2009).

The comparability characteristic of financial information states that financial information disclosed to the end-users must be comparable. This means that end-users must be able to identify and understanding the similarities and differences among the reporting items of consecutive years. The changes in the financial value of key items must be comparable with that of previous year to identify the percentage growth and decline in the financial performance of an entity. Comparability cannot be regarded as uniformity that is the financial information to be comparable must be depicted in a way that like things should be arranged similarly while different things should look in a varied manner. The qualitative characteristics of verifiability means that the financial information must faithfully present the economic phenomena for which it has been developed. This infers that the information can be verified by the end-users using direct or indirect method. Direct verification means that the information must be verifiable through direct observation for example by counting cash. This refers hat the information must be numerically depicted so that it can be verified through direct observation. On the other hand, indirect verification means that it can be verified by checking the accounting policies used for calculating the value of financial items (Australian Accounting Standards Board: Conceptual Framework, 2017).

Critical Discussion of Primary Factors that are Relevant in Determination of an Entity to be a Reported Entity

The understandability characteristic of the financial information states that it should be disclosed in a clear and concise manner so that it is easily understandable by the end-users. This implies that the financial information that is complex to be understood by the users should be made easy to understand by disclosing the relevant policies used for developing it in the notes section of the financial report. At last, the timeliness characteristic of the financial information stated that it should be to assist the decision-makers in time for influencing their decisions.  As such, the information disclosed must be current because the older it is the less worthy it becomes to be used in making investment decisions. As such, the business entities are required to disclose the financial information on an annual basis to released updated and current news about their financial performance to the end-users. Thus, it can be stated that the enhancing qualitative characteristics of conceptual framework improves the quality of financial information by making it understandable, comparable, verifiable and timely (Conceptual Framework for Financial Reporting, 2015).

The SAC (Statement of Accounting Concepts) has stated that reported entities need to develop and disclose the general purpose financial reports complying with the statement of accounting concepts and accounting standards. It is necessary for the entities having legal status to develop and disclose their financial information as per the needs and requirements of the users that are dependent on this information for taking relevant decisions such as investors, creditors, lenders and borrowers. SAC has identified that individual reporting entities are identified based on present of users who are dependent on them for making effective resource allocation decisions using information disclosed in their general purpose financial reports. Thus, identification of an entity as a reporting entity is based on the information needs of users as per the SAC concept (Whittington, 2008). In this context, the concept has identified and stated the factors that are relevant in identifying the situations of classifying a reporting entity as follows:

The larger the separation of management from the owners and other members having an economic interest in the entity the more likely is the presence of users who are dependent on the information provided in the general purpose financial report of a firm. The users rely of financial information disclosed by a firm for taking and valuation of their resource allocation decisions (Statement of Accounting Concepts, 2001).

Limitations of Historical Cost as a Measurement Base in Developing Decision-Useful Information to the Users of Financial Statements

There is large impact of the economic and political pressures on the ability of an entity for promoting the welfare of its external stakeholders. In this context, it has been stated that the larger is the economic or political significance of an entity the greater is the presence of users who are dependent on general purpose financial reports. As per this factor, a reporting entity can be regarded as an organization that have dominant position within the market and places large emphasis on balancing the needs and interest of significant groups. The reporting entities can be stated as businesses having employer and employee association’s and all the public-sector entities that have regulatory power (Vasek, 2014).

The reporting entities as per the SAC concept should possess the specific financial features that should be emphasized at the time of classifying it as a reporting entity. The financial characteristics to be considered includes determining its size that can be assessed by considering the sales value of assets or number of employees and customers. The case of non-business entities in specific should consider the amount of resources provided by the government for carrying its activities to determine the financial characteristics of an entity. The determination of size of an entity is largely important for gaining an evaluation of its dependent users as it is believed that larger the size of a reporting entity the more the users dependent on general purpose financial reports.

The purpose of the statement is to define the concept of a reporting entity and establishing the benchmark for the minimum required quality of financial reporting for an entity (Nawas, 2013).

Historical cost accounting method ahs been used over the past many decades by large number of business entities for reporting the financial transactions during the financial reporting. It has been regarded as the most dominant method for reporting the value of key financial items by the accountants over the years. Historical cost can be regarded as a measure of value used in accounting in which an asset price is recorded in the balance sheet on its original cost at the time of acquistion by a company. The US Generally Accepted Accounting Principles (US GAAP) has advocated the use of historical cost as a measurement base for recording the value of financial items such as assets and liabilities (Munteanu, 2015). Despite of the various criticism received by the cost accounting method, it has been widely used by the accounting managers due to ease of its application and simple to be understood. It is also easy costly among all the measurement systems that are currently available in accounting practices. It is also attributed to be an objective and reliable method of cost accounting as compared with that of other cost accounting practices.  Also, it is regarded to have the least possibility of having a measurement slack that is extent to which the financial statement numbers can be manipulated. Thus, these benefits of historical cost accounting method have caused the need for such a method to measure the assets and liabilities by the accounting board of various countries. Australia Accounting Standards Board (AASB) have also identified and stated the sue of historical cost basis as a measurement base for measuring the value of financial assets and liabilities (Effiong, 2012).

The assets and liabilities are measured based on past transactions or past events as stated in the AASB framework. However, the use of historical based cost accounting method has received large criticism from the various accounting professionals due to its numerous weaknesses that restricts its reliability for providing decision useful information. The major limitations of the historical cost accounting model can be stated as follows:

The financial reports developed with the use of historical cost accounting method does not represent the true value of a business entity. It does not consider the change in the money value due to fluctuations in the market prices. As such, the use of this accounting method does not seem to be adequate for providing realistic and true state of the financial position of an entity. The changes corresponding due to fluctuations in the market prices due to inflation is not considered under this method. The instability has resulted in causing distortions in the financial statements and this can be regarded as a major limitation of historical accounting method.

The historical method of cost accounting records the value of assets and liabilities at the price of its acquisition. It has not considered the changes in their value that has occurred due to market fluctuations. Therefore, historical method of cost accounting does not seem to be adequate for reporting the value of fixed assets and thus the values reported are unrealistic. The model assumes that the value of currency remains stable over the time-period. However, the monetary value of assets does not remain static as it is altered due to inflation that can lead to misinterpreted financial results due to measurement problems. This can lead to distortion of reported profits and its extent is dependent on the nature of assets that an entity holds. As such, if an entity has less of fixed assets then there will be less divergence in the deprecation calculated and therefore the distortion in its financial outcomes will be significantly less (Rahmawati, 2006).

The depreciation in the method of historical cost accounting is calculated based on original price recorded for valuing the fixed assets. The provision used for charging the depreciation on the initial costs is not adequate for replacing the assets. This could lead in reporting the manipulated financial results thus depicting unrealistic value of a business entity.

The income statement developed with the use of historical cost accounting is not accurate for revealing the actual state of financial profits of a company. This is because the revenue realized is reported on the current value and the expenses are recorded with the use of historical cost method. Therefore, it can give lead to overstating the reported profit by the income statement due to inflation.

The balance sheet also does not seem to be adequate in presenting the actual financial performance of an entity. This is because balance sheet consists of both monetary and non-monetary items. The monetary items such as cash, debtors and others are reported at current value whereas the non-monetary items such as inventory, land and building are reported at historical cost.  Therefore, it includes a probability of understating the value of non-monetary items due to period of inflation (Effiong, 2012).

Comparison of AASB 15 ‘’Revenue from Contracts with Customers’ with the Suspended Accounting Standard AASB 18 ‘’Revenue regarding measurement and recognition of Revenue’

AASB 15 for reporting the ‘Revenue from Contracts with Customers’ has replaced AASB 118 ‘Revenue’’ and is applicable to all the profit entities from the annual reporting period on or after January 2018. The major reason behind the change in the revenue standards by AASB to depict the transfer of goods or services to the customers at the amount that a firm expected to gain for exchanging those specific goods or services. The new standard does not expect to cause any change in the accounting practices used for recording the value of transactions that involves the sale of goods. The standard however is expected to cause major changes in the financial transactions that involves the provision of services containing multiple elements. The new accounting standard is expected to cause large-scale changes business reporting. AASB 15 has introduces a new revenue recognition model for improving the comparability pf revenue recognition practices across business entities. The replacement of AASB 18 from AASB 15 has lead to simplification of the accounting standards that is used for reporting and measuring revenue (Compiled Accounting Standard AASB 118, 2007). The standards have simplified the accounting method used for reporting the revenue as it has replacing all the existing methods and has incorporated them into a single standard. AASB 15 has extended the guidance provided for reporting the revenue by making it more specific for identifying the performance obligations. As per the standard, an entity should report the revenue only when it meets the criteria for performance obligations by transferring the promised good or service to a customer. The standard considers the assets to be transferred only when a customer obtains its control. It has enhanced the revenue comparability across the business entities and simplifying the guidance provided (Applying AASB 15 Revenue, 2017).

AASB 18 reports revenue based on measuring it on the fair value when it is received whereas AASB 15 measures the revenue when it is expected to be entitled by an entity. There have significant changes introduced in AASB 15 (“Revenue from Contracts with Customers”) as compare to AASB 18 (“Revenue”). In new standard accountant are required to allocate the revenue according to the satisfaction of the performance obligations of a contract. The action to satisfy the performance of obligations of contract has been divided into five steps. There have been no such requirements in old revenue recognition standard. As per old standard, sale of goods and rendering of services are being recognized respectively when company has transferred the rewards and risks to the buyer and stage of completion of services can be measured reliably. In old standard there are some more criteria that need to be fulfilled to recognize the revenue from sale of goods and services in the income statement.

In new revenue recognition standard income has not been divided into sales of goods and rendering of services but it has been classified as contracts with customers. The contracts with customers can be in nature of sale of goods, rendering of services, construction contract or ant type of contract that flow some consideration to the company. The income generated through the contracts with the customers must be recognized in the income statement after performing five main steps given in the AASB 15. These five steps are identification of contract with the customer, calculation of performance obligation under the contract, calculation of full transaction price, allocation of determined transaction price in each performance obligation that has actually been met and finally recognizing the revenue in income statement for each of performance obligation that has been successfully completed by the company. Here the contract can be verbal, written or implied. The most significant change between the AASB 15 and AASB 18 is that AASB 15 requires to record revenue after the satisfaction of performance conditions while there are no such conditions in AASB 18. Hereby it can be said that new standard will increase the volatility of revenue recognition (Probono Australia, 2018).  

Conclusion

It can be stated from the overall discussion held in the report that the use of right accounting method for measuring and recognizing the value of key financial items during financial reporting plays a significant role for providing decision-useful information. The business entities need to adopt the sue of adequate accounting policies for financial reporting to protect the interest of end-users. The report in this context has discussed the enhancing qualitative characteristics stated by the conceptual accounting framework for guiding the accountants during development of financial reports. The compliance with these characteristics will improve the quality of financial reporting. Also, the primary factors of political influence, financial characteristics and the segregation of management from owners play a significant role in classifying an entity as reporting entity has been identified through the report. The limitations of historical cost have been discussed that can lead to misinterpretation of financial results of a reporting entity. At last, the comparison of AASB 15 with AASB 18 has depicted that it has been done for improving the comparability of revenue classification. Therefore, it can be stated that all these measures are undertaken by IASB for improving the quality of financial reporting to provide decision-useful information to the end-users.

References

Applying AASB 15 Revenue. 2017. [Online]. Available at: https://nexia.com.au/news/accounting/applying-aasb-15-revenue [Accessed on: 14 September 2018].

Australian Accounting Standards Board: Conceptual Framework. 2017. [Online]. Available at: https://www.aasb.gov.au/Pronouncements/Conceptual-framework.aspx [Accessed on: 14 September 2018].

Compiled Accounting Standard AASB 118. 2007. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB118_07-04_%20COMPapr07_07-07.pdf [Accessed on: 14 September 2018].

Conceptual Framework for Financial Reporting. 2015. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/ACCED264_06-15.pdf [Accessed on: 14 September 2018].

Effiong, C. 2012. Comparative analysis of fair value and historical cost accounting on reported profit. Research Journal of Finance and accounting 3(8), pp. 132-149.

Kabalski, P. 2009. Comments on the Objective of Financial Reporting in the Proposed New Conceptual Framework. Eurasian Journal Of Business and Economics 2(4), PP. 95-111.

Munteanu, V. 2015. Debate Regarding Measuring Accounting Value: Historical Cost against Fair Value. Academic Journal of Economic Studies 1 (4), pp. 91–102.

Nawas, R. 2013. Factors affecting the quality of Auditing: The Case of Jordanian Commercial Banks. International Journal of Business and Social Science 4(11), pp. 206-222.

Probono Australia. 2018. Impact of Accounting Standard Changes in Recognition of Revenue. [Online]. Available at: https://probonoaustralia.com.au/news/2017/07/impact-accounting-standard-changes-recognition-revenue/ [Accessed on: 15 September, 2018].

Rahmawati, E. 2006. Support and Against Historical Cost Accounting: Is it Value Relevance for Decision Making. Jurnal Akuntansi dan Investasi 7 (1), pp. 113-125.

Statement of Accounting Concepts. 2001. Definition of the Reporting Entity. [Online]. Available at: https://www.aasb.gov.au/admin/file/content102/c3/SAC1_8-90_2001V.pdf [Accessed on: 14 September 2018].

Vasek, L. 2014. Can a New Concept of Control under IFRS Have an Impact on a CCCTB? European Financial and Accounting Journal 9 (4), pp. 110-127.

Whittington, G. 2008. Fair value and the IASB/FASB conceptual framework: an alternative view”. Abacus 44 (2), pp 139-168.

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