You are required to explain which qualitative characteristics of financial reporting, as per the conceptual framework, do not, in the opinion of the above quoted individuals, appear to be satisfied by current reporting practices pursuant to IFRS. Also, you are required to consider whether the views are consistent with the view that corporate financial reports satisfy the central objective of financial reporting as identified in the Conceptual Framework.
IFRS vs GAAP - Differences in Revaluation of Assets
The information which is given in the financial statements, annual report and notes to accounts and disclosures of the companies form the basis for decision making by most of the investors and the stakeholders as to if the company is in good financial and economic state of affairs. But all the information that appears in the financial statements may not be relevant for decision making. There are some financial and non financial information that should be provided to the stakeholders so that the decision making can be enabled (Alexander, 2016). Some of these qualitative characteristics that forms the pre requisite for the information disclosed are mentioned below:
- Understandability: All the information that is being disclosed in the financial statements should be very clear and should not involved any sort of confusion or having different meaning in different contexts. It should be easily understandle by the end user and he.she should be able to interpret the same. This involves the users who would be having the basic knowledge of finance, accounting, taxation and economics and who will possess business intelligence and the financial wisdom and would be able to comprehend the information mentioned in the financial statements in the true manner(Belton, 2017). If the information is being posted clearly and without ambiguity, then the user can draw conclusions out of the same and form an opinion as to whether to invest or not. In case the balance sheet and profit and loss account and the cash flow statement of the company includes any complex transactions which are not easily understandable, then the note should be provided in the financial statements to evade any sort of confusion for the end user.
- Relevance: The information which is given in the financial statements should be relevant to the circumstances of the case and that adds value to the decision of the investor. It should not be vague and redundant and should not be just given in financial statements just for the sake of giving it. The management who is responsible for preparation and presentation of the data should keep in mind that the vast and enormous quantity of data does not help but its quality helps. In the end, it should result in meaningful inferences and conclusion. To be relevant, the data should be relative and can be connected with the given option which is under consideration(Bromwich & Scapens, 2016).
- Reliability: It is clear that the financial statements cannot be completely free from error and mistakes, but effort should be taken by the preparers of the financial statements such that the material misstatements and mistakes cum errors should be kept minimum while preparing the same. For any data to be reliable and trustworthy, the same should be free form any biasness and personal predujice meaning any personal interpretation should not be applied and it should be reporesented in its true form. All the transactions and business events and balances in the accounts should be reflecting the true and fair view of the business and there should be appropriate disclosure for the same in case if they are not quantifiable(Chron, 2017). However, in case any non financial item is being shown in the financial statements, the reason as to why the same cannot be quantified should also be disclosed.
- Comparability: To enable the comparison for the end user and take the decision accordingly, the data must be prepared and presented in a comparable manner. It can be among the periods or two companies in the same industry or the company against the industry as well. Such comparability enables the end user to establish the trends and make analytical study of the performance of company against the benchmark as well as on standalone basis. It also helps to know whether the company is moving and achieving its strategic goal as to whether it is growing or stagnant or declining.
Having thrown light at each of the individual qualitative characteristics of the financial statements, it can be said that the current reporting practices based on IFRS do not satistfy the same. The disclosures that are being given under IFRS are inelastic and rigid which are less meaningful in the contect of the investor requirement. Also, since it is intricate, it makes the understanding to be complicated and decision making a far fetched process. It can only be interpreted well by the person having technical knowledge and expertise of the subject and those who are able to the interpret and analyses the abundance of data (Dichev, 2017). Such a overflow of data will confuse the lay man or a normal investor and would complicate the decision making process. Therefore, Mr. Bowen has correctly quoted that “Once you get into the notes you have to be technically trained. If you’re not, lot of it could be misleading”. Hence, it can be concluded that the views mentioned in the case study are not consistent and are an anomaly to the view that the corporate financial statements satisfy the central objective of financial reporting.
The Public Interest Theory: The name itself is suggestive of the fact that the theory is based on the general good and prosperity of the public. It aims to solve all the issues and give ideas to curb the inefficiencies for making things better and productive for the general masses. There can be internal as well as external stakeholders both of which are crucial from the company point of view and they need to adequately catered. Internal stakeholder include the employees, the debtors, the creditors, the management etc and the external stakeholders include the government, the investors, the banks and financial institutions, etc (Félix, 2017). The theory is based on the idea that the imperfect markets are being controlled by the government. However, in actual the companies are being given all the opportunity to take the business decisions and generate returns that are satisfactory. Looking into the current situation where the separate set of laws, rules & regulations have not been defined by the government, it can be said that the public interest theory has been disregarded. Had the government considered it important and significant to disclose the given set of policies and procedures in the general public interest and its welfare, then the government would have come out with some sort of regulation to make it mandatory.
Theories Related to Financial Reporting
Capture Theory: This theory is based on the relationship between the regulatory agencies, the government and the industry or business entities as a whole. Decision is generally being taken for the market to which the above mentioned parties are the participants. As per the theory, the regulators are framing the laws and taking the decisions in such a manner that the needs and interest of the entire group is satisfied (Werner, 2017). This theory believes in the idea that the theories can be modified and twisted to make ist suitable for the parties who are affected by it. In case this theory is being applied to the decision of the government of not adding any separate statute to the existing statute, it can be concluded that even this theory has not been met and given due consideration. In the first place, the government has not framed any rules or regulations which would be affecting the industry and its participations, thereby the question of changing, modifying or amending it in the long run does not even exists.
Economic interest theory and regulation: This theory is based on the idea that the laws and regulations are being made on the continuous interaction of forces of demand and supply. In general parlance, government and its agencies form the supply side whereas the general public forms the demand side. This model mentions that the industry forms the given code of conduct to be applicable for the entire market and which are formed for the benefit of various companies. There is no external interference and the government invites all the relevant stakeholders for matters involving any decision making. In the given case, the government taking decision not to implement any separate legislation has been taken considering the economic interest. The admisintration or the government has made it clear that since the decision is being taken by combined forces of demand and supply, therefore only those firms would be succeeding who would be meeting the expectations of the general public (Visinescu, et al., 2017).
One of the differences which come out on top in between the IFRS and the GAAPs of the individual countries across the globe is the method and topic relating to revaluation of the assets. The discussion and varied views arise from the fact that the revaluation of assets is allowed under IFRS standards and not under respective GAAPs. The decision to revalue or not directly relates to the qualitative characteristics of relevant and reliable information in the financial statements (Vieira, et al., 2017). Therefore, the same should be considered from view point of disclosure requirements. The stakeholders and the end users do wish to know the fair value of the assets being held in the balance sheet and therefore the management provides the same to meet the requirements of conceptual framework but the correctness and reliability of the same is still a debatable issue as it is almost impossible to determine the exact fair value of the asset considering a number of assumptions and estimates that are taken into consideration. Diefferent analysts and management consultants may come up with different fair values. The realizable value keeps on changing every day based on the variables like estimated useful life, the efficiency of the asset and the degree of uncertainity involved in valuation. Due to all this issues, IFRS eliminates the entire idea of revaluation of the non current assets. Instead, it is mandatory to account for the impairment cost on account of the non current assets and disclose and adjust the same in the financial statements as the same is certain and can be quantified easily. Therefore the presently laid down standards aims of achieveing the objectives of relevance and faithfulness in the representation of information in the financial statements.
The decision whether to revalue the assets or not is taken on the basis of size of the organization and the quantum of fixed assets that it possesses.
- Amidst so much of controversies and contradictions, some companies still continue to revalue the assets upwards and downwards. However, practically, asset revaluation involves both modification of accouting as well as financial data. It has its impact on a number of variables like future depreciation, the tax liability and the retained earnings. This in turn might have an impact on the share prices of the company. Besides this, the revaluation tasks brings about a lot of complexity and compliance related takes such that the disclosures are to be made(Linden & Freeman, 2017). The carrying amount needs to adjusted in such a manner that the fair values of the entire class of assets is being calculated. On top of that, since revaluation is a non cash item, it does not have a direct impact on the cash flows of business. Hence, every step of revaluation requires complex tasks, compilation and calculation of a huge range of data which also involves monetary outflow in case the professional help is being sought for. After all this activity and efforts, the revalued figure may still not be reconciling with the real values. Due to all the abive mentioned factors and the level of uncertainity involved, management is generally unwilling to take up the revaluation of plant, property and equipment.
- Financial statements are generally prepared and issued in the public forum not only to meet the requirements of law, regulations and standards but it should also represent the true and fair view of state of affairs of business. This means that the balance sheet as well as profit and loss account should represent clear and realistic figures which can be evidentiated through workings. When the assets are being shown at hiostorical cost less depreciation, it may not be on par with the market or fair values(Kuhn & Morris, 2016). This is like sharing unfair and wrong informtion in the financial statements basis which the financial decisions would be taken. Furthermore, we know that equity is always being shown at the fair market value and so not showing fixed assets at fair value will give wrong results for the debt equity ratio. This has a direct impact on the borrowing powers of the company.
- The impact not to revalue the assets on the shareholder’s wealth is dependent on internal and external factors. It is true that it gives an unrealistic picture of accounts but its direct impact on shareholders cannot be measured as it does not results in the actual inflow or outflow of cash. Even though this does not have a direct impact on profitability but the revaluation balance when added to retained earnings might give and impression that the shareholders’ wealth has increased but the same is not true. The same is the case when there is a downward revaluation. The reaction of the market to this change does not results in value creation or destruction to the shareholder’s wealth(Sithole, et al., 2017).
References
Alexander, F., 2016. The Changing Face of Accountability. The Journal of Higher Education, 71(4), pp. 411-431.
Belton, P., 2017. Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat International ltd.
Bromwich, M. & Scapens, R., 2016. Management Accounting Research: 25 years on. Management Accounting Research, Volume 31, pp. 1-9.
Chron, 2017. five-common-features-internal-control-system-business. [Online]
Available at: https://smallbusiness.chron.com/five-common-features-internal-control-system-business-430.html
[Accessed 07 december 2017].
Dichev, I., 2017. On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), pp. 617-632.
Félix, M., 2017. A study on the expected impact of IFRS 17 on the transparency of financial statements of insurance companies. MASTER THESIS, pp. 1-69.
Kuhn, J. & Morris, B., 2016. IT internal control weaknesses and the market value of firms. Journal of Enterprise Information Management, 30(6).
Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), pp. 353-379.
Sithole, S., Chandler, P., Abeysekera, I. & Paas, F., 2017. Benefits of guided self-management of attention on learning accounting. Journal of Educational Psychology, 109(2), p. 220.
Vieira, R., O’Dwyer, B. & Schneider, R., 2017. Aligning Strategy and Performance Management Systems. SAGE Journals, 30(1).
Visinescu, L., Jones, M. & Sidorova, A., 2017. Improving Decision Quality: The Role of Business Intelligence. Journal of Computer Information Systems, 57(1), pp. 58-66.
Werner, M., 2017. Financial process mining - Accounting data structure dependent control flow inference. International Journal of Accounting Information Systems, Volume 25, pp. 57-80.
