Discuss about the International Classification of Financial.
Conceptual framework guides the preparation and presentation of financial statements with the objective of enhancing the ability of the financial statements to reflect the true and fair financial position of an organization as on the end of the financial period for which the financial statements have been prepared. The brief history of conceptual framework will help us to understand the initial objective with which it was established. The history of conceptual framework will guide us to understand the direction that it has given to the overall financial reporting and how the financial reporting has evolved over the years with the introduction of conceptual framework (Macve 2015). In order to evaluate the actual impact of conceptual framework on the process of financial reporting, each and every aspect of conceptual framework has been thoroughly assessed to track the evaluation of financial reporting along with the evolution of conceptual framework.
Underlining the concept to be used in the preparation and presentation of financial reporting was the main objective behind the conceptual framework at the time of introduction of the concept. However, with the changing time other objectives have been included to modify the conceptual framework accordingly (Bice 2014). However, the main objective remains the same, i.e. to set out the concept to guide the preparation and presentation of financial statements in a manner suitable for reflecting the true and fair picture of an organization with respect to its financial performance and financial position as on a particular date.
The purpose of conceptual framework in financial reporting:
Financial reporting is the process of preparation and presentation of financial statements of an entity with the objective of providing the stakeholders of the entity necessary information about the results and financial position of the entity over a particular period which is being covered in these statements (Zhang and Andrew 2014). In order to be useful the financial statements must portray the true and fair picture of an entity to the stakeholders. Thus, in order to reflect the true and fair financial performance of the entity and financial position as on a particular date the financial statements must follow some standard guidelines. The need of some standard guidelines for the preparation and presentation of the financial statements give rise to the conceptual framework of financial reporting. Thus, the purpose of conceptual framework is to guide the accountants and management in preparation and presentation of financial statements to ensure that the financial reporting process provides the users of financial statements and stakeholders of an organization useful information about the financial performance and position of an entity as on a particular date (Henderson et al. 2015). The purpose of conceptual framework can broadly be discussed as following:
- To provide the accountants and management a standard guideline to be followed in preparation and presentation of financial statements.
- To improve the quality of financial reporting.
- To enhance the usefulness of the financial statements.
- It helps the accounting standard setting bodies to develop appropriate accounting standard.
- Reducing the scope of personal judgements, estimates in the process of financial reporting by reducing the alternative accounting principles and policies to limited few.
- It helps the auditor to form audit opinion by evaluating the financial statement based on the conceptual framework;
History of conceptual framework:
The conceptual framework of financial reporting has undergone numerous modifications and it is still developing as there is still continuous efforts been made by the International Financial Reporting Standards Board (IFRSB), earlier used to be known as International Accounting Standards Board (IASB), to improve the conceptual framework to enhance the quality of financial repairing in the future. IASB with the primary objective and purpose of assisting the accountants in preparation and presentation of financial statements introduced the conceptual framework of financial reporting (Cheng et al. 2014). Initially there were International Accounting Standards, here in after to be referred to as IASs, which were prepared to guide the preparation and presentation of financial statements of an organization. However, with the continuous development and changes in the economic and financial environment around the globe the need of modification to the erstwhile IASs arose and hence, the International Financial Reporting standards were formulated and issued by the IFRSB.
Development of conceptual framework:
With the ever-changing economic, financial and accounting environment across the globe, the importance of financial reporting which once was considered luxury for the business organizations became integral to the success and efficient functioning of an organization. Thus, with the passage of time and the changing circumstances and situations the need and importance of financial reporting have also increased (Erb and Pelger 2015). With these changes, the need for a comprehensive conceptual framework also arose thus, it was necessary to continue on the path of evolution to ensure further solidarity to the conceptual framework in financial reporting.
The size and complexities of a business organization has changed significantly as with globalization the entities have the license to operate from different parts of the world. Thus, the importance of financial reporting have increased significantly. The conceptual framework must also be developed accordingly, to ensure that it is align with the requirements of changing business environment. Accordingly, the IASB must in consultation with premier accounting standards boards of different countries that are also member of the IASB should modify the conceptual framework to suit the needs of modern financial reporting. Thus, constant modification and development of conceptual frame work is a must to enhance the quality of financial reporting.
Limitations of existing conceptual framework:
The existing conceptual framework of financial reporting has numerous issues which have been identified in order to fix these issues by making necessary modifications to the conceptual framework to improve the quality of financial reporting in the future. The problems and issues identified in the existing conceptual framework are as follows:
- Numerous areas important to the financial reporting process have not been covered in the existing conceptual framework. These areas include presentation, guidance on measurement, disclosure requirements and above all the requirements to identify a reporting entity (Simnett and Huggins 2015).
- The definitions provided on assets and liabilities are certainly not clear and could be improved since the whole concept of financial reporting is pretty much standing on the foundation of assets and liabilities and recognition of these in the books of accounts of an organization.
- There are certain areas which are quite confusing in the existing conceptual framework. For example, the existing conceptual framework states that only if the flow of economic resources is probable, i.e. outflow of economic resources in case of a liability and inflow of economic resources in case of an asset, only then an asset or liability should be recognized. However, the IASB has also mentioned that in some cases recognition of assets and liabilities without the probability of flow of economic resources will provide useful information to the users of the financial statements (Chih and Zwikael 2015).
Potential usefulness of the conceptual framework:
The IASB has formulated number of accounting standards along with accounting principles and policies to guide the practice of the accountants for recording the financial transactions in the books of accounts of an entity. Following the underlying concepts provided in the conceptual framework which include the accounting standards, fundamental accounting principles and policies is mandatory in preparation and presentation of reports to portray the true and fair picture of entity as on the date to which the reports relate (Sierra?García et al. 2015). Thus, the concept to underline the preparation and presentation of financial reports have a huge influence on the overall financial reporting as the quality of financial reporting has improved immensely with the introduction conceptual framework. Considering that the process of evolution in conceptual framework is a continuing process the utility of it in the overall financial reporting is immense. The usefulness of the conceptual framework can be broadly classified and discussed as following;
Improving the quality of financial reporting:
The quality of financial reporting has improved a lot due to the conceptual framework as it has enhanced qualitative characteristics of financial statements. Qualitative characteristics such as comparability of financial statements, improving the ability of the financial statements to reflect the true and fair picture of an organization etc (Palea 2014).
Reducing the alternative accounting policies and principles:
The alternative accounting policies and principles prior to the introduction of conceptual framework were greater in numbers. However, with the conceptual framework these alternatives have been reduced significantly to improve the quality of financial reporting (Lee and Zhong 2014). As the number of alternative accounting principles and policies have reduced, the qualitative characteristics of the financial statements have enhanced simultaneously.
Reduction in scope to manipulate accounts: Conceptual framework provides standard guidelines that are to be followed by the accountants to prepare and present the financial statements (Nobes 2014). Thus, the scope to manipulate accounts by using personal estimates and judgments have reduced significantly.
Reflecting the true and fair financial position:
As a result of conceptual framework the ability of the financial statements to show the true and actual financial performance and true and fair financial position of an organization have improved considerably (Kroeger and Weber 2014). The concepts underlying the preparation and presentation of financial statements have improved the quality of financial reporting thereby improving the ability of the financial statements to show the true and fair financial position of an organization as on a particular date.
Useful information to the users of the financial reports:
The financial statements prepared in accordance with the guidelines provided in conceptual framework contain important financial information’s that are very useful for the users of the financial statements (Alrazi et al. 2015). The users of the financial statements will be able to take better decision about matters affecting their interests in an organization by using the financial statements.
Enhancing the confidence of the stakeholders on the financial reporting process:
The conceptual framework has enhanced the confidence of stakeholders of an organization and the users of the financial statements on the overall financial reporting process. The use of mandatory accounting standards and accounting principles in preparation and presentation of financial statements have improved the quality of these statements (Fonseca et al. 2014). As a result the confidence of the users on the financial reporting process have increased significantly.
Eight points to indicate the new knowledge:
The usefulness of conceptual framework has made it clear that even though there are certain limitations of the existing conceptual framework of financial reporting however, the benefits are far in excess of the limitations (Reuter and Messner 2015). Taking into consideration the discussion above the eight new points including both usefulness and limitations are discussed below.
The lack of clarity in defining the assets and liabilities in the existing framework certainly affects the financial reporting process:
The definitions provided in the existing conceptual framework for assets and liabilities have certainly added to the limitations of the conceptual framework. Thus, a better definition on the assets and liabilities would help to improve the overall quality of financial reporting.
Asset and liabilities recognition criterions could have been modified to clear the confusion:
There is significant confusion in recognition criterions of assets and liabilities. Thus, whether to follow the probability of economic benefits flowing to or from the organization should be made clear to get rid of the confusion (Reuter and Messner 2015).
Process of evolution continues:
The process of evolution whether by formulating and issuing new and improved accounting standards or by any other means will continue as it is a continuing process.
Additions to cover further areas:
The existing conceptual framework does not cover certain areas such as measurements, disclosure and identification criterions for reporting entity. It is essential to make necessary additions to cover these areas to improve the overall financial reporting quality.
Integration with the economic and financial environment:
The conceptual framework takes into consideration the changes in economic and financial environments to ensure that it is relevant and up-to-date with requirements of the present situation (Heald and Hodges 2015).
IFRSs and its importance:
The IFRSs developed to succeed the IASs are also to be continuously up-dated in accordance with the need of the time to ensure they are not out-dated and are in accordance with the requirements of the modern financial reporting environment.
Disclosure and presentation requirements:
The disclosure and presentation requirements are equally important to the financial reporting process and the conceptual framework makes it amply clear that an organization must take into consideration their importance while preparing and presenting the financial statements in accordance with the conceptual framework (Dinnie 2015).
Applicability of IFRSs and IASs:
Irrespective of the nature of the organization, whether profit oriented or non-profit organization the applicability of conceptual framework is Perpetual.
Summarizing from the above discussion it is clear that the benefit of conceptual framework in financial reporting is numerous. However, there are certain limitations of the existing conceptual framework which must be addressed in the future by making necessary changes to the existing framework to ensure that the existing framework does not lose relevance in the future. Continuous up-gradation of the accounting standards and policies on the basis of the modern day requirements of financial reporting will be useful in improving the quality of financial reporting in the future.
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