This is an organized system of complimentary objectives and principles guiding financial accounting and reporting. Its application results in uniform application of the accounting standards and defines the scope and limitations of them. The framework was generated majorly for accounting activities. It can be used as a procedure for developing the standards and as well as settling conflicts (Z. Rezaee, 2010).
The theoretical framework is an accounting assumption created by a body involve in the formulation of accounting standards. The use of this framework allows fair testing of practical problems. Hence, the exact definition of the conceptual framework is the group of theories and targets which are used in the formulation of significant set of guidelines. In the accounting field, these rules are complementary. The framework therefore forms the basis of defining the accounting standards and the main principles (Daske, 2008).
The use of financial framework in financial reporting has some clear advantages such as enables discussion of accounting problems and acts as a roadmap to guide the setters of accounting guidelines. Furthermore, using of the agreed framework is associated with several other benefits such as boosting the confidence and understanding of the users regarding financial reporting, provision of the scale against which some distinguished accounting can be verified with accuracy (Ball, 2003). It also provides the basis for reasons and decisions in addition to offering a space for consistency in developing decisions which are majorly associated with various ways of assisting the accounting standards (Karampinis, 2011).
Due to globalisation and improvements in the field of technological advancements there has been a lot of focus among the academicians and professionals in the field of accounting for in line with the IFRS (Chamisa, 2000).
IFRS are accounting guidelines which are availed by the International Accounting Standards Board and they are majorly as per the scope of developed countries guidelines. To this extent, it’s still quit not clear if the adoption of the IFRS in the developing countries will be beneficial given the large different in the setup of the economies between the developing and developed countries. For accounting standards to avail helpful learning, it is recommended they reflect their areas of operation.
The essence of the conceptual framework was to acts as guideline for the Australian Accounting Standard Board in its creation of future Australian Accounting Standards as well as assessment of the planned International Accounting Standards Board pronouncements.
It also used by the AASB to harmonise the board tasked with monitoring accounting activities together with the rules associated with preparing of financial statements through provision of a foundation for cutting down the extent to which other accounting treatments are acceptable to the AASB.
In addition, the framework also helps the people tasked with preparing the financial statements I their application of the Australian Accounting Standards as well as in handling issues that are yet to be covered by the AAS. Furthermore, auditors may rely on it when they are generating an opinion on the financial statements conformity with the Australian Accounting Standards.
When decoding the information portrayed by financial statements generated by the guidance of the AAS the users of the information may rely on the conceptual framework. Also, the various parties with interest on the AASB’s work can obtain information regarding the path used to generate the Australian Standard Board.
Assumptions under the Australian conceptual framework system
The framework assumes that the entity preparing the financial statements will be in operation in the foreseeable future. So, in this case the accounting documents preparation are based upon the mentality of the firm not being in the path of terminating its operations or winding up soon. In case such a case arises, the statements may be made in line with another principle other than the one outlined by the Accounting Standards Board and the basis revealed within the notes to the financial statements.
Elements of financial statements
The financial statements are majorly divided into statement of income statement and balance sheet. Assets, liabilities and equity are the components of the balance sheet while components related directly with the income statement are the incomes and expenses
As per the Australian conceptual framework of the elements is defined as stated below
This are tangible or intangible goods with potentiality to benefit the firm economically either directly or indirectly in future.
For non-profit organizations, be it in the public or private sector this future economic benefit can be utilised to avail goods and services as per the requirements of the firm’s objects. Though considering the entities non-profit statue the provision of goods and services might not result into any form of cash flow to the firm. This lack of cash flow should not be interpreted as lack of economic benefit to the firm. Since, by being able to provide the services either freely or at a partial cost the firm will reach its target of availing the goods to their target group.
The major feature of a liability if the presence of responsibility on the part of the entity to perform in specific way. Some obligations especially those arising from binding contacts or guided by legal provisions are legally enforceable. Settlement of the obligations results into cash outflow.
This are the shareholders claim in the business. They include retained earnings, shareholder’s contribution and reserves. The grouping of the equity is useful for the decision making by the accounting information users. Also, through the classification of equity we can identify the variation on claims among the different shareholders. The reserves are mainly statutory requirements which are put in place to give the creditors of the firm substantial security from losses in their dealings with the firm.
These are reductions in the economic benefit on the course of the accounting year via cash outflows or depreciation of assets
These are additions in the economic benefits of the firm within the accounting year resulting from reduction in liabilities hence increase in equity.
Performance evaluation of organizations under the framework system
Most of the firms use evaluation of profits to ascertain the performance of the firm as well as in analysing other measurements such as earnings per share. The measurements of profit are directly based on income and expenses elements. The presentation of incomes and expenses may take variety of patterns depending on the information needed by the users to make relevant decisions.
Evaluating the components of financial statements
This is the procedure of gauging the monetary value upon which the financial statements are recorded within the books of original entry as well as transferred to be balance sheet and the income statement. The importance part is choosing the basis for the measurement. A variety of principles are applied in varied magnitude in alternating ratios in the financial statements:
Historical cost: In this basis asserts are recognised at the cash value or cash equivalent paid. On the other hand, liabilities are recognised at the value of the proceeds offered in exchange for the obligation. In some situations, it is measured in terms of the amount expected to be paid to fulfil the obligation during the business’ operation.
Current cost: Here assets are recognised at the monetary value or cash equivalents that would be offered for the asset should it trade currently in the market while liabilities are recognised at the overall amount that would be needed to cater for the obligation currently
Realisable value: Assets are priced at the cost or cash equivalent that we would get should we sell the asset in an orderly market and liabilities are recognised at the expected value of settling them in the ordinary business course.
Present value: Records assets at the presented discounted value of the future net cash inflows expected to be generated by the asset. On the other hand, liabilities are recognised at the present discounted value of the future cash outflows expected to result from the liability in the future.
This concept id adopted by many entities in their preparation of financial statements. As per financial concept of capital, capital is synonymous while under the physical concept of capital, capital is defined as the productive capacity of the organization. The necessary concept of capital selected by the frim when preparing its financial statement is based on the users’ requirements. This is because the chosen concept gives an indication of the objectives to be attained while measuring the firm’s profits (Rezaee, 2010).
Concept of capital maintenance and the calculation of profits
Under capital maintenance there are a variety of concepts
Financial capital maintenance, here the profit is considered earned only if the monetary value of the assets at the year-end exceeds the monetary value of the similar asset at the beginning of the financial year. This calculation excludes any additions by the shareholders during the financial period.
Physical capital maintenance, here profit is generated whenever the physical productive of the entity at the year-end exceeds the productive capacity at the beginning of the financial year. Any distribution to or contribution from the shareholders during the financial year are excluded.
The capital maintenance concept deals with the way an organization defines the capital that it targets to maintain. It gives the relationship between the capital concept and profit concept. It’s a requirement for separating an organization’s return on capital and returns of capital. Profits are only regarded by the inflows of capital which exceeds the amount necessary to maintain capital. Hence profits are the amount that are left after deducting the expenses from the income. Should expenses exceed income then the different will be regarded as a loss.
The physical capital maintenance concept needs the adoption of the current cost basis in the measurement on the other hand the financial capital maintenance concept requires no use of a basis of measurements, the choice of a basis in this case simply depends on the form of financial capital the firm needs to maintain.
This two concept of capital primarily differs in the treatment of the results of changes in the prices of assets and liabilities of the organization. An organization is said to have retained its capital if at the end of the accounting period it has as much capital as it had at the beginning of the accounting year. Any value above the one necessary to maintain capital at the beginning of the period is regarded as profit (Prather-Kinsey, 2006).
The choice of bases for measurement of capital maintenance guides the accounting model applied in the preparation of financial statements. The magnitude of relevance and reliability between various accounting models differ and in some cases, it might be upon the management to strike a balance between relevance and reliability
Information regarding the reporting firm’s resources and claims
Generally, the financial statements avail information regarding the financial position of the firm. This entails the information concerning the firm’s resources and the claims against the resources either by the shareholders or the outsiders (creditors). The statements also avail information on effects of transactions and other significant events that might change the reporting firm’s economic resources and claims. Either way the information gives useful inputs for decisions regarding the resources of the firm (Tyrrall, 2007).
Claims and the economic resources
The data regarding an entity’s nature and quantity of economic resources assist users to gauge the reporting firm’s strengths and weaknesses. That information can be used to analyse the firm’s liquidity and solvency status. The data regarding the priorities and payment needs of the current claims allows the users to predict the distribution of cash flows among the individual with claims on the reporting firm’s resources (Tyrrall, 2007).
The variety of economic resources determines a user’s analysis of the reporting firm’s prospects for the expected future cash flows in different ways. Some of the future cash flows may arise directly out of the existing economic resources like the account receivables while others arise from the use of a combination of a variety of resources to cater for the needs of the consumers (Sidik, 2012). Even though such resources can’t be attached to individual economic resources the users of the financial statements still need to be aware of the nature and value of the resources present for utilisation by the operations of the organization.
Alterations in the economic resources and claims
The entity’s financial performance has a direct effect on the alterations in the entity’s economic resources and claims. This is also contributed to by other activities or transactions such as issuance of equity instrument. To thoroughly assess predictable future cash flow of the reporting firm, the users of the financial will need to be able to differentiate these changes.
The information contained in the statement of financial performance is useful in the gauging of the return of the organization from its invested economic resources. On the other hand, this information regarding the entity’s return is useful in judging the performance of the organizations management (Tan, 2007). The data on the variability and elements of the return is useful in predicting uncertainties associated with future cash flows. Finally, the data on the reporting firm’s previous financial performance and the management’s efficiency is useful in analysing the firm’s future returns on its invested economic resources.
Financial performance as indicated by accrual accounting
Accrual accounting shows the consequences of transactions, activities and situations on a reporting firm’s economic resources and claims in the financial years in which the changes took place. Even if the period of cash receipt and payments differs. This is useful due to the influence of information about the economic resources and claims of a firm in forming the basis for analysing the firm’s past and future performance.
Data on the reporting firm’s operations during a financial year shown by alterations in its economic resources and claims gives a basis for analysing the firm’s past and future operations compared to information specifically talking about cash receipts and payments within a financial year.
The data regarding a firm’s financial performance within an accounting year shown by alterations in its economic resources and claims other than by gaining extra resources directly from shareholders and creditors is importance in assessing the organization’s past and future capacity to raise net cash inflows. That data shows the magnitude to which the reporting firm
Has expanded its present economic resources and as a result its capacity for raising net cash inflows via its activities rather than gaining extra resources directly from investors and creditors.
In the case of non-profit organizations, the data necessary to predict a firm’s past and future capacity to raise net cash inflows via its activities is in turn necessary for gauging whether the cash inflows from taxpayers, and other sources have the likelihood or remaining adequate to cater for the cost of providing a given capacity of goods and services.
Arguments against conceptual framework system
One of the biggest challenge of the conceptual framework is the complexity in setting it up. The resources consumed in terms of time and capital is massive a reason why it’s not common in developing countries. Moreover, the framework is characterised with massive rigidity which may not avail adequate path for accounting purposes. Due to this rigidity, it becomes difficult to integrate new ideas in to the framework (Wallace, 1990).
A conflict between the previously established standards and the conceptual framework may also be a preparation as well as an interpreter hurdle. Together with this the fact that the framework can only offer opportunity for utilisation by a portion of the users also hinders its adoption (Joshi, 2008).
The Australian conceptual framework gives a well and easy to understand guideline concerning the preparation and presentation of financial statements. It clearly outlines the definition of elements, recognition of elements in the financial statements, measurements of the elements for purpose of inclusion in the statements as well as ways of calculating profits. Furthermore, the idea of capital and capital maintenance is well explained. Even though putting all the details outlined in the framework in place might be a task for companies, clearly the advantages derived from adhering to the framework are visible (Assenso-Okofo, 2011)
The economic countries adopting the Australian conceptual framework system will truly make the preparation and reporting of the financial statements much easier. Considering the uniformity that will be generated by integration of other economic countries to the framework together with the ease of use resulting from presenting the elements as per this framework, I can therefore conclude that its adoption will clearly go ahead to improve the presentation of the financial reports a lot (Aljifri, 2006).
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