Essay: Importance Of Conceptual Framework In Accounting For Environmental Liabilities And Risks.

Importance of IASB and FASB sharing a common conceptual framework

Discuss about the Reporting of Environmental Liabilities and Risks.

The conceptual framework has been developed by the IASB and FASB for explaining and defining the objective of accounting. The conceptual framework provides an in-depth understanding of the theoretical and conceptual issues in financial reporting that underlines the development of accounting standards. The accounting standards are generally based on generally accepted accounting principles (GAAP) that develops a frame of reference for the businesses worldwide at the time of preparation of financial statements. The principles-based standards require a conceptual framework to provide a proper explanation of the body of principles that are used for financial reporting. The use of principles-based approach for the development of accounting standards would help to attain the objectivity of financial reporting by providing practical-based outcomes. The conceptual framework will provide proper guidance for the application of accounting standards at the time of financial reporting. The FASB has developed conceptual framework that provides proper explanation to the accounting concepts for facilitating the development of financial statements (Barth, 2007).

The principles-based approach provides a conceptual basis for accountants to ensure the development of sound financial reports. The incorporation of principles-based standards in conceptual framework will provide broad guidelines to explain the objectives of accounting. The principles-based standards must be rooted in fundamental concepts for developing good financial accounting and reporting. The fundamental concepts of accounting must constitute a framework that is sound, comprehensive and internally consistent. The FASB and IASB has developed the conceptual framework of accounting that is mainly rules-based and should be developed into principles-based for providing broad guidelines to develop sound financial reports (Pounder, 2009).

The FASB and IASB should develop a common conceptual framework for increasing accuracy and consistency in accounting and financial reporting. The FASB and IASB have undertaken a common project in the year 2002 for revisiting the conceptual framework. The main objective of the project is to refine, update, complete and converge the existing frameworks of tow boards into a common conceptual framework. This is necessary for developing a common conceptual framework that is principles-based and therefore develops accounting standards that are fundamentally based. The sharing of a common conceptual framework by both the IASB and FASB will help in reducing the complexity and ambiguity that exist in developing of financial reports by business corporations. The fundamental concepts of accounting must be rooted in the conceptual framework guidelines that underline the preparation of financial reports by businesses. This is helpful in enhancing the reliability and relevance of financial reporting and therefore reduces the chances of error-occurrence.  The development of principles-based conceptual framework will help in application of international financial reporting accounting standards (Kieso et al., 2010).

Reason for Conceptual Framework more important to some parties than others

Thus, a common conceptual framework that is shared by both IASB and FASB will help in easy implementation of accounting concepts and conventions that are principles-based. Also, the development of a common project will help in alignment of agendas and thus supports faster decision-making.  The boards encounter problems during decision-making due to presence of two different conceptual frameworks. The development of a common conceptual framework will also help in overcoming the difficulty of the boards that arises due to presence of different accounting concepts and conventions in their existing frameworks. Thus, it can be said that there is large importance of sharing a common conceptual framework by both the IASB and FASB (Camffermann and Zeff, 2015).

The basic purpose of conceptual framework is to provide support to preparers during the development of financial statements. The development of a common conceptual framework will help in increasing the uniformity of financial statements worldwide. The main user of the conceptual framework is IASB that makes its decisions on the basis of its stated accounting concepts and principles. The conceptual framework is most important to IASB as it develops accounting concepts and conventions adopted worldwide in guidance with the conceptual framework (Epstein, 2009).  As per the IASB, the main purpose of the conceptual framework is to identify accounting concepts that will help in development and revisiting of IFRS (International Financial Reporting Standards).  The conceptual framework also provides assistance to the IASB in development of accounting policies and thus has a large influence on development of accounting standards. In addition to this, the conceptual framework is also important to preparers, investors and auditors as it underlines the preparation and presentation of financial statements. The preparers and auditors will gain the support from the accounting concepts and conventions of the conceptual framework during developing and interpreting the financial reports of businesses worldwide. The conceptual framework also help in maintain the trust of investors by provide reliable and relevant information in the financial statements (Greenberg, 2013).

Cross-cutting issue refers to take into account the uncertainty that occurs due to measurement of an asset or liability. The reduction in uncertainty during the measurement of an asset or liability can occur by providing most relevant financial information to the users. The uncertainty in the measurement of an asset or liability can occur if there are uncertain cash flows. In this context, the IASB should also include the technique of measuring an asset or liability in the conceptual framework. The fair value of an asset or liability can be measured through the use of cash flow information that helps in real estimation of the fair value.  The possible examples of cross-cutting issues include assessing the unit of account that is measuring the assets in groups rather than estimating its fair value individually. The main reason for the occurrence of cross-cutting issues is lack of fully developed measurement concepts in the conceptual framework. This is responsible for the occurrence of uncertainty in the measurement of an asset or liability and therefore lead to the occurrence of cross-cutting issues (Jones, 2015).

Cross-Cutting Issues and its examples

The generally accepted accounting principles (GAAP) incorporate the use of historic cost measurement principle while recording the value of an asset in the balance sheet. The historic cost can be stated as a price of an asset based on its initial cost at the time of its purchase. Thus, the historic cost measurement principle does not take into account the change in the price of an asset over a period of time. The historic cost is mainly based on the price of an asset when acquired by a company and does not reflect the real market value of an asset. Thus, the fundamental problem associated with the cost measurement principle is that it only states historic facts. It fails to depict the real market situation and thus do no present the fair value of an asset. The investors fail to predict the real economic condition of an organization and thus it is not able to maintain the trust of investors and analyzers (Maali and Jaara, 2014).

The historic cost measurement principle is easier in application than other costing method but does not provide a fair picture of state of affairs of a business entity. The income statement prepared with the use of historic cost accounting does not reflect true profitability as revenues are recorded on the basis of current value while expenses are recorded on the basis of historic cost. Thus, investors and analyzers are not able to predict the real profitability position of an organization with the use of historic cost measurement principle. The balance sheet also fails to depict the true financial condition of an organization as monetary items such as cash, loan, debtors and creditors are stated at the current money value. On the other hand, non-monetary items such as inventory, land, and building are recorded at historic cost. Therefore, the real profitability position of an organization is not reflected with the use of historic cost measurement principle (Macve, 2015).

Accounts must reflect economic reality’ as a core principle of measurement in accounting

The GAAP principles are mainly based on historic costing that record the price of an asset at the initial price and do not take into account the changes in market value. This is responsible for occurrence of large number of issues in accounting as actual financial condition of an organization is not reflected with the use of historic cost measurement principle. The accounts must incorporate the principle of reflecting true market reality as a core principle of measurement in accounting. This is essential for providing a fair estimate of the financial performance of an organization to all its stakeholders. The stakeholders of an organization must have a real estimate of the operating performance of a business entity. The protection of interests of all the stakeholders is essential for a business organization to achieve transparency in its operational activities. Thus, accounting must incorporate the use of fair value measurement principle for depicting the real market value of an asset. The use of fair value accounting method would help in providing a true and actual estimate of the price of an asset. The incorporation of market changes in the price of an asset would help in depicting the actual economic condition of an organization. Thus, it can be stated that historic cost measurement principle in accounting is not able to depict the economic reality and therefore there is high need for the use of better measurement principle in accounting.

Historic Cost Measurement Principle Issues under GAAP

The economic reality in accounting can be measured through the help of fair value accounting technique. As per the IASB, fair value in accounting reflects rational and unbiased estimate of the current market price of an asset. The fair value of an asset takes into account the acquisition, production, replacement and distribution cost and thus reflects the real market price of an asset. The method of fair value accounting is more useful in financial reporting as it provides real estimate of the assets and liabilities and thus depicts the real economic situation of an organization. The fair value of an asset takes into account all the fluctuations existing in the market and therefore reflects true economic reality. The main objective of financial accounting is to reflect corporate and economic realities for protecting the interests of investors. This is possible only when the financial statements of a business corporation reflect the actual market condition of a business entity. The fair method of accounting depicts the economic reality and therefore should be accepted as a core principle of measurement in accounting under GAAP (Stolowy and Lebas, 2006).

The GAAP principles in accounting have incorporated the reliability principle according to which the accounting system should only record those business transaction that can be verified with objective evidence. The objective evidence can include canceled cheques, bank statements, purchase receipts that provides reliable and consistent financial information. The principle in accounting is developed is that only materially accurate and reliable information is presented to the end-users and there is no misrepresentation of the financial statements. The reliability principle in accounting also reduces the chances of occurrence of errors and therefore only true and relevant information is disclosed to the end-users. The principle of reliability is qualitative in nature as per which the information should be verifiable and objective in nature. The financial information presented to the users should be verified and reliable to be used by the investors and creditors. The accounting rule of reliability ensures that accounting records and statements incorporates the use of most accurate and precise financial information during the preparation of the financial statements. The financial statements prepared meets the principle of reliability if the information presented through it can be verified and is consistent in nature. The principle of reliability and relevance in accounting is one of the major qualitative characteristic in accounting that provides a conceptual basis for accountant during financial reporting (Weygandt et al., 2009).

Environment liability of companies refers to their obligations and measures adopted for ensuring environment protection. The business companies operating in the US should record a provision in relation to environment cost of retiring an asset as per the US standard setter. The FASB has made it mandatory for the business entities operating in the US to reserve for environment liabilities if its fair value can be estimated properly. The recognition of environment liabilities has emerged as a major issue among the countries worldwide for ensuring environment protection. The companies in the US and worldwide should promote a minimum level of disclosure relating to environment issues for missing the damage that occur to environment as a result of business operations (Bergkamp and Goldsmith, 2013). The US FASB has issues a provision in 2002 to account for environment liabilities for retiring assets. The main condition of recording a provision in relation to reserving environment liabilities is that its fair value should be reasonably estimated. However, it is rather difficult for the companies to comply with such a provision as estimating the fair value of an asset is very problematic. The companies are complying with FASB provision of reserving environment liabilities by recording huge funds in the income statement against environment liability. This is done to minimize the chance of occurrence of any contingency and for covering the environment risk that exist due to business operations. The companies must maintain adequate financial reserves as environment liabilities for retiring assets as per the FASB litigation. Thus reserving environment liabilities is mainly important for business corporations for obtaining environment compliance (Rogers, 2005).

The main requirement for deferring recognition of the environment liability for US companies is to record the fair value of retiring assets. This is essential in order to account for the reserves that should be maintained for overcoming the environment damage that can occur in future with such an asset. The estimation of the market value of retiring asset is essential for the US companies in order to defer recognition of an environment liability. Also, the US companies should provide a fair picture of the possession of contaminated property that can cause environment damage in future period of time. The adequate reserves against such a contaminated property should also be maintained by the US companies for granting environment protection. The US corporations can defer the recognition of an environment liability through ‘mothballing’ a contaminated property. This means that a contaminated factory should maintain proper reserves for covering the cost of environment damage that can occur with the possession of such a contaminated property (Rogers, 2005).

The recognition of environment liability in a business corporation requires maintaining proper reserves for covering the environment damage associated with it. Thus, companies are required to maintain huge funds as environment liability in their income statements. This is likely to have a negative impact on the operation profit of companies for a short-term. However, the recognition of environment liability and maintaining proper reserves for it will help the companies to minimize the chance of occurrence of any contingency condition in the future. Also, it is likely to increase the brand image of a corporation in the international market thus enhancing the operating profit in long-term. Thus, it can be stated that recognition of an environment liability can decrease the net profit of a company in the current year but will increase it in the future period of time (Uzochukwu et al., 2009).

The cash-flows of a business corporation are also likely to decrease with the recognition of an environment liability. This is due to decrease in net profit of a corporation as discussed above. On the other hand, the cash-flows of a corporation will increase in future period of time with the increase in its profitability position (Uzochukwu et al., 2009).

Importance of recognition of environment liability and extent of its disclosure by business Corporations

The recognition of environment liability is very important for business corporations around the world. This is because maintenance of proper reserves for covering the environment damage by business operations is necessary to eliminate the occurrence of environment risk. The environment damage can be recovered easily with recognition of environment liability in advance thus ensuring its protection and growth. The protection of environment by a business corporation would also promote its growth and development by enhancing its goodwill in the international market. The different type of operational activities of a business corporation can cause destruction of environment in many ways. The FASB has implemented litigation for business corporations to achieve environment compliance by maintaining proper reserves (Bergkamp and Goldsmith, 2013).

The business corporations should maintain a proper disclosure regarding the material risks associated with operational activities to obtain environment compliance. The companies have to adequately disclose the financial reserves in the income statement that it maintains to comply with provision of reserving environment liabilities. This is necessary for businesses not only to properly cover environment risk but also to promote its brand image in the international market. The proper disclosure of environment liabilities strengthens the brand image of a company and promotes brand awareness internationally. Thus, it increases the customer base of an organization enhancing its profitability position. Therefore, it can be stated that recognition of an environment liability is highly important for business entities to ensure its sustainable growth and development (Uzochukwu et al., 2009).

References

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Bergkamp, L. and Goldsmith, B. 2013. The EU Environmental Liability Directive: A Commentary. OUP Oxford.

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Greenberg, M. 2013. Fair Value Accounting, Historical Cost Accounting, and Systemic Risk: Policy Issues and Options for Strengthening Valuation and Reducing Risk. Rand Corporation.

Jones, S. 2015. The Routledge Companion to Financial Accounting Theory. Routledge.

Kieso, D. et al. 2010. Intermediate Accounting: IFRS Edition. John Wiley & Sons.

Maali, B. and Jaara, O. 2014. Reality and Accounting: The Case for Interpretive Accounting Research. International Journal of Accounting and Financial Reporting 4(1), 155-168.

Macve, R. 2015. A Conceptual Framework for Financial Accounting and Reporting: Vision, Tool, Or Threat? Routledge.

Pounder, B. 2009. Convergence Guidebook for Corporate Financial Reporting. John Wiley & Sons.

Rogers, G. 2005. Financial Reporting of Environmental Liabilities and Risks after Sarbanes-Oxley. John Wiley & Sons.

Stolowy, H. and Lebas, M. 2006. Financial Accounting and Reporting: A Global Perspective. Cengage Learning EMEA.

Uzochukwu, G. et al. 2009. Proceedings of the 2007 National Conference on Environmental Science and Technology. Springer Science & Business Media.

Weygandt, J. et al. 2009. Financial Accounting. John Wiley & Sons.