Introduction to International Accounting Standards Board
1. The International Accounting Standards are being introduced and implemented by the International Accounting Standards Board with the objective of having acceptance worldwide. These standards have now been adopted almost all over the world except a few countries including United States. This is because the Securities Exchange Commission wants all its listed entities to present and prepare its financial statements based on existing US GAAP and the accounting principles as it gives a lot of flexibility to the accountants in terms of decision-making and estimations and judgements (Alexander, 2016). However, the closely held firms or the non-listed companies have the freedom to use the IFRS standards, as SEC. is not directly monitoring them.
Off late, we have seen that the financial reports including the conceptual framework of reporting can either embrace decision usefulness as the basis of preparing financial statements or stewardship function as the basis. Now what do these terms actually imply. Financial statements form the basis of decision making for a number of stakeholders, which can be both internal as well as external. They can be investors, the creditors, the debtors, employees, banks or even financial institutions and government (Belton, 2017). To ensure that the information which has been disclosed in the financial statements are relevant to the given set of stakeholders, it needs to meet the minimum qualification criteria of completeness, timeliness, relevance, reliability, verifiability and understandability. Besides this, it also has to meet the standards, which have been laid down by IASB. This is what is called decision usefulness.
On the other hand, stewardship which basically means governance emphasis on the role of and places an obligation on the agents or stewarts such as directors of the company who will be responsible for provide, preparing and presenting the relevant and reliable information in the financial statements in relation to the resources which are not being owned by them but others like shareholders of the company (Choy, 2018). It is a traditional approach of accounting where the responsibility of accounting and using the resources of the company to best possible use to derive the results is being entrusted on the directors of the company. It is kind of relationship between the company and the shareholders based on agency function. Its data, information or result may not match with that of the decision worthiness or decision usefulness as the most recommended steward is the one who makes the most of money for the owner or shareholders. In other words, an ideal stewart is the one who increase the cash flow for the owners.
Decision Usefulness vs. Stewardship Function
But there are varied opinions and conceptions of these 2 concepts. A stewardship or an agency relation is often seen as agent possessing the power to commit fraud and is very narrow in its approach. It lacks the concept of corporate governance. It is essential and critical that the board of management should consider the responsibility and accountability of the financial statements before the stakeholders (Bromwich & Scapens, 2016). From stewardship perspective they would want that the requirements of the shareholders (a limited group) is achieved through the financial statements rather than meeting the data necessity of the broad mass of stakeholders (investors, debtors, government, creditors). Thus, IASB focuses more on the decision usefulness rather than stewardship function. The other advantages which are being ensured through decision usefulness is that it leads to uniformity and makes the data comparable at the global level, its leads to better flow of investment from the investors and enables commonly accepted standard format for financial reporting across the globe.
2. As per the historical cost method of accounting, recording of transactions relating to the assets and liabilities are being done at the cost at which they have been procured. They are not altered further in future as well to avoid duplicacy and are being recorded in the financial statements like balance sheet and profit and loss account at the historical cost rather than the replacement cost or fair value. Some of the major drawbacks of historical cost accounting have been mentioned below:
- Inaccurate Fixed Asset Cost: As most of the companies do record the fixed assets at the worth at which they are being procured, so the change in the market value of the asset loses its relevance as the same is not being recorded (Defond & Lennox, 2017).
- Wrong picture of profit and loss account resulting in impractical gains: Since the incomes are being recorded at current price or present value whereas few of the expenses are being shown or booked at the historical cost basis, gains are generally overstated in the profit and loss account.
- Non accounting of price alterations: When the financial statements are being prepared at the historical cost level, it fails to show the impact of the price changes over the years or simply inflation. Thus, in a sense, it shows the wrong picture of the books of accounts of an entity (Vieira, O’Dwyer, & Schneider, 2017).
- Mixing up of the holding profits and the actual operating profits: In case the historical cost accounting is being followed, the holding profits of the past might be blended up with the current operating profits or the employed profits/losses. This does not give the view of correct profits from actual operations and given functionalities.
- Inappropriate and insufficient provision for depreciation: Depreciation is a way of allocation for the replacement of the fixed asset in future. The provision is made based on the historical cost method and not at the value at which the asset will be procured again (replacement cost). Thus, the provision that is being made may be inappropriate and insufficient in terms of replacing it in future (Raiborn, Butler, & Martin, 2016).
- Financial status of the company not being reflected: The balance sheet of the company includes both the financial as well as non-financial items. Financial items like cash, debtors and creditors are being valued at present worth whereas the non-financial items like machinery, building and furniture are being listed at historical values, thus not capturing the impact of inflation. Hence, it does not shows the true and fair financial status of the company.
IASB introduced an alternative method of capital assets accounting at constant purchasing power basis under which the financial investment would be accounted and maintained at either nominal monetary value (Historical cost model) or in terms of constant purchasing capacity during both the inflation as well as deflation which is called the CMUCPP model. This alternative method of evaluation of the capital investment as per CMUCPP model as being shown in the plan for Preparation and presentation of the financial statements was being approved and certified by International Accounting Standards Board’s preceding body called the International Accounting Standards Committee Board in the year 1989 and was being later adopted by IASB in 2001 (Goldmann, 2016).
Accountants mainly in the economy are adopting this method of constant purchasing power where the inflation is on the lower side even if it will look into the actual worth of the generally constant non-financial things as share capital, trade debtors, trade creditors, withholding gains, etc. This method captures the real value of the above mentioned balance sheet items at all the stages of inflation and deflation. The IASB initially did not certify capital maintenance in quantity of constant purchasing power as it was an inflation accounting measure. This method takes into account financial capital maintenance concept, considers profit on real time basis and an option to capital logic (Linden & Freeman, 2017). Finally, with the modified version, IASB came up with IAS 29, which deals with capital maintenance in quantity of Constant Purchasing Power method and is to be applied only in case of high inflation.
Historical Cost Accounting Drawbacks
3. The IASB, International Accounting Standards Board came up with the host of new accounting standards, which are in line with the global requirement and are aimed to streamline the financial reporting structures. It was being adopted by a number of countries except for a few including US as the Securities and Exchange Commission Board of United States wants its listed companies to follow the commonly used principles and standards of accounting including the US GAAP for the reporting and accounting purposes (Grenier, 2017). However, there is no foundation of the private companies in US as there are not being monitored by SEC and therefore are free to use international accounting standards if it fits their requirement.
The conceptual framework is a coherent system of interrelated fundamentals and objectives which are expected to give consistent and thus comparable results. It is based on normative theory of accounting and defines the nature, purpose, content and subject of general purpose financial reporting. In short, it is a guideline, concept as well as a vision. It lays down the path for the improvement of the advanced accounting standards. In places where there is a conflict between the framework and the accounting standard, the latter will proceed over the former (Visinescu, Jones, & Sidorova, 2017). While the introduction and implementation of the framework, following points are being considered:
- It ensures that the set standards of accounting have a specific method to resolve the issue rather than having the solution in bits and pieces.
- Helps the global body i.e., International Accounting Standards Board to set up the logical and meaningful accounting standards (Chron, 2017)
- The Framework is no longer a standard but a guide to the preparers of the financial statements to help them to solve the regular day-to-day accounting issues, which are not being resolved through the standard.
- It also enlightens on the very purpose as well as the drawbacks of financial reporting.
- Forms the basis for preparation and presentation of the financial statements and the books of accounts in particular (Linden & Freeman, 2017).
It aims to answer the very basic question as to why the financial statements are being prepared itself and the answer as per Framework is to render financial information and data to those who need it. It can be in the form of internal or external stakeholders like the debtors, creditors, banks, government, financial institutions, present and future investors, etc. In order to render the data useful for decision-making, it has qualitative characteristics, which needs to be met. These characteristics include relevance and reliability of the data that is, the information that is useful and true should only be presented or else it will become redundant. Furthermore, the timeliness of the data should be ensured and must be made available at the correct time. In addition, it should have the comparability aspect or else there is no trend analysis and the user would not be able to know whether the company is progressing or digressing as compared to the industry or past years (Sithole, Chandler, Abeysekera, & Paas, 2017). Finally, the data presented should be understandable such that it renders meaningful information. Despite all these aspects being covered and truly being justified by the conceptual framework, it has not been able to provide any significant breakthrough in the field of measurement issues. This is evident when the issue arises as to whether the assets and liabilities are to be valued at cost or the fair market value. Where cost is focusing on the past, fair value is focusing on the present and the future. However, it just focuses on the recognition criteria, which needs to be met to be eligible to be known as components of the financial statements. The identification criteria includes:
- That it can be computed with faithfulness and is measureable
- That any financial benefit attached to the given component will arise to or from the entity.
References
Alexander, F. (2016). The Changing Face of Accountability. The Journal of Higher Education, 71(4), 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, 31, 1-9.
Choy, Y. K. (2018). Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, 145. Retrieved from https://doi.org/10.1016/j.ecolecon.2017.08.005
Chron. (2017). five-common-features-internal-control-system-business. Retrieved december 07, 2017, from https://smallbusiness.chron.com/five-common-features-internal-control-system-business-430.html
Defond, M., & Lennox, C. (2017). Do PCAOB Inspections Improve the Quality of Internal Control Audits? Journal of Accounting Research, 55(3), 591-627.
Goldmann, K. (2016). Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, 4, 103-112.
Grenier, J. (2017). Encouraging Professional Skepticism in the Industry Specialization Era. Journal of Business Ethics, 142(2), 241-256.
Linden, B., & Freeman, R. (2017). Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), 353-379. Retrieved from https://doi.org/10.1017/beq.2017.1
Raiborn, C., Butler, J., & Martin, K. (2016). The internal audit function: A prerequisite for Good Governance. Journal of Corporate Accounting and Finance, 28(2), 10-21.
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), 220. Retrieved from https://psycnet.apa.org/buy/2016-21263-001
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), 58-66.
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