Purpose
The present report is developed to examine the measurement and recognition issues that are present in the financial accounting. The analysis of such issues is highly important for developing an in-depth understanding of these problems as these influence the decision-making process of users of general purpose financial reports. The accountants, in this context, have major responsibility of providing significant information to the users of financial statements for facilitating them to take investment decisions. The report as such has particularly evaluated the enhancing qualitative characteristics of financial reporting stated by the conceptual accounting framework. The factors determined by the statement of accounting concepts for making an entity as a reported entity is also discussed in the report. Also, it has presented the limitations associated with historical method of costing to be used for measuring the financial value of assets and liabilities. Lastly, it has carried out a comparative analysis between AASB 15 and AASB 18 for reporting revenue by the business entities.
The conceptual accounting framework has identified and stated the fundamental and enhancing qualitative characteristics of financial reporting. The qualitative characteristics for financial information has been developed for providing guidance to the financial users regarding the type of information that is most relevant to be disclosed to present and future investors. The conceptual framework has stated relevance and faithful presentation to be the fundamental principle of conceptual accounting framework. The framework has also stated enhancing qualitative characteristics of financial reporting that are comparability, understandability, timeliness and verifiability. The financial information disclosed as per the framework qualitive characteristic must be comparable for facilitating the users to take accurate decisions by selecting the best possible alternative. The information about a reporting entity can be stated to be comparable if it can be compared with other similar information provided by other entities. The reporting entities need to present the financial information of two consecutive years in their financial reports so that it is easily comparable. It enables the user to identify and understand the similarities and differences among the financial items. The financial information must be prepared with the use of consistent set of accounting methods so that it can be compared easily from one year to another (Conceptual Framework for Financial Reporting, 2015).
The financial information need to be verifiable in the sense that it can be verified using direct or indirect method. Direct verification mans that the financial information can be verified by observation while indirect verification means that it can be verified using accounting policies and methods used to obtain the value of such financial items. As such, it is essential for the business entities to report the financial information in a numerical form and should explain the underlying assumptions and policies used for calculating the value depicted. The verification of financial information ensures that it has presented the economic phenomena it aims to represent. The timeliness characteristics of financial reporting states that the financial information provided must be latest and should not be older to facilitate the decision-making process of users. As such, the reporting entities need to develop and disclose the financial reports on an annual basis so that the end-users received current financial information and can take accurate investment decisions.
Answers
The fourth and last enhancing qualitative characteristic of financial reporting is understandability. The reporting entities need to report the financial information in a simple and understandable format to the end-users. The financial data must be presented in a clear and specific manner for providing an in-depth understanding of the complex phenomena. The business entities disclose the notes section to financial reports for providing a discussion about the significant accounting policies adopted for development and presentation of the financial information. Therefore, it can be said based on discussion of enhancing qualitative characteristics that these features should be present in a financial information to make it relevant. However, it should also be kept in mind that these enhancing qualitative characteristics must be used in application of fundamental principles of relevancy and faithful presentation. This is necessary to protect the interest of end-users and meeting the ultimate objective of financial reporting as stated by the framework. This will help in ensuring the maximization the application of qualitative characteristics of financial reporting.
The Statement of Accounting Concept (SAC) has stated that an entity can be regarded as a reporting entity on which users are dependent for gaining financial information for taking investment decisions. The dependent users can be regarded as the users of financial information who rely on such information for making an evaluation of the financial performance of an entity for taking pertinent decisions. SAC has defined that the reporting entities are identified based on dependent users who relies on general purpose financial reports for making resource allocation decisions (Saccon, 2007). SAC has also identified and stated the preliminary factors to be considered for determination of an entity as a reporting entity that are discussed as follows:
It is important to have a distinction between the management and the owners for determination of an entity as reporting entity or other members that are having an economic interest. The larger the difference between the management and the ownership in a business entity the more likely is the presence of its dependent users. Therefore, it is an important factor for classifying an entity as a reporting entity (Whittington, 2008).
As per this factor, an entity qualifies for the criterion of a reporting entity based on it having an impact on the external party’s welfare. The larger is the economic or political power of an entity it will have more dependent users that rely on the information disclosed by such an entity for taking important decisions regarding the resource allocation. The business entities have an influencing political or economic power are dominant one’s having a complete control on the market. The entities possessing the authority to attain a balance between the interest of other entities. The example of such business entities includes having regulatory power and employer-employee associations (Kabalski, 2009).
The dependent users of an entity are also influenced by its financial characteristics and as such they impact its identification as a reporting entity. The financial characteristics include its size that can be determined based on sales volume or number of employees and customers possesses by an entity. The greater the size of an entity larger will be the resource allocation and therefore it will have a direct impact on its dependent users. Therefore, it can be said that larger is the size of a business entity greater will be its existing users interested in making resource allocation decisions (Nawas, 2013).
1:Enhancing Qualitative Characteristics Improving the Quality of Information Provided by Conceptual Accounting Framework
Therefore, it can be said that the creation of a company or its structure does not result in development of a reporting entity. A reporting entity need to satisfy all the above-mentioned criteria’s for satisfying itself as a reporting entity. The statement of accounting concept has established the relation between the information need of users to the nature of general purpose financial reports. It has been carried out by establishing the concept of a reporting entity and the identification of its boundaries. Therefore, it can be stated based on identification of the factors required for classifying an entity as a reporting entity that it should be the provider of resources and should have a dependent base of current users.
The method of historical cost accounting can be regarded as a traditional model used by accountants for measuring the value of financial assets and liabilities. Historical cost can be regarded as a measure of value that is used on accounting for determination of the price of an asset on its balance sheet based on original cost when it was acquired by an entity. This method of cost accounting is based on the generally accepted accounting principles (GAAP). The model of historical cost accounting is regarded as a well-established method of accounting that is used across the world for financial reporting. The method has proved to be very useful for depicting the pertinent information to the users of financial reports thus facilitating in taking significant decisions. AASB (Australian Accounting Standards Board) has also directed its business entities to report the value of financial items such as assets and liabilities using historical method of accounting. However, the business entities at present are emphasizing on adopting the use of other cost accounting method for measuring the value of financial items such as assets and liabilities due to numerous limitations associated within the method of historical costing. These are stated as follows:
The method of historical cost accounting is not regarded to be useful for taking significant business decisions. The primary role of accounting is to meet the needs of end-users that relies on such information for taking significant decisions. The primary users of accounting information are not only interested in ensuring the stewardship of accounting process but also have specific interest in increase or decrease in the value of investment as depicted by its net assets. This is because the value of assets and liabilities calculated using historical method of accounting does not represent the realistic value. This is because it is based on its original value at the time of its acquisition and thus is not adequate for present the true and fair value as per the current market changes. Therefore, it can be said that statement of financial position developed based on historical costing is not realistic for predicting the future cash flows. The financial statements developed with the sue of historical method is only a statement of historical facts as it does not take into consideration the changes in the price level due to market changes. The monetary value is bound to change during the period of inflation and the instability results in causing number of distortions in the financial statements (Effiong, 2012).
2: Relevant Primary Factors Important in Determination of an Entity as a Reporting Entity
The depreciation in the method of historical cost accounting is charged on the asset cost. Depreciation can be regarded as a method of generating funds for replacing the fixed assets when they become due to be replaced. The charging of depreciation in the method of historical accounting is assessed based on original price and does not consider the price at which an asset could be acquired. Therefore, it can be stated that this method does not prove to be adequate in charging the depreciation as it will result in overstating the profit in periods of inflation (Rahmawati, 2006).
The financial reports that are developed with the use of historical method of cost accounting does not prove to be useful for comparing the financial information over the years for a business entity. This is because the value of key financial items tends to fluctuate over the years due to inflation and thus comparison of the financial information does not prove to be reliable method for examining the financial statement of an entity. The profits reported by business are overstated and the value of assets are understated during the period of inflation. Also, the impact of inflation is not same for all the entities in the market and therefore the historical cost accounts does not prove to be useful on comparing the performances of business entities (Munteanu, 2015).
The use of historic method of accounting is also not significant in providing a true impression of the ability of a company to continue its operation at a given level. The historical method of accounting provides a false impression of the ability of a company to continue its operations in the future as assets are undervalued with the use of such method of accounting. His can results in causing negative impact on the interest and welfare of investors who have invested in the company (Bakar, 2007).
Australian Accounting Board has adopted the new accounting standard AASB 15 of revenue recognition and measurement to replace the old accounting standard AASB 18. AASB 15 has been derived from the IFRS 15 “Revenue from the contracts with customers”. The main objective of AASB 15 is to establish the accounting principles that entities applies to report the useful information for the users of the financial statements in relation the nature, amount, timing and uncertainty of the revenue recognition and amount of cash flows from the various contracts with customers. The main purpose of introducing AASB 15 is supersede the ongoing accounting standards for two main revenue recognition standards such as AASB 111 construction contract and AASB 118 Revenue. There are many differences in AASB 15 and AASB 18 as International Accounting Board has changed how the entities can recognize the revenue in the financial statements.
The differences between both the standards are specifically related with recognition criteria, measurement, and disclosures. These are explained in detail below:
In standard AASB 118 “Revenue” the recognition criteria are divided separately for each type of transactions. The main transactions that are identified by the AASB 118 are sale of goods; rendering of services; and Interest, royalties and dividends. There is separate recognition criteria for each type of transactions such as revenue from the sale of goods are recognized when entity transferred the risks and rewards of ownership of goods to the buyer. Similarly, from rendering of service and other income from interest, royalties and dividends entity must apply separate recognition criteria (AASB 118, 2010). In AASB 15 there are no separate recognition criteria for different transactions but it requires entities to recognize the revenue in accordance with the satisfaction of the performance of obligations defined for each type of contract. Basically, entities are required to complete the five-step process for recognition and measurement of revenue from the contracts with the contracts (AASB 15, 2014). The five steps defined under AASB 15 are identification of contracts that has been made with the customers, to identify the performance obligation in each contract, determining the transaction of each contract, allocating the identified transaction price to each performance obligation and lastly recognition of revenue when each performance obligation has been completed. Here the word contract has greater meaning as all the things are based on this word. So, it can be said that transactions identified in AASB 18 has been grouped as one and it was named as contract and contract is defined in detail to club the definition of sale of goods, rendering of services and transactions of dividend, royalties and interest (Probono Australia, 2018).
The contract is defined as an agreement between two or more parties and this agreement creates enforceable rights and obligations. The identification of performance obligations is an important part in the whole process of revenue recognition under AASB 15(AASB 15, 2014). Performance obligation is a consideration in form of goods or services, or something like that in lieu of some consideration. Lastly entities are required to recognize the revenue after completing two more steps of five step process i.e. calculation of transaction price and allocation of transaction for each performance obligation. Other point that needs to be taken care of in AASB 15 is that AASB 15 requires entity to combine similar contracts with the same customer and take them as one for revenue recognition (AASB 15, 2014).
As per AASB 18, revenue must be measured at fair value of the consideration received or receivable. Fair value is defined as consideration received or receivable in from of cash or cash equivalents after considering any trade discounts and volume rebates (AASB 118, 2010). While in AASB 15, revenue must be recognized when performance obligation is satisfied, and transaction price has been identified and allocated to each performance obligation (AASB 15, 2014). The two main criteria that must be satisfied to measure the revenue are determining the transaction price and allocation of identified transaction price to each performance obligation. Thus, it can be said that there is huge difference between both the standards in relation to the measurement of revenue.
Conclusion
It can be stated from the overall discussion held in the report that it is the responsibility of business entities to provide useful information to the users who are dependent on it for taking significant decisions. In this context, the conceptual framework of accounting has reported the enhancing qualitative characteristics that should be present within a financial information to make it relevant for decision-making. These characteristics require the financial formation to be comparable, verifiable, timeliness and understandability. There also some criterion that an entity need to satisfy for classifying itself as a reporting entity. The report has also stated the shortcomings present in the use of historical method of accounting that is adopted by AASB for measuring and recognition of the value of financial items such as assets, liabilities, expenses and equity. This include providing misleading and manipulated financial information to the end-users that can result in taking incorrect investment decisions. As such, it has identified the need for adoption of other method of measurement such as fair value accounting to measure and recognize the value of financial assets. The advantages of AASB 15 over AASB 18 for recognition of revenue is also discussed in the report.
References
AASB 118. 2010. Revenue. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB118_07-04_COMPoct10_01-11.pdf [Accessed on: 16 September, 2018].
AASB 15. 2014. Revenue from Contracts with Customers. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB15_12-14.pdf [Accessed on: 16 September, 2018].
Bakar, N. 2007. Historical Cost VERSUS Current Cost Accounting. [Online]. at https://www.academia.edu/25453.
Historical_Cost_Accounting_Versus_Current_Cost_Accounting [Accessed on: 16 September 2018].
Conceptual Framework for Financial Reporting. 2015. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/ACCED264_06-15.pdf [Accessed on: 16 September 2018].
Effiong, C. 2012. Comparative analysis of fair value and historical cost accounting on reported profit. Research Journal of Finance and accounting 3(8), pp. 132-149.
Kabalski, P. 2009. Comments on the Objective of Financial Reporting in the Proposed New Conceptual Framework. Eurasian Journal Of Business and Economics 2(4), PP. 95-111.
Munteanu, V. 2015. Debate Regarding Measuring Accounting Value: Historical Cost against Fair Value. Academic Journal of Economic Studies 1 (4), pp. 91–102.
Nawas, R. 2013. Factors affecting the quality of Auditing: The Case of Jordanian Commercial Banks. International Journal of Business and Social Science 4(11), pp. 206-222.
Probono Australia. 2018. Impact of Accounting Standard Changes in Recognition of Revenue. [Online]. Available at: https://probonoaustralia.com.au/news/2017/07/impact-accounting-standard-changes-recognition-revenue/ [Accessed on: 16 September, 2018].
Rahmawati, E. 2006. Support and Against Historical Cost Accounting: Is it Value Relevance for Decision Making. Jurnal Akuntansi dan Investasi 7 (1), pp. 113-125.
Saccon, C. 2007. The Reporting Entity Concept in Australia. [Online]. Available at:https://dspace.unive.it/bitstream/handle/10579/1196./866274-1226868.pdf?sequence=2 [Accessed on: 16 September 2018].
Whittington, G. 2008. Fair value and the IASB/FASB conceptual framework: an alternative view”. Abacus 44 (2), pp 139-168.
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