Relevance and Faithful Representation in Accounting
1: Relevance is that characteristic which makes the information relevant and helpful for the purpose of decision making. Relevance is a combination of the predictions related to the future and the past (Bragg, Relevance definition, 2013). Faithful representation vouches for the accuracy with respect to the business. Apart from the financial statement, it extends its reflection on the financial position and another course of operations (Bragg, Faithful Representation, 2014).
As per my level of understanding, faithful representation is more important. In order to make the financial information useful, only being relevant will not be sufficient enough. It should authentically represent the occurrences it implies to represent. The quality of faithful representation elevates the inner characteristics of completeness, error free and neutrality. The role of relevance is an important but faithful representation is the necessity. Faithful representation acts as a backbone to the financial information and result which can be cross verified at different areas. This confirms the authenticity and reliableness of an organization (Charterededucation, 2017).
Suppose a difference has been found between the substance and legal form, it is the faithful representation which comes to the rescue. Relevance cannot solve this issue solely. With the help of faithful representation, the financial information should signify the financial substance. For example, if the company possess $ 125,640 inventory, it can be easily traced with the help of past trends and the requirements of future. But, if it is not fairly represented in the financial information, the decision making of users will stand misleading. Such is the role play of fair representation that it needs to be accurately mentioned and cross verified by other sources. The agenda of any information stands incomplete and incorrect if it has not been fairly represented even if confirms its relevancy. Practically, the companies are getting trapped in fair representation due to which fraud and misleading decisions crop up in the corporate world (iasplus, 2017). Fair representation also includes the required compliance of accounting policy, relevant disclosures, and reliable information. Its domain is relatively broader than relevance and without satisfying fair representation, it is highly difficult to survive for any organization.
The framework of IAS, Presentation of Financial Statements itself includes the component of fair representation. The basic theme of any accounting standard is to disclose proper information with disclosures and depicts its true nature. The purpose of faithful representation is somewhat similar to the theme of any accounting standard. Fairness in the quality of information, proper disclosures and error free are its three distinctive features. The backbone of any accounting standard also stands on these three pillars. It is not required to be outrightly discussed in fact it is an unsaid fact in some of the accounting standards (iasplus, 2017).
In this developing environment, the need for different kinds of disclosures has increased since the past decades. Stakeholders want both kinds of information to be it financial or non-financial information. It has been noticed that now the stakeholders are understanding the importance of non-financial information and its impact in the corporate world. The changes made in the accounting standards have been made in connection with the diversifying needs of the corporate environment. For example, related party disclosures were not exhaustive enough as it is in today’s times.
Importance of Faithful Representation
But today, due to the need for transparency, the list of details required for the related parties had been made exhaustive. Apart from the name and the nature of transaction of related parties, the outstanding amount, the relation of such parties and other parameters are required to be disclosed. The importance of faithful representation is so high that the auditors can even qualify their report if the financial statements are not complying its characteristics (FASB, 2017).
By judging the requirements of the stakeholders, companies and the corporate world, it can be understood that faithful representation is not just a mere requirement, but a necessity. If the financial information is not faithfully represented, the organization will not survive in the long run on the basis of projecting a misleading image. It is very important to gain the confidence of the stakeholders and the government in order to establish a brand image.
Though, it is still difficult to maintain this quality because there exist some companies who are misleading their stakeholders but not for a longer period of time. If completeness does not comply, the stakeholders will not invest in such companies. If the financial information is not free from biases, the final result will turnout vague or misleading. Omissions or inaccuracies will tantamount to fraud be it intentional or unintentional. It is now a basic need to follow such parameters for the survival of companies.
2: Current Purchasing Power: The first alternative is of Current Purchasing Power. This alternative works on the basis of the price index. The historical cost was supposed to be adjusted with respect to the purchasing power through price index. Price index used to exist for a particular asset and in the form of Current Price Index (CPI) as well. For example, if an asset is required to be valued, a specific price index can be used and if not available for anytime, CPI is adopted to make the necessary adjustments. The profit and loss of such kind of accounting are only confined to the monetary items and excludes the non-monetary ones (Accounting-Management, 2017).
Current Cost Accounting: The second alternative i.e. the current cost accounting defines works on the replacement cost mechanism with respect to the non-monetary concerns. This, in turn, uplifts the value of assets and hence the inflated mechanism is not included in it when the profit is calculated. For example, a machine’s cost is $200,000 with a life of 10 years and no salvage component. Depreciated as per straight line mechanism, its expense will be $20,000 per year. As per current cost accounting, if the replacement cost of $220,000, the new depreciation amount will be $ 22,000 per year. Thus, this extra $2000 will be reduced to ascertain the current cost accounting profit (AccountingManagement, 2017).
Continuously Contemporary Accounting: The third normative alternative, i.e. the continuously contemporary accounting works on the mechanism of the current cash price. For example, if an asset is supposed to be sold at $1500 but if its net realizable value is $2000, as per this method of accounting, it will be measured at $2000. It does not recognize any difference between the realized and unrealized profits like other methods of accounting. In this component, all types of gains are considered as a fragment of profit. The method incorporates the adjustments with respect to the general purchasing power to the assets (Chambers, 1967).
Normative Alternatives to Historical Cost
For Current Purchasing Power, a single price index does not practically turn out to be the best solution for the purpose of accounting. A single price index for all the assets will not correspond accurately to the actual value of assets. The valuation as per this method of accounting turns out to be more time consuming and costly (Nandwani, 2017).
For Current Cost Accounting, replacement cost does not reflect the asset’s selling price. It is, in fact, the buying price. When it comes to the specialized form of assets, it is not easy to ascertain its replacement cost. This process of accounting may turn out to be quite expensive for an organization. A lot of effort and time is required to know the replacement cost, so the result may not be positive always (Nandwani, 2017).
For Continuously Contemporary Accounting, subjectivity prevails when it comes to valuation of assets. It is because the market price is not available for all kinds of assets. The concept of value in use has been totally ignored by this method of accounting. It fails to value goodwill on the exit price because it cannot be sold separately (Nandwani, 2017).
The definition of successful is an exhaustive one which not only includes the profitability of an organization but other factors like, going concern, transparency, consistency, neutrality, and error free information. As far as the above types of accounting are concerned, none of them are in use as per the modern concepts. Previously, as the method of accounting was evolving from time to time, each of the methods was successful for a certain period of time.
When the CCA and CoCoA were not ascertained, it was CPP which was adopted by the organizations and the business used to be successful. Similarly, CCA and CoCoA also had their own period of being successful. As on today, historical method of accounting is not much in use because it fails to recognize the other parameters of accounting like transparency, error free work, neutrality etc. The mode concepts have been adopted which paves the way towards the success of an organization.
3: Building blocks refer to the base on which conceptual framework has been framed. Reporting entity, the purpose of financial statements, users related to the financial reports, its assumptions, objectives, and elements serves the purpose of the building block. The reporting entity is that responsible entity who knows the fact that there are users who are going to make decisions based on their reports. The basic purpose of the financial statement is to provide relevant information to all the possible users. Users are of three kinds i.e. the providers – investors, receivers – customers and the regulatory parties – government, media, and labor group. The basic objective is to measure and maintain the scope of accountability between an organization and its related person who make decisions based on the organization’s information (Bovens, 2007).
The assumption based on which financial statements are prepared is on the accrual basis. Going concern is another assumption which helps in justifying the conceptual framework. The concept of making things understood to its users, information free from any error and represented in a faithful manner are the basic pillars of a conceptual framework. Comparability and conservatism also serve the purpose of the conceptual framework. The elements like, equity, assets, expenses, liabilities, and income are the basic tenets based on which the conceptual framework works on a larger basis. Thus, these are all key building blocks of a conceptual framework based on which the world of accounting works worldwide (IFAC, 2013).
One of the advantages of accounting that can result from the development of conceptual framework is the setup of accounting standards. These define each characteristic of accounting in terms how to classify them to its relevant disclosures. These are the logical and most consistent parameters that have evolved from the conceptual framework. Another advantage is the role of political pressure is very minimal because the standard setter cannot go beyond the basic tenets of the conceptual framework when setting the standards (Chartered-education, 2017).
There exists its own level of criticism like due to the weight of the conceptual framework, smaller organizations may feel overburdened due to the reporting obligations. A conceptual framework has only been stressing upon the financial perspective. Social and environmental perspective are still being undermined in the corporate world. Today, profitability is the barometer of measuring the success rate of any organization whereas the duty towards the environment and society are totally being ignored. It fails to depict an ideal step towards accounting rather it is a bundle of standards and practice (Chartered-education, 2017).
To some extent, I agree with the criticism because of our world, today, is not limited to the power of money. The dimension has widened enough to incorporate our duty towards the society and environment. This somehow seems to be untouched today. Reporting requirements surely highlight transparency to the users but at the same time, it turns out to be a cumbersome process for those organizations who are not multinationals. For smaller organizations, the conceptual framework should be flexible enough to provide them relaxation otherwise it may affect their normal course of business.
It is now high time that our conceptual framework should now be diversified. It should not be limited to the practices and standards of the financial component but should also govern non-financial component. Though, a system like corporate social responsibility has been introduced, this shows that it is getting diversified gradually. In this dynamic corporate environment, we cannot adopt or practice with conventional methods.
References
AccountingManagement. (2017). Meaning and Characteristic of Current Cost Accounting. Retrieved from Accoutning-Management: https://accountlearning.blogspot.in/2011/06/meaning-features-and-objectives-of.html
Accounting-Management. (2017). Meaning and Characteristics of Current Purchasing Power. Retrieved from Accounting-Management: https://accountlearning.blogspot.in/2011/06/meaning-and-characteristics-of-current.html
Bovens, M. (2007). Analysing and assessing accountability: A conceptual framework. European law journal, 13(4), 447-468.
Bragg, S. (2013, March 12). Relevance definition. Retrieved from Accounting Tools: https://www.accountingtools.com/articles/what-is-relevance-in-accounting.html
Bragg, S. (2014, September 22). Faithful Representation. Retrieved from Accounting Tools: https://www.accountingtools.com/articles/what-is-faithful-representation.html
Chambers, R. (1967). Continously Contemporary Accounting. The Accounting Review, 42(4), 751-757. Retrieved from https://www.jstor.org/stable/244170
Charterededucation. (2017). Accounting Policies- Fair Representation and Faithful Representation in IFRS. Retrieved from Chartered Education: https://www.charterededucation.com/ifrs/accounting-policies-fair-presentation-and-faithful-representation-for-ifrs/
Chartered-education. (2017). Understanding the Purpose of Conceptual Framework for IFRS. Retrieved from Chartered Education: https://www.charterededucation.com/ifrs/understanding-the-purpose-of-conceptual-framework-for-ifrs/
FASB. (2017). Conceptual Framework. Retrieved from FASB: https://www.fasb.org/project/cf_phase-c.shtml
iasplus. (2017). IAS1 – Presentation of Financial Statements. Retrieved from Ias Plus: https://www.iasplus.com/en/standards/ias/ias1
IFAC. (2013). Conceptual Framework for General Purpose Financial Reporting . Retrieved from IFAC: https://www.ifac.org/publications-resources/conceptual-framework-general-purpose-financial-reporting-public-sector-enti-6
Nandwani, M. (2017). HCA – meaning, benefits and limitations. Retrieved from Accounting Notes: https://www.accountingnotes.net/historical-cost-accounting/historical-cost-accounting-hca-meaning-benefits-and-limitations/5454
Order an Essay Now & Get These Features For Free:
Turnitin Report
Formatting
Title Page
Citation
Outline
