Theconceptual framework and accounting standards for financial reporting providesan agreed set of fundamental principles and concepts that leads to consistentstandards to ensure that these principles are met accordingly and theinformation required by users are faithfully represented and relevant (FASB,2010). These standards are required in order to ”assess managements stewardshipand make informed economic investment decisions” (Elliot & Elliot, 2017).

Thepurpose of this essay is to critically evaluate how the conceptual frameworkand accounting standards are facilitating the reporting of ”relevant andfaithfully represented” information in the entities financial statements thatare useful in assessing the prospects for future net cash inflows to theentity. Specifically, this essay will evaluate the objectives of financialreporting, ‘valuation usefulness’ and’stewardship usefulness’. Also, the importance of reporting relevant andfaithfully represented information within the conceptual framework will bediscussed in depth. Theconceptual framework and accounting standards state the qualitativecharacteristics of financial information that is required to reflect truthfullya company’s financial performance (IASB, 2010). Relevant information is capableof making a difference to a user’s decision.

Relevant information haspredictive value because it helps users to evaluate the potential effects ofpast, present, or future transactions or other events on future cash flows (Nobesand Stadler, 2015). In addition to predictive value, confirmatory value contributesto the relevance of financial reporting information. If the information in thefinancial report provides feedback to the users regarding previous transactionsor events, this will help them to confirm or change their expectations (Jonas& Blanchet, 2000) (Christensen, 2010).

Faithful representation is thesecond fundamental qualitative. To faithfully represent economic phenomena thatinformation purports to represent, financial information must be neutral, complete,and free from error (IASB, 2010). However, the quality of ‘transparency’ is not directlymentioned in the Exposure Draft. In practice, it is often referred to in thecontext of good financial reporting. A study from Nobes and Stadler (2015) regardingthe usefulness of qualitative characteristics, showed that preparers frequentlyrefer to transparency in the context of policy changes under IAS 8. IAS 1 statesthat the primary objective of financial reporting is to provide informationthat is useful to those making investment decisions, such as buying, selling orholding equity investments (Gore & Zimmerman 2007).

  Given that valuation usefulness is seen asthe dominant role of contemporary financial reporting (Zeff, 2013), it is ratherunsurprising that financial statements are found to be very useful to investorsand other creditors when valuing a firm. The conceptual framework providesaccurate and timely financial information, relevant to the accounting standardsfor investors and stakeholders (Ball,2006). This should lead to more-informedvaluation in the equity markets.   A majorfeature of the conceptual framework and accounting standards that facilitates thereporting of relevant and faithfully represented information is the concept offair value (IFRS 13). Hermann (2006) states that fair value is the mostrelevant measure of financial reporting.

IAS 16 provides a fair value optionfor property, plant, and equipment and IAS 36 requires asset impairments and reversalsadjusted to fair value. Under the fair value measurement approach, assets andliabilities are re-measured periodically to reflect changes in their value, resultinga change in either net income or other comprehensive income for the period. In addition,fair value meets the conceptual framework criteria in terms of qualitativecharacteristics of accounting information better than other measurement bases. Fairvalue makes financial information relevant because current prices are reliablemeasures of value as it reflects present economic conditions that is related toeconomic resources and obligations (Barth, 2008). Also, according to Hermann(2006), fair value is more relevant to decision makers.

Fair value makes anentity’s financial information faithfully represented because it accuratelyreflects the condition of the business. Management and entities may sometimesrearrange asset sales and use the gains or losses from the sales to over orunderstate net income at a current time. Fair Value prevents entities from manipulatingtheir reported net income as gains or losses from price changes are reported inthe period in which they occur. As pointed out by Ball (2006), this results ina balance sheet that better reflects the current value of assets andliabilities.

However, the use of fair values results in an unavoidabletrade-off between relevance and reliability of accounting standards and couldincrease manipulation opportunities in highly liquid markets (Marra, 2016)(Barth, 2008). Moreover, IAS1 requires entities to prepare its financial statements, except for cash flowinformation, using the accrual basis of accounting (IASB 2010).  Accrual accounting is a method which measuresthe performance of a company by recognizing economic events regardless if anycash transaction occurs. The accruals concept gives entities a better assessmentand understanding of future net cash flows, thus enabling managers to make moreinformed financial decisions. The accrual basis informs users about obligationsto pay cash in the future and of economic resources that represent cash to bereceived in the future. Just like fair value, Accrual accounting also meets theframework criteria of qualitative characteristics. Accrual accounting enablespredictability as it helps users evaluate the potential effects of past,present or future transactions or future cash flows, and confirmatory value toconfirm or correct their previous evaluations. Accrual accounting produces morefaithfully represented financial statements as it constitutes better representationsof actual circumstances and the entities performance in any time period.

There isevidence that as a result of the accruals process, reported earnings tend to besmoother than underlying cash flows and that earnings provide betterinformation about economic performance to investors than cash flows (Dechow1994).  Overall,both the accruals and fair value concept makes financial statements relevantand faithfully represented, Therefore, making valuation more useful asinvestors are able to accurately assess the prospects for future net cash flows.In fact, it would be tough to identify better alternative methods in order tomeet the requirements of the qualitative characteristics from accountingstandards and the conceptual framework.  However, theconceptual framework and accounting standards has been criticized due to beinginconsistent and its lack of guidance when defining and recognising assets andliabilities. Most notably, IAS 38 Intangible Assets. Intangible assets are onlyrecognised if it is probable that the expected future economic benefits thatare attributable to the asset will flow to the entity. The general requirementin IAS 38 is similar to the requirement for Property, Plant, and Equipment of IAS16.

Conversely, in the remainder of the standard, and interrelated requirementsin IFRS 3 Business Combinations, different requirements are included whichcould result in the recognition of intangible assets that do not meet the recognitionand definition criteria of the Conceptual Framework as well as the exclusion ofintangible assets that do meet the definition of an asset (Brouwer, 2015). Thelack of recognising many intangible assets on financial statements due to thisproblem has been criticised by Lev (2003), who holds that this information isrequired to solve the issue of partial, inconsistent and confusing information regardingnon-current assets. Eckstein (2004) concludes that the objective of providingrelevant information must include the recognition of intangible assets. Disclosingthe true value of intangible assets in the financial statement is fundamentalin order to meet the objectives (Laux, J.

(2011).According to the recentconceptual framework of IASB, the objectives of financial reporting has twoaspects. One is stewardship, which deals with management responsibility towardsthe company, and another is decision-usefulness, which mainly deals with thedecision-making users of financial statements. The current ExposureDraft gives more prominence to the role of stewardship, which is an improvementon the existing 2010 framework (IASB 2015). Thisissue concerns the very nature of financial reporting, and may hinge on whetherone believes that financial reports are utilized to such an extent or more forcontrol and evaluation of management as they are for resource allocation decisions(Gore & Zimmerman 2007). AndrewLennard (2007) argues that stewardship and decision usefulness should berecognised as separate objectives. The assessment of howmanagement has satisfied its stewardship responsibilities may require more informationthat is not necessarily provided to achieve the objective of financialreporting. Stewardship helps to increase the decisionusefulness to the relevant decision maker by imposing responsibility for managementto take care of the entity’s resources, thus increasing the relevance andfaithful representation of the financial report.

Stewardship helps to accuratelyrecord, assessmanagements performance, and provide information to optimisefirm value, therefore improve investment decisions. Managementstewardship is meaningful to financial reports users who are interested inmaking resource allocation decisions because managements performance indischarging its stewardship responsibilities significantly affects an entitiesability to generate net cash inflows (Kuhner and Pelger 2015).However, assessing the performance of managements stewardship through financialstatements may prove difficult because of the agency problem.

Some of the concern about stewardship being a separate objective seemsto arise from the potential conflict between the owners and managementsinterest (Agrawel andKoeber, 1996). Bebchuck and Fried (2003) state that managers have a lot ofinfluence and power over shareholders in different aspects, such as their own salarybecause of the ability to reduce the link between their performance and theirsalary. Managers have almost complete freedom allowing them plenty ofopportunities to benefit for their own private interests. For example, amanager may not want to distribute excess cash when the firm does not have profitableinvestment opportunities, therefore, making financial statements express aninaccurate reflection of managerial allocation of resources. Boshkoska(2014) states thatincreasing managerial compensation will reduce the agency costs to shareholderswhich would make financial statements more likely to represent accurateinformation about a firm’s stewardship.  Also,this will help support managerial and shareholder interests together, so that whenshareholders benefit, managers can also benefit.

Furthermore, Kuhner and Pelger (2015) showthat the concept of fair value has different impacts on the valuation andstewardship usefulness of financial statements. To clarify, fair value can displaya negative impact on the ability of financial statement users to assessstewardship of the managers of the company. Lennard (2007) argues that, to beable to assess how the management discharged their responsibilities towards theshareholders, a piece of information that is difficult to disagree with isdemanded. In other words, the historical cost method to value assets andliabilities is seen as a more relevant and superior measure for the purpose of relevantand faithful representative financial statements. Different opinions continue to exist aboutwhether providing information about management stewardship should be stated asan objective of financial reporting. A separate objective for stewardship isnot required because it is comprised within the decision usefulness objective. The decision usefulness objective is toprovide decision useful information to current and future providers of finance.

Additionally, the same information about economic resources and claims, andchanges in them, is the same information needed for assessing managementstewardship. Therefore, adding a discussion about the information that ishelpful in assessing stewardship would be impractical to the objective (Whittington, 2008).Toconclude, it is evident that there are limitations by using the conceptual frameworkand accounting standards. The limitations may make aninvestors’ assessment of an entities net future cash flow inaccurate.

However, the contributions faroutweigh the shortcomings. Without these regulations it would beimpossible to produce accurate, and unbiased financial statements. Even iffinancial statements were slightly inaccurate, it would be impossible topredict future net cash inflows without them.

Faithful representative andrelevant financial information would not be possible without these accountingstandards. Continued developmentand enhancement is recommended. With regards to stewardship, it would not be sufficientto only use financial statements to measure management responsibilities of theentity. Therefore, I believe that valuation should be considered as the main objectiveof financial reporting.

 

Written by
admin
x

Hi!
I'm Colleen!

Would you like to get a custom essay? How about receiving a customized one?

Check it out