Analysis of Accounting Policies Based on IASB Conceptual Framework

This report delves into the analysis of accounting policies within the context of the IASB Conceptual Framework. It critically examines the relevance of historical costing principles in periods of rising prices, contrasting them with the fair value approach. The report explores the contributions of the...Read More

Accounting Policy based on IASB Conceptual
Framework
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Table of Contents
Introduction.................................................................................................................................................2
Discussion and Analysis...............................................................................................................................3
Answer to Question No. 1.......................................................................................................................3
Answer to Question No. 2.......................................................................................................................5
Answer to Question No. 3.......................................................................................................................7
Conclusion...................................................................................................................................................9
References.................................................................................................................................................10
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Introduction
Our study is intended to address the three major issues with the help of a set of questionnaire
consisting of three questions in the context of IASB .The first being the relevance of the
application of Historical costing Principles in the age of growing prices, the second being the
contribution of the conceptual framework in boosting up the public standing of accounting
profession and the last being the shifting of the recent accounting standards from the historical
costs to fair value and reason for clear stipulation by the accounting standard in relation to such
shift.The profession of accounting and financial reporting is undergoing radical changes in view
of the changes in the accounting policies and the business scenarios. The historical cost poses a
number of challenges in the period of rising prices which renders the information given to the
stakeholders useless and as such there has been an increasing focus that has been given to fair
values in the recent times (Belton, 2017). Furthermore, conceptual framework are not only the
devices to ensure smooth functioning of the accounting profession and have the public standing
but they also provide a guidance on how the financial reporting should be done. All these issues
have been discussed below.
Discussion and Analysis
Answer to Question No. 1
Problem of adoption of Historical Cost during Price rise and alternative to Historical Cost
The Historical Costing principle is used to measure the nominal monetary value of an asset or
liability as being reflected through its Balance sheet, but such a value may be significantly
different from the current economic or market value of such an asset or the liability. In simple
words this principle fails to account for the loss that is caused by the inflation by way of
decreasing the nominal monetary value of an item and the vice-versa during the period of
deflation (Alexander, 2016). During the period of inflation, the value of monetary unit that is
used to measure the value of an asset or liability keeps on declining and such standard of
measurement cannot remain constant in such case due to the shrinkage in its value.
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As per the historical costing principle the cost of the transactions occurred in different dates are
being added by simply ignoring the changes caused to the value of such transactions as a result
of inflation and it simply reflects the mixture of values completely dependent on the various
dates on which such values are incorporated or brought into the accounts (Dichev, 2017).
At the same time it fails to account for the matching principle so as to match the current revenue
with the current cost of operation. It is because revenues are always measured at current value or
at inflated price, but corresponding costs for earning such revenue are represented in a
combination of current value and historical cost. In other words, Historical Costing principle has
the tendency to reflect the inflationary profits and lowering the cost of production and use of
fixed assets during the inflationary trend. This inflationary profit is not the real profit but the
illusionary one.
This causes the inadequacy in the computation of the amount of depreciation allowance which
contributes significantly by way of its contribution in terms of funding the replacement of the
fixed asset for future growth and expansion of the entity. Overly distributed dividends, industrial
dispute by way of raising the claim for wage increase, misleading the investors about the entity’s
performance are few of major sufferings caused by the adoption of this principle (Werner, 2017).
The best alternative for curing the problems faced by the Historical Costing principle is Fair
value Accounting Concept. The description of the fair value as provided by FASB is the value at
which knowledgeable and willing parties shall be willing to exchange or settle assets or
liabilities. Further there is no need to have an active market in order to determine the fair value
of an asset or a liability.
Fair value concept serves the best shareholders reporting purpose only if the shareholders’ value
is solely dependent on the market prices of the assets and liabilities. Shareholders’ value is the
result of the total value of the assets and liabilities of the firm; hence fairs value accounting
provides a match to the fair values of assets and liabilities so as to report the correct value to the
shareholders. Again it is to be kept in mind that the fair value of the asset can be thought as a
replacement to the concept of the Historical costing principle only when it is not dependent on
the historical costing information. Fair value of the transaction settles it at again actual
transaction as a result of which it trues up against realization. The fair value accounting concept
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undoubtedly brought the volatility in the reporting of the financial position, but that does not
mean that it is a flaw in financial reporting but it should be perceived as a commonly anticipated.
The major reason for adoption of the fair value is that it reflects the current cash equivalent to the
financial position of the entity by completely ignoring the past price of the transaction entered
into by it or in other words it could be said that it is the true reflection of the economic substance
of the transaction (Choy, 2018). Moreover decisions based on the fair value estimations are more
reliable than those based upon the historical cost principle by enabling its investors, creditors and
others to make a proper evaluation of its investment and financing strategies or in other words a
basis for the evaluation of its performance. In simple terms it is better to adapt to the changes as
per the business requirements rather than just relying on the past processes and regulations.
Answer to Question No. 2
The major purpose of the conceptual framework of accounting is to develop such accounting
concepts and standards that can make the financial reporting and accounting more comparable,
consistent and logical in terms of its international acceptability by means of enhanced
communication (Defond & Lennox, 2017). The conceptual framework of accounting actually
provides valuable feedback in those cases where there is no accounting standard or guidance to
treat a particular accounting item or it may be helpful in those cases where there are numerous
suggested ways of the treatment of any particular item which are conflicting in nature as a result
of which treating it as per conceptual framework may call for less criticism.
With the help of this framework the setters of the accounting standards can provide much
clarified and reasonable explanation behind implementing a particular standard by making them
more accountable to the users of the financial statement. As in enhances the credibility and
public confidence in the financial reporting by incorporating the elements of reliability,
consistency and relevance in it.
Though there is another side of it is that is actually of the least use while talking about the actual
preparation of the financial statement and also in terms of their contribution in the development
of the accounting standards there is huge prospect of the development of the academic and
theoretical standards lacking its practical application (Félix, 2017).
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Conceptual framework basically aims at focusing on the usefulness of the financial information
but sometimes due to the factor of complexity and difficulty in understanding it may fail to serve
this purpose. It is because these users of financial information represent the diverse group with
the diverse needs for which various types of standards are demanded that cannot make itself free
from the complexity associated with it. Despite these limitations associated with the conceptual
framework of accounting it cannot be denied that its contribution in the development of the
various accounting standards is of immense importance. Further what is to be done is to focus
how it can cater the diversified needs of the diversified groups of stakeholders (Jefferson, 2017).
The major purpose of the development of this conceptual framework is summarized as under:
1. To assist the IASB in the development of the future IFRS and review those IFRS already
implemented.
2. To provide necessary guidance to the preparers of the financial information in dealing
with those items of financial statements for which no guidance or standards have been
developed yet.
If in any case if the IASB has already issued any such IFRS which is in conflict with the existing
conceptual framework, then in such a case it is the IFRS that shall prevail over the framework.
From the above discussion it is quite clear that there is no doubt that conceptual framework of
accounting has boosted up the public standing of the accounting profession. It is because they lay
down foundation for the development of the various accounting standards and policies. Without
such basis it might be quite difficult for the IASB to lay down the various accounting standards
or may even think about that (Knechel & Salterio, 2016). Further while drafting any of the
accounting standards it is always kept in mind that they should at least meet the basic
requirements of the preparation and presentation of the financial statements as has been
envisaged by this framework.
Not only this but also it provides valuable feedback to the auditors in forming an opinion as to
whether the financial statements comply with the requirements of the International accounting
standards. It further assists the users of financial statement in interpreting the financial
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information contained in such financial statement. All these if combined together may reflect the
fact that it has significantly contributed in boosting up the accounting profession (Kangarluie &
Aalizadeh, 2017).
Though at the same time it is to be understood that these framework too demand significant
changes from time to time depending on the changing scenario of the Finance and Accounting
reporting framework, though fundamentally its strong purpose shall remain constant, but that
does not mean that it has some other purpose.
If there is no such framework then accounting standard development shall become haphazard or
random resulting into the conflict of the various accounting standards with each other as well as
the concerned regulation too (Marques, 2018).
The common ideology behind the preparation and presentation of the financial statements is well
reflected through the conceptual framework of accounting. Hence it is agreed that it boosts up
the public standing of the accounting profession.
Answer to Question No. 3
It is absolutely true that the conceptual framework does not provide any detailed prescription on
the issue of measurement, but few of the basic criteria for the basis of measurement have been
derived from it are mentioned hereunder:
1. How does the future expected cash equivalent associated with the particular asset or
liability is measured
2. Cost or benefit considerations
3. Basic attributes of the financial statement like reliability, usefulness, comparability etc.
4. Usefulness in making decision
As per the IASM the major objective of the financial reporting is nothing but to provide the
useful information to its existing as well as the potential investors, creditors and other
stakeholders in making decisions as to whether or not to invest in a particular firm or entity
(Grenier, 2017). From this viewpoint it seems that it is the fair value which serves this need
much logically than the Historical costing principle. It is because Historical cost are old or past
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costs not reflecting the current market value, but the same is being reflected by the fair value
concept.
Though it can be argued that financial statement is based on Historical costing principle is more
reliable and conservative too, but it the fair value based financial information that is more
relevant (Heminway, 2017). Another major argument in favor of fair value accounting is that
now day’s financial markets are efficient enough to depict the correct and reliable market value
of a particular asset or liability.
At the same time it is to be kept in mind that we cannot sat that the fair value accounting seems
to be always better than the Historical costing concept, but it actually it is because of the
weaknesses associated with the implementation or poor oversight of the legislators or regulators
that should be blamed for the limitations associated with fair value accounting and historical cost
accounting (Linden & Freeman, 2017). Actually it is current economic environment that is
highly influencing the way in which the organizational performance of an entity is being
currently evaluated. It is because these entities are working under unstable environment that is
subject to rapid and unpredictable changes.
But at the same time it cannot be denied that there are certainly few of the notable merits
associated with the Fair value accounting system that has caused the industry to choose the fair
value option over the Historical cost (Visinescu, Jones, & Sidorova, 2017).
At the same time it is being suggested that the conceptual framework are yet to stipulate clearly
an alternative to historical cost. It is because this conceptual framework actually forms the basis
for providing the necessary guidance as to the preparers of the financial statements when there is
no clear cut guidance or accounting standard to deal with any particular item in the financial
statement (Trieu, 2017).
Further conceptual framework play a major role in boosting up the public standing of the
accounting profession. Hence if the alternatives to the historical costing principles are clearly
mentioned in the conceptual framework then in future it shall provide the necessary assistance to
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the members of the IASB so as to frame a particular accounting standard or the relevant
accounting policy in relation to the same (Raiborn, Butler, & Martin, 2016). Moreover on this
basis the requisite changes into the conceptual framework as being demanded currently
worldwide can also be introduced. Because it can also be said that the conceptual framework
already in existence are required to be modified too. Further the origin or the popularity of the
fair value concept is a recent phenomenon since 2008 and it seems quite important to note that
before this no such claim has been made by any other measurement principles (Sonu, Ahn, &
Choi, 2017).
Hence it is being suggested that having seen the current global scenario it becomes important to
make such stipulation through the Conceptual framework of reporting.
Conclusion
From the above it can be concluded that now a days the fair value concept has gained significant
importance over the historical cost concept and conceptual framework of accounting has
significantly contributed towards boosting up the public standing of the accounting profession. It
is also clear that the conceptual framework is inevitable to the profession of accounting and
reporting and the same is also undergoing changes in view of the changing requirements of
business houses so as to ensure transparency and genuineness of books of accounts. Since the
historical costs are not able to reflect true and fair value of the assets and liabilities in the balance
sheet, therefore the use of the fair value methodology for valuations of assets and liabilities
becomes inevitable for showing correct financial position of the entity
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