The New Accounting Conceptual Accounting Framework Essay Sample
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The New Accounting Conceptual Accounting Framework Essay Sample
FASB (the Financial Accounting Standards Board, a US body) was the first organization to develop “Concepts Statements”. All the other “Concepts Statements” have been based on those developed by FASB. A new “Conceptual Framework for Financial Reporting” was worked on jointly by FASB and IASB (the International Accounting Standards Board) and was published simultaneously by FASB and IASB in September 2010. It deals with “The Objective of General Purpose Financial Reporting” and the “Qualitative Characteristics of Useful Financial Information”. The contents would be excessively long to read at a single sitting: this article restricts itself to ““The Objective of General Purpose Financial Reporting” as agreed upon by FASB and IASB. The IPSASB (the International Public Sector Accounting Standards Board, a committee of the International Federation of Accountants – IFAC,based in New York) Framework is quite different: below, I point out the objectives of reports for private and public sector entities. The rest of the IPSASB Framework will be dealt with in a separate article. FASB and IASB state that the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.
Those decisions involve buying, selling or holding equity and debt instruments and providing or settling loans and other forms of credit. IPSASB states that the objectives of financial reporting by public sector entities are to provide information about the entity that is useful to users of general purpose financial reports (GPFRs) for accountability purposes and for decision-making purposes. GPFRs of public sector entities are developed primarily to respond to the information needs of service recipients and resource providers who do not possess the authority to require a public sector entity to disclose the information they need for accountability and decision-making purposes. The legislature (or similar body) and members of parliament (or a similar representative body) are also primary users of GPFRs, and make extensive and ongoing use of GPFRs when acting in their capacity as representatives of the interests of service recipients and resource providers. Therefore, for the purposes of the Conceptual Framework, the primary users of GPFRs are service recipients and their representatives and resource providers and their representatives. Citizens receive services from, and provide resources to, the government and other public sector entities. Therefore, citizens are primary users of GPFRs.
Some service recipients and some resource providers that rely on GPFRs for the information they need for accountability and decision-making purposes may not be citizens―for example, residents who pay taxes and/or receive benefits but are not citizens; multilateral or bilateral donor agencies and many lenders and corporations that provide resources to, and transact with, a government; and those that fund, and/or benefit from, the services provided by international governmental organizations. In most cases, governments that provide resources to international governmental organizations are dependent on GPFRs of those organizations for information for accountability and decision-making purposes. FASB states that decisions by existing and potential investors about buying, selling or holding equity and debt instruments depend on the returns that they expect from an investment in those instruments; for example, dividends, principal and interest payments, or market price increases.
Similarly, decisions by existing and potential lenders and other creditors about providing or settling loans and other forms of credit depend on the principal and interest payments or other returns that they expect. Investors’, lenders’ and other creditors’ expectations about returns depend on their assessment of the amount, timing and uncertainty of, or the prospects for, future net cash inflows to the entity. Consequently, existing and potential investors, lenders and other creditors need information to help them assess the prospects for future net cash inflows to an entity. To assess an entity’s prospects for future net cash inflows, existing and potential investors, lenders and other creditors need information about the resources of the entity, claims against the entity, and how efficiently and effectively the entity’s management and governing board have discharged their responsibilities to use the entity’s resources. Examples of such responsibilities include protecting the entity’s resources from the unfavourable effects of economic factors such as price and technological changes and ensuring that the entity complies with applicable laws, regulations and contractual provisions.
Information about management’s discharge of its responsibilities is useful for decisions by existing investors, lenders and other creditors who have the right to vote on or otherwise influence management’s actions. Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide information directly to them and must rely on general purpose financial reports for much of the financial information they need. Consequently, they are the primary users to whom general purpose financial reports are directed. However, general purpose financial reports do not and cannot provide all of the information that existing and potential investors, lenders and other creditors need. Those users need to consider pertinent information from other sources, for example, general economic conditions and expectations, political events and political climate, and industry and company outlooks.
General purpose financial reports are not designed to show the value of a reporting entity; but they provide information to help existing and potential investors, lenders and other creditors to estimate the value of the reporting entity. Individual primary users have different, and possibly conflicting, information needs and desires. The Board, in developing financial reporting standards, will seek to provide the information set that will meet the needs of the maximum number of primary users. However, focusing on common information needs does not prevent the reporting entity from including additional information that is most useful to a particular subset of primary users. The management of a reporting entity is interested in financial information about the entity. However, management need not rely on general purpose financial reports because it is able to obtain the financial information it needs internally. Other parties, such as regulators and members of the public other than investors, lenders and other creditors, may find general purpose financial reports useful. However, those reports are not primarily directed to these other groups.
To a large extent, financial reports are based on estimates, judgments, and models rather than exact depictions. The Conceptual Framework establishes the concepts that underlie those estimates, judgments and models. The concepts are the goal towards which the Board and preparers of financial reports strive. As with most goals, the Conceptual Framework’s vision of ideal financial reporting is unlikely to be achieved in full, at least not in the short term, because it takes time to understand, accept, and implement new ways of analyzing transactions and other events. Nevertheless, establishing a goal towards which to strive is essential if financial reporting is to evolve so as to improve its usefulness. General purpose financial reports provide information about the financial position of a reporting entity, which is information about the entity’s economic resources and the claims against the reporting entity. Financial reports also provide information about the effects of transactions and other events that change a reporting entity’s economic resources and claims. Both types of information provide useful input for decisions about providing resources to an entity. Information about the nature and amounts of a reporting entity’s economic resources and claims can help users to identify the reporting entity’s financial strengths and weaknesses.
That information can help users to assess the reporting entity’s liquidity and solvency, its needs for additional financing, and how successful it is likely to be in obtaining that financing. Information about priorities and payment requirements of existing claims helps users to predict how future cash flows will be distributed among those with a claim against the reporting entity. Different types of economic resources affect a user’s assessment of the reporting entity’s prospects for future cash flows differently. Some future cash flows result directly from existing economic resources, such as accounts receivable. Other cash flows result from using several resources in combination to produce and market goods or services to customers. Although those cash flows cannot be identified with individual economic resources or claims, users of financial reports need to know the nature and amount of the resources available for use in a reporting entity’s operations. Changes in a reporting entity’s economic resources and claims result from that entity’s financial performance from other events or transactions, such as issuing debt or equity instruments.
To properly assess the prospects for future cash flows from the reporting entity, users need to be able to distinguish between both of these changes. Information about a reporting entity’s financial performance helps users to understand the return that the entity has produced on its economic resources. Information about the return the entity has produced provides an indication of how well management has discharged its responsibilities to make efficient and effective use of the reporting entity’s resources. Information about the variability and components of that return also is important, especially in assessing the uncertainty of future cash flows. Information about a reporting entity’s past financial performance and how its management discharged its responsibilities usually is helpful in predicting the entity’s future returns on its economic resources. Accrual accounting depicts the effects of transactions, and other events and circumstances on a reporting entity’s economic resources and claims in the periods in which those effects occur, even if the resulting cash receipts and payments occur in a different period.
This is important because information about a reporting entity’s economic resources and claims and changes in its economic resources and claims during a period provides a better basis for assessing the entity’s past and future performance than information solely about cash receipts and payments during that period. Information about a reporting entity’s financial performance during a period, reflected by changes in its economic resources and claims other than by obtaining additional resources directly from investors and creditors is useful in assessing the entity’s past and future ability to generate net cash inflows. That information indicates the extent to which the reporting entity has increased its available economic resources, and thus its capacity for generating net cash inflows through its operations rather than by obtaining additional resources directly from investors and creditors. Information about a reporting entity’s financial performance during a period may indicate the extent to which events such as changes in market prices or interest rates have increased or decreased the entity’s economic resources and claims, thereby affecting the entity’s ability to generate net cash inflows.
Information about a reporting entity’s cash flows during a period also helps users to assess the entity’s ability to generate future net cash inflows. It indicates how the reporting entity obtains and spends cash, including information about its borrowing and repayment of debt, cash dividends or other cash distributions to investors, and other factors that may affect the entity’s liquidity or solvency. Information about cash flows helps users understand a reporting entity’s operations, evaluate its financing and investing activities, assess its liquidity or solvency, and interpret other information about financial performance. A reporting entity’s economic resources and claims may change for reasons other than financial performance, such as issuing additional ownership shares. Information about this type of change is necessary to give users a complete understanding of why the reporting entity’s economic resources and claims changed and the implications of those changes for its future financial performance.