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Conceptual Framework in Financial Accounting

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Conceptual Framework in Financial Accounting

Introduction

Financial accounting refers to a field of accounting that treats money as an entity of measuring economic performance of an organization. Most of the financial accounting departments in numerous international organizations employ conceptual framework project of financial accounting, which is approved, by the International Standards Accounting Board (ISAB). The main purpose of the conceptual framework project in financial accounting report is to provide information that is useful to current potential investors and creditors and others in building investment, credit and similar resource allocation decisions (Wiley, 2010). In other words, it is essential for making investment and credit decisions. However, it is worth noting that the conceptual framework project is not efficient for financial reporting due to some reasons. Therefore, the ultimate aim of this paper is to examine arguments that both defend conceptual framework project in financial accounting and the argument against it. However, before that, let us have an overview of what conceptual framework project is all entails.

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The conceptual Framework

The [draft] conceptual framework for financial reporting develops the factors that motivate financial reporting (BPP, 1999). The framework is a logical system of concepts that run from objectives. These objectives are responsible for discovering the financial reporting. The other features give out guidance on discovering the boundaries of financial reporting, choosing the transactions, other occurrences and circumstances to be represented, how they are to be identified and evaluated (or disclosed), and how they need to be shortened and reported. In general, the consent principles lean on a conceptual framework of accounting (Jackling, 2010). This framework runs logically from the ultimate objective of financial reporting: to issue information that is significant in making investment and credit decisions. The conceptual framework is modeled to encourage and back up the development of a reliable set of accounting standards and issue a coherent body of thought for financial reporting (Wood & Sangster, 2000). Knowledge of the conceptual framework need to help individuals familiarize themselves with complicated accounting criterion by providing a coherent structure for financial accounting, in other words, the concepts help to explain ‘why’ accountants embrace certain practices. One fundamental issue about the conceptual framework project is that it contains some characteristics of useful information used in financial accounting. Therefore, the following are essential factors of the conceptual framework in financial Accounting.

Importance of Conceptual Framework in Financial Accounting

Common goal of the boards

It should be noted that the conceptual framework was a common goal of the boards, a target divide by their constituents where their standards were to be centered on consistent principles. Conceptual framework was crucial at this point because to be consistent principles had to be based on fundamental factors rather than being a group of conventions (Black, 2003). Therefore, as a common goal between the two international financial bodies (ISAB and FADS, conceptual framework played a very significant role in finance as far as accounting information is concerned (Wiley, 2010). Besides, the framework of IASB and the concept statements of FASB are eloquent notions that go a long way towards being an efficient foundation for coherent standards and the boards have employed them for that objective (Henderson, Peirson & Herbohn, 2011). For instance, the basis for conclusions of most standards of the board explains how their suppositions are consistent with the applicable notions. Moreover, the other goal of the boards is to bring their standards into union. The boards are lining up their schedules more intimately to attain unity in future standards. However, they will come across difficult times in doing that because they base their verdicts on different frameworks.

Foundation basis for convergence of standards

The conceptual framework project is highly essential because it provides the best foundation for establishing principles-based and unity standards. The boards carried out a joint project to establish a common and modified conceptual framework (BPP, 1999). The main aims of the project included updating and re-washing the existing notions to mirror changes in markets, the economic environment and business practices in more than two decades from the time of creation of the concepts. This means that the conceptual framework was particularly crucial in purifying the information and changes that characterised the financial statements and reports. These changes were extremely essential for modification of market functions and settings across members of ISAB and FASB.

The boards also have plans to modify some parts of the available frameworks like identification and evaluation as well as to pack some gaps in the frameworks. For example, neither framework involves a robust notion of a reporting unit (Jackling, 2010). The concepts of FASB statements include no single description of a reporting unit or discussion of how to discover one. Therefore, clearly through the conceptual framework, the two boards were able to establish a strong unity between them that has helped them to improve financial and economic status of numerous organizations functioning under these two boards especially the US, UK, Australia among others (Wood & Sangster, 2000). However, this board have been successful in improving and modifying conceptual frameworks in organizations due to the following qualitative characteristics of useful information, which are, part of conceptual frameworks.

Qualitative Characteristics

There are some qualitative characteristics of useful information like satisfying, clear, understandable and many others, but the key ones are relevance and reliability, which are employed in all financial reports to make the report complete (Black, 2003).

Relevance

The question that can be asked at this point is: what does relevance mean and of what does it consist? Does it consist of predictive value, confirmatory or feedback value, materiality, timeliness? The current meaning attached to the term is materiality and confirmatory where everything comes out as perfect as required (Wiley, 2010). However, the predictive value notion could be another suggestion for its meaning but not precise.

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Reliability

Financial analysts recommended that faithful representation of information continue to be recognized as the main quality (or sub quality) of accounting information. Faithfulness is a quality that encompasses completeness and creates no room for representations that subordinate entity form. The ISAB board supported the direction taken by staff on the same issue. The board also expressed their support to removing the term ‘substance over form’ from the framework. This is because it has the same meaning as faithful representation meaning that it cannot be a subset thereof. Besides, there is authentication, which encompasses precision and uncertainty (Henderson, Peirson & Herbohn, 2011). The staff showed their contentment with the ISAB Framework on the need for financial information is error free, and as far as material is concerned to make it reliable when employed by the users. The staff also concurred with the concept statements of FASB and others that the way to make certain to the users that they can be reliable on the information is by making it verifiable, if possible by direct verification. Being verifiable is essential to issue out assurance to users that the information is much safe from material error as well as being faithful, complete and neutral. Therefore, the board needed to encompass authentication in the framework where the idea of being able to vow is a subset of authentication (Black, 2003).

Neutrality is also another sub quality of reliability, and it encompasses freedom from bias, prudence, and conservatism (BPP, 1999). The board also agreed to include the notion of conservatism into the framework that needs keen consideration and use of caution when challenged by uncertainty such as estimate. The argument also shifted to the general issue of reliability that varies in usage among accountants (Henderson, Peirson & Herbohn, 2011). Many tend to equate reliability with authentication, not representational faithfulness. In regard to reliability different standards have different notions.

Arguments Against the Development of Conceptual Framework

Although there appears to be strong reinforcement for the development of the conceptual framework, estimation is not undisputed (Jackling, 2010). This is because it also has its downfalls that downgrade conceptual framework. The argument against such a progress is winded up as follows.

Feasible

The conceptual framework project is depicted as being feasible because several people who do not agree to the feasibility of this project point out that there are not even one of the attempts by numerous individuals or organizations that have succeeded (Wood & Sangster, 2000). This means that indeed there is an infeasibility within the conceptual framework project although the organizations should not consider it a defeatist attitude because they can conquer it if they are focused. Therefore, infeasibility is a factor affecting the project and should be fought out to be successful in financial accounting (Black, 2003).

‘True Income’ Assumptions

Another key setback is the assertion that financial accounting aims to gauge “true income” and the allegation that this objective cannot be met because no one knows what true income is. True income of any organization can be estimated by there is no way it can be proved because there is not even a single organization that has a constant profit that they always count on even before it is acquired (Henderson, Peirson & Herbohn, 2011). However, whereas it may be possible to calculate one true income figure, there is no proof that the same can be done to every income of the organization and there are other ways that can be useful than others. It is better to accept the fact because no matter how conceptual framework project is praised, it can never determine true income.

The Project was Rushed

The conceptual framework project has some benefits in financial accounting but then it was speed up than expected. It should have been delayed until it when it would have been established by research. If this could have been researched well, we would not be asking questions like why accounting is what it is, why accountants do what they do and what effect these phenomena have on people and resource utilization (Wiley, 2010). The problem here is that the advocates are not willing to concur with anything less than perfection while accounting on the other hand, needs a conceptual framework even if imperfect as a guide in solving crucial outstanding issues in financial reports. This means that the conceptual framework could have been perfect and much efficient in resolving financial reports than it is now and such questions would not be coming up at all. Thus, accounting could be better than what it is today and accountants would be able to do better than what they do today. Such outcomes could lead to total satisfaction of people who uses financial reports.

The project is majorly a political process

Conceptual framework project works as a resolution of accounting issues; however, it is essentially a political process. This is because the project is majorly used by the advocates with powerful clout who have their issues resolved in their favor. However, the advocates with middle or law clout have their issues unresolved (Jackling, 2010). This means that there is unfair usage of the conceptual framework within financial settings, thus making the conceptual framework project seem irrelevant to the society because its development is a waste of time. The counter to this however, is the fact that the conceptual framework may assist the standard setters to stand up to any political pressure. Nevertheless, this is not a solution because the setters may stand the pressure but still have their clout unresolved (Black, 2003). The solution here is to do away with political grounds in the whole process to bring in equality to people with both strong and weak clouts.

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No Need of Accounting Standards

The suggestions from the majority of the users of conceptual frameworks in accounting can see through numerous accounting adjustments and thus it is problematic whether accounting standards are needed (Wood & Sangster, 2000). If the users can see through the adjustments being made in the accounting department, there is no need of any standards brought about by the conceptual framework because it means people can do without them. Moreover, the users may be in a position to adjust for dramatic changes in accounting practices, it is challenging as to what they would make of the data if there were no standards.

Rigidity in Accounting

There have been some arguments concerning the development of the conceptual framework where people argue out that they may be undesirable thus leading to too much inflexibility and firmness in accounting (Henderson, Peirson & Herbohn, 2011). Once the accounting system becomes rigidity, the operations cannot be proper meaning that there might be a problem on the effectiveness of the conceptual framework. However, it is considered better to have such rigidity in the conceptual framework than attempting to develop standards without a framework.

Raw Data can Work Out

It has been suggested that units should report primarily raw data where users can then arrange the data in whatever way they find most appealing (Black, 2003). In reporting raw data, there would not be the need for a conceptual framework at all because, both perform the same task. Therefore, raw data can be a substitution of the conceptual framework because it is cheap and can be a bit useful than conceptual framework.

Conclusion and Recommendation

The ultimate aim of the conceptual framework in financial accounting is to give out information concerning the entity to the external users who do not have the strength to prescribe the information they need meaning that they must rely on the information provided by the management of an entity (Jackling, 2010). Note that the management of this entity will also be interested in that information. Nevertheless, since management has the power to attain the information it requires, any extra information requirements of management are above the scope of the framework. This means that in any organization, financial information is very beneficial but conceptual framework determined the project and how it is managed. However, just as we have noted, the project also has its limitations that make it very important because some people suggest that an organization can use raw data which is cheaper than a conceptual framework in financial accounting.

All said and done, an individual must view both pros and cones and view what outweighs what before making your conclusion (Henderson, Peirson & Herbohn, 2011). The most valuable thing that I believe is that the conceptual framework is essential for any financial accounting system because other than being approved by the ISAB and FASB boards, the project is generally advantageous for any financial system, and it can straighten the path of accounting in all organizations. Therefore, I recommend that organizations adopt conceptual frameworks, and they shall never be disappointed if they use it effectively.

References

Black, G. (2003), Students’ Guide to Accounting and Financial Reporting Standards, Letts, Chapter 2.

BPP, (1999), CAT Interactive Text – Drafting Financial Statements, BPP Publishing Ltd, London, Chapter 3.

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Henderson, S., Peirson, G. and Herbohn, K. (2011). Issues in financial accounting (14th ed.). Frenchs Forest NSW: Pearson Education Australia.

Jackling, B. (2010). Accounting: a framework for decision making, (3rd ed.). North Ryde, N.S.W.: McGraw-Hill Education. Bundoora General 657 A1725.

John Wiley, (2010). Accounting information systems: understanding business processes. Considine, B. (3rd ed.). Milton, Qld.: Bundoora General 657.0285 A1727.

Wood F., and Sangster A., (2000), Business Accounting 1, Financial Times Professional Ltd, Chapter 10.

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