Why principles-based standards require conceptual framework

Assignment Help Accounting Basics
Reference no: EM13733665 , Length: 3000 Words

Case Study 1

The FASB and IASB began a joint agenda project to revisit their conceptual frameworks for financial accounting and reporting in 2002. Each board bases its accounting standards decisions in large part on the foundation of objectives, characteristics, definitions, and criteria set forth in their existing conceptual frameworks. The goals of the new project are to build on the two boards' existing frameworks by refining, updating, completing, and converging them into a common framework that both Boards can use in developing new and revised accounting standards. A common goal of the FASB and IASB, shared by their constituents, is for their standards to be 'principles-based'. To be principles- based, standards cannot be a collection of conventions but rather must be rooted in fundamental concepts. For standards on various issues to result in coherent financial accounting and reporting, the fundamental concepts need to constitute a framework that is sound, comprehensive, and internally consistent.

Without the guidance provided by an agreed-upon framework, standard setting ends up being based on the individual concepts developed by each member of the standard- setting body. Standard setting that is based on the personal conceptual frameworks of individual standard setters can produce agreement on specific standard- setting issues onf y when enough of those personal frameworks happen to intersect on that issue. However, even those agreements may prove transitory because, as the membership of the standard-setting body changes over time, the mix of personal conceptual frameworks changes as well. As a result, that standard-setting body may reach significantly different conclusions about similar (or even identical) issues than it did previously, with standards not being consistent with one another and past decisions not being indicative of future ones. That concern is not merely hypothetical: substantial difficulties in reaching agreement in its first standards projects was a major reason that the original FASB members decided to devote substantial effort to develop a conceptual framework.

The IASB Framework is intended to assist not only standard setters but also preparers of financial statements (in applying international financial reporting standards and in dealing with topics on which standards have not yet been developed), auditors (in forming opinions about financial statements), and users (in interpreting information contained in financial statements). Those purposes also are better served by concepts that are sound, comprehensive, and internally consistent. (In contrast, the FASB Concepts Statements state that they do not justify changing generally accepted accounting and reporting practices or interpreting existing standards based on personal interpretations of the concepts, one of a number of differences between the two frameworks.) Another common goal of the FASB and IASB is to converge their standards. The Boards have been pursuing a number of projects that are aimed at achieving short-term convergence on specific issues, as well as several major projects that are being conducted jointly or in tandem. Moreover, the Boards have aligned their agendas more closely to achieve convergence in future standards. The Boards will encounter difficulties converging their standards if they base their decisions on different frameworks.

The FASB's current Concepts Statements and the IASB's Framework, developed mainly during the 1970s and 1980s, articulate concepts that go a long way toward being an adequate foundation for principles-based standards. Some constituents accept those concepts, but others do not. Although the current concepts have been helpful, the IASB and FASS will not be able to realise fully their goal of issuing a common set of principles-based standards if those standards are based on the current FASS Concepts Statements and IASB Framework. That is because those documents are in need of refinement, updating, completion, and convergence.

The planned approach in the joint project will identify troublesome issues that seem to reappear time and time again in a variety of standard-setting projects and often in a variety of guises. That is, the focus will be on issues that cut across a number of different projects. Because it is not possible to address those cross-cutting issues comprehensively in the context of any one standards-level project, the conceptual framework project provides a better way to consider their broader implications, thereby assisting the boards in developing standards-level guidance.

As noted in the chapter, the boards have issued and received comments on an exposure draft relating to Phase A Objectives and Qualitative Characteristics. A discussion paper relating to Phase D Reporting Entity had been issued and work is continuing on Phase B Elements and Recognition and Phase C Measurement.

Questions

1. Explain why principles-based standards require a conceptual framework.

2. Why is it important that the IASB and FASB share a common conceptual framework?

3. It is suggested that several parties can benefit from a conceptual framework. Do you consider that a conceptual framework is more important for some parties than others? Explain your reasoning.

4. What is meant by a 'cross-cutting' issue? Suggest some possible examples of cross-cutting issues.

Case Study 2

The trend toward fair value accounting by J Russell Madray, CPA

The Debate

Critics contend that GAAP is seriously flawed. Some in the accounting profession go so far as to pronounce financial statements almost completely irrelevant to the financial analyst community. The fact that the market value of publicly traded firms on the New York Stock Exchange is an average of five times their asset values serves to highlight this deficiency. Many reformers, including FASB chairman Robert Herz, believe that fair value accounting must be part of the answer to making financial statements more relevant and useful.* Advocates of fair value accounting say it would give users of financial statements a far clearer picture of the economic state of a company.

But switching from historical cost to fair value requires enormous effort. Valuing assets in the absence of active markets can be very subjective, making financial statements less reliable. In fact, disputes can arise over the very definition of certain assets and liabilities. The crux of the fair value debate is this: Each side agrees that relevance and reliability are important, but fair value advocates emphasize relevance, while historical cost advocates place greater weight on reliability.

Relevance versus Reliability

The pertinent conceptual guidance for making trade-offs between relevance and reliability is provided by FASB Concepts Statement No. 2, Qualitative Characteristics of Accounting Information. It provides guidance for making standard-setting decisions aimed at producing information useful to investors and creditors. Concepts Statement No. 2 states:

The qualities that distinguish "better" (more useful) information from "inferior" (less useful) information are primarily the qualities of relevance and reliability ... The objective of accounting policy decisions is to produce accounting information that is relevant to the purposes to be served and is reliable.

Critics of fair value generally believe that reliability should be the dominant characteristic of financial statement measures. But the FASB has required greater use of fair value measurements in financial statements because it perceives that information as more relevant to investors and creditors than historical cost information. In that regard, the FASB has not accepted the view that reliability should outweigh relevance for financial statement  measures.

Some critics also interpret reliability as having a meaning that differs in at least certain respects from how that term is defined in the FASB's Conceptual Framework. Some critics equate reliability with precision, and others view it principally in terms of verifiability. However, Concepts Statement No. 2 defines reliability as "the quality of information that assures that information is reasonably free from error or bias and faithfully represents what it purports to represent." With respect to measures, it states that "[t]he reliability of a measure rests on the faithfulness with which it represents what it purports to represent, coupled with an assurance for the user, which comes through verification, that it has that representational quality." Thus, the principal components of reliability are representational faithfulness and verifiability.

Although there are reliability concerns associated with fair value measures, particularly when such measures may not be able to be observed in active markets and greater reliance must be placed on estimates of those measures, present-day financial statements are replete with estimates that are viewed as being sufficiently reliable. Indeed, present day measures of many assets and liabilities (and changes in them) are based on estimates, for example, the collectability of receivables, salability of inventories, useful lives of equipment, amounts and timing of future cash flows from investments, or likelihood of loss in tort or environmental litigation.

Even though the precision of calculated measures such as those in depreciation accounting is not open to question since they can be calculated down to the penny, the reliability of those measures is open to question. Precision, therefore, is not a component of reliability under Concepts Statement No. 2. In fact, Concepts Statement No. 2 expressly states that reliability does not imply certainty or precision, and adds that any pretension to those qualities if they do not exist is a negation of reliability.

Questions

1. What you think is the fundamental problem with financial statements based upon the historic cost measurement principle used under US GAAP ?

2. What do you think of the principle' ... accounts must reflect economic reality' as a core principle of measurement in accounting?

3. How would you measure economic reality?

4. What is reliability in accounting?

Case Study 3

Disclosure of environmental liability by Lindene Patton C.l.H., Senior vice-president and counsel, Zurich

Around the world, companies are being required to meet higher levels of disclosure of environmental liability ... In the United States, for example, the US Financial Accounting Standard Board (FASB) issued provisions in 2002 for accounting for environmental liabilities on assets being retired from service. The provision for accounting for asset retirement obligations required companies to reserve environmental liabilities related to the eventual retirement of an asset if its fair market value could be reasonably estimated.

The intent of the ruling was disclosure, but the conditional nature of estimating a fair market value caused corporations to take the position that they could defer their liability indefinitely by 'mothballing' a contaminated property. Companies effectively postponed the recognition of their environmental liabilities in the absence of pending or anticipated litigation.

Earlier this year, FASB clarified its intention by providing an interpretation that said companies have a legal obligation to reserve for environmental and other liabilities associated with the eventual retirement of manufacturing facilities or parts of facilities, even when the timing or method of settlement is uncertain. Among examples given by FASB:

• An asbestos-contaminated factory cannot simply be 'mothballed' without adequate reserves to cover the eventual cost of removing the asbestos
• Reserves must be established today for the eventual disposal of still-in-use, creosote- soaked utility poles

As a result of what may seem like a minor technical re-interpretation, companies may have to recognise immediately millions of dollars in liabilities in their income statements to comply with this change.

In Europe, regulators have also initiated efforts to promote disclosure. In 2001, the European Commission promulgated tougher, non-binding guidance for disclosing environmental costs and liabilities, and various countries in Europe have issued additional requirements related to environmental disclosure. In 2002, the Canadian Institute of Chartered Accountants published voluntary guidance that stressed the importance of disclosing all material risks, including environmental liabilities, in companies' annual reports.

Some financial institutions have also pledged to adhere to tenets of international initiatives such as the Equator Principles, which factor environmental and social considerations into assessing the risk of a project. Also, a group of pension funds, foundations, European investors and US state treasurers have endorsed UN efforts to promote a minimum level of disclosure on environmental, social and governance issues.

Recognition of environmental liabilities may also soon emerge as an issue for companies in Asia. While environmental issues may have taken a back seat to rapid economic development over the past 20 years, that situation may change as legislation and regulation catch up with development.

The responsibility for disclosing future environmental liability is clearly a growing issue for companies around the world. However, accurately estimating cleanup costs is not an easy task due to unknown contaminants, legacy liabilities related to formerly operated property, regulatory changes or unexpected claims related to natural resource damage.

Questions

1. The article states that the US standard setter FASB requires companies to record a provision in relation to environmental costs of retiring an asset ('to reserve environmental liabilities') if its fair value could be reasonably estimated. How do you think companies would go about estimating such a provision?

2. What aspects of the requirements were used by US companies to defer recognition of a liability?

3. In what ways does the recognition of the liability in relation to future restoration activity affect (a) net profit in the current year and future years; and (b) cash flow in the current and future years?

4. The article refers to changes in disclosure requirements relating to environmental liabilities in many countries around the world. How important is it that companies recognise the liability? To what extent is disclosure about the liability sufficient?

Verified Expert

Reference no: EM13733665

Questions Cloud

Determine whether the viewing audience proportions changed : During the first 13 weeks of the t.v season the Saturday evening 8:00pm-9:00pm audience proportions were recorded as ABC 29% CBS 28% NBC 25% and independents 18%. a sample of 300 homes two weeks after Saturday night schedule revision yielded the foll..
Data for applications built with modern technologies : 1. Provide an example of a software component and another example of a software service. Explain what these examples have in common and how they differ. 2. Consider a legacy system and explain how services could be used to implement wrappers to provi..
Prepare an even-point modified likert scale : Prepare an even-point modified Likert scale to focus on the value of energy drinks and Both scales should be properly constructed as described and demonstrated in the marketing research text
Discuss any differences in the employment plans for private : Samples of human resource executives were asked how their company planned to change their work force over the next 12 months. A categorical response variable showed 3 options: add employees, no change, lay off employees. discuss any differences in th..
Why principles-based standards require conceptual framework : What aspects of the requirements were used by US companies to defer recognition of a liability - Explain why principles-based standards require a conceptual framework.
What is a pro forma invoice and what is a purchase orders : What's a Pro Forma invoice? How are these used in international trade? What does one look like? Is there a standard form
Actuarial table indicates-anticipated years in retirement : You want to retire in 35 years. The Actuarial table indicates that your anticipated years in retirement will be 20 years. If you anticipate the return on your investments will be 5% and you wish to get $100,000 per year in retirement, how much money ..
Environment for opportunities and threats to a company : Examining the external environment for opportunities and threats to a company, brand, and product is an essential step in the development of a marketing strategy
Sql server express edition and adventureworks : Assignment 1 SQL Server Express Edition and AdventureWorksLT2012 answer to Unit 3 is not provided for Questions 4 and 10 which I need, and Question 9 code returns no results (assignment requires Join statements which I was able to use). Please advise..

Reviews

Write a Review

 

Accounting Basics Questions & Answers

  Determining amount of cash received of carson company

Carson Company on July 15 sells merchandise on account to Tayler Co. for $1,000, terms 2/10, n/30. On July 20 Tayler Co. returns merchandise worth $400 to Carson Company. On July 24 payment is received from Tayler Co. for the balance due. What is ..

  Tudor company acquired 500000 of carr corporation bonds for

tudor company acquired 500000 of carr corporation bonds for 487706.69 on january 1 2013. the bonds carry an 11 stated

  Company predetermined overhead rate problem

A company expected its annual overhead costs to be $ 600000 and direct labor costs to be $ 1000000. Actual overhead was $ 580000 and actual labor costs totaled $ 1100000. how much is the company's predetermined overhead rate to the nearest rent?

  Addy company has two products a and b the annual production

addy company has two products a and b. the annual production and sales of product a is 2350 units and of product b is

  Wenner furnace corp purchased machinery for 334800 on may 1

wenner furnace corp. purchased machinery for 334800 on may 1 2012. it is estimated that it will have a useful life of

  Since the start of development work on the wireless wizard

johnson and gomez inc. is a small firm involved in the production and sale of electronic business products. the company

  A group term life insurance policy

Clint collected $50,000 as the beneficiary of a group term life insurance policy when his wife died. The premiums on the policy were paid by his deceased wife's employer.

  Tucki co receives 269083 when it issues a 269083 10

tucki co. receives 269083 when it issues a 269083 10 mortgage note payable to finance the construction of a building at

  Janice was a cash basis taxpayer at the time of her death

janice was a cash basis taxpayer. at the time of her death she was owed 100000 in accrued salary. upon janices death

  Which of the following conditions will not normally cause

An IT system is designed to ensure that management possesses the information it needs to carry out its functions through the integrated actions of.

  Noncontrolling interest in kent total income

At the end of the year, 20% of the goods were still in X-Beams' inventory. Kent's reported net income was $300,000. What was the noncontrolling interest in Kent's net income?

  Sartain corporation is in the process of preparing its

sartain corporation is in the process of preparing its annual budget. the following beginning and ending inventory

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd