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The conceptual framework and accounting standards for
financial reporting provide an agreed set of fundamental principles and
concepts that lead to consistent standards to ensure that these principles are
met accordingly and the information required by users are faithfully
represented and relevant. (IASB 2010). These standards are required in order to
”assess managements stewardship and make informed economic investment decisions”
(Elliot & Elliot, 2017). The purpose of this essay is to critically
evaluate how the conceptual framework and accounting standards are facilitating
the reporting of ”relevant and faithfully represented” information in the
entities financial statements that are useful in assessing the prospects for
future net cash inflows to the entity. Specifically, this essay will evaluate
the objectives of financial reporting, ‘valuation usefulness’ and ‘stewardship
usefulness’. Also, the importance of reporting relevant and faithfully
represented information within the conceptual framework will be discussed in
depth.

 

The conceptual framework identifies and defines the
qualitative characteristics of financial information that is required to
reflect truthfully a company’s financial performance. The fundamental
qualitative characteristics are relevance and faithful representation. The
enhancing qualitative characteristics are understandability, comparability,
verifiability, and timeliness and can improve decision usefulness only when the
fundamental qualitative characteristics are established (IASB, 2010).

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Relevant information is capable of making a difference to a
user’s decisions. Relevant information has predictive value. The financial
statements show predictive value because it helps users to evaluate the
potential effects of past, present, or future transactions or other events on
future cash flows (Nobes and Stadler, 2015). In addition to predictive value,
confirmatory value contributes to the relevance of financial reporting
information. If the information in the financial report provides feedback to
the users regarding previous transactions or events, this will help them to
confirm or change their expectations (Jonas & Blanchet, 2000). Faithful
representation is the second fundamental qualitative. To faithfully represent
economic phenomena that information purports to represent, financial statements
must be complete, neutral, and free from material error (IASB, 2010).

However, the quality of ‘transparency’ is not mentioned in
the Exposure Draft. In practice, it is often referred to in the context of good
financial reporting but is not directly mentioned in the framework. A study
undertaken by (Nobes and Stadler, 2015) regarding the use of qualitative
characteristics showed that preparers frequently refer to transparency in the
context of policy changes under IAS 8.

The primary objective of financial reporting as stated by
IAS 1 is to provide information that is useful to those making investment
decisions, such as buying, selling or holding equity investments. (Gore &
Zimmerman 2007).  Given that valuation
usefulness is seen as the dominant role of contemporary financial reporting
(Zeff, 2013), it is rather unsurprising that financial statements are found to
be very useful to investors and other creditors when valuing a firm. The
conceptual framework provides accurate and timely financial information,
relevant to the accounting standards for investors and stakeholders
(Ball,2006). This should lead to more-informed valuation in the equity markets
and less risk to investors. In addition, the conceptual framework can help to
reduce the cost to investors of processing financial information, therefore,
increasing the efficiency with which the stock market incorporates it in
prices.

 

A major feature of the conceptual framework and accounting
standards that facilitates the reporting of relevant and faithfully represented
information is the extent to which they are imbued with fair value accounting
(IFRS 13). According to Hermann (2006), Fair value is the most relevant measure
of financial reporting. Notably, IAS 16 provides a fair value option for
property, plant, and equipment and IAS 36 requires asset impairments and
reversals adjusted to fair value. Under the fair value measurement approach,
assets and liabilities are re-measured periodically to reflect changes in their
value, with the resulting change either impacting net income or other
comprehensive income for the period.

 

Moreover, fair value meets the conceptual framework criteria
in terms of qualitative characteristics of accounting information better than
other measurement bases. Fair value makes financial information relevant
because prevailing prices are reliable measures of value as it reflects present
economic conditions relating to economic resources and obligations (Barth
(2008). Additionally, fair value also makes an entity’s financial information
faithfully represented because it accurately reflects the condition of the
business in financial statements as management are not able to rearrange asset
sales to increase or decrease net income at certain times. In addition, it
prevents entities from manipulating their reported net income. Management may
sometimes rearrange asset sales and use the gains or losses from the sales to
over or understate net income at a current time. Fair value stops this from
happening as gains or losses from price changes are reported in the period in
which they occur. As pointed out by Ball (2006), this results in a balance
sheet that better reflects the current value of assets and liabilities.

 

However, the use of fair values results in an unavoidable
trade-off between relevance and reliability of accounting standards and could
increase manipulation opportunities in highly liquid markets.

IAS 1 requires that an entity prepare its financial statements,
except for cash flow information, using the accrual basis of accounting (IASB
2010).  Accrual accounting is an
accounting method which measures the performance of a company by recognizing
economic events regardless when any cash transaction occurs. The accruals
concept of accounting will give a business a better idea of when money is
coming in and out and can help managers make informed financial decisions in
order to assess the prospects for future net cash flows. Financial statements
prepared on an accrual basis inform users of obligations to pay cash in the
future and of resources that represent cash to be received in the future.
Hence, it provides accurate information useful to users in making economic
decisions. The conceptual framework and accounting standards make the financial
information relevant. Accrual accounting helps users evaluate the potential
effects of past, present or future transactions or future cash flows
(predictive value) or to confirm or correct their previous evaluations (confirmatory
value). Accruals concept also makes financial statements faithfully represented
as it is useful in making an investment, credit and similar resources
allocation decisions. There is evidence that as a result of the accruals
process, reported earnings tend to be smoother than underlying cash flows and
that earnings provide better information about economic performance to
investors than cash flows (Dechow 1994).

 

Overall, both the accruals and fair value concept makes
financial statements relevant and faithfully represented. Therefore, making
valuation more useful as investors are able to accurately assess the prospects
for future net cash inflows to the entity. In fact, it would be tough to
identify better alternative methods in order to meet the requirements of the
qualitative characteristics that accounting standards must meet.

 

The conceptual framework has been criticized due to the
inconsistencies and lack of guidance in defining and recognizing assets and
liabilities. Most notably, IAS 38 Intangible Assets. intangible assets are only
recognized if it is probable that the expected future economic benefits that
are attributable to the asset will flow to the entity. The general requirement
in IAS 38 is thus similar to the requirement for PPE in IAS 16. However, in the
remainder of the standard, and related requirements in IFRS 3 Business
Combinations, various requirements are included that may result in the
recognition of intangible assets that do not meet the Conceptual Framework
definitions and recognition criteria as well as the exclusion of intangible
assets that do meet the definition of an asset (Brouwer). The lack of
recognizing many intangible assets on the balance sheet has been criticised by
Lev (2003), who holds that this information on the balance sheet is required to
solve the issue of partial, inconsistent and confusing information about these
important assets. Eckstein (2004) concludes that the objective of providing
relevant information mandates the recognition of intangible assets. The disclosure
of the true value of intangible assets in the financial statement is
fundamental in order to meet the objectives. 
(EMERGING ISSUES IN ACCOUNTING FOR INTANGIBLE ASSETS) Babu Bakhsh
Mansuri)

 

 

According to the recent conceptual framework of IASB, there
are two aspects of objectives of financial reporting. One is stewardship, which
deals with management responsibility towards the company to provide relevant
and faithful represented information, and another is decision-usefulness, which
mainly deals with the decision-making users of the financial statement. There
is ongoing debate whether stewardship should be considered as an objective of
financial reporting and whether the decision usefulness provides the same
concept of stewardship. This issue concerns the very nature of financial
reporting and may hinge on whether one believes that financial reports are used
as much or more for control and evaluation of management as they are for
resource allocation decisions (Gore & Zimmerman 2007). The current Exposure
Draft gives more prominence to the role of stewardship, which is an improvement
on the existing 2010 framework. (IASB, 2015 para 1.3).

Andrew Lennard (2007) argues that stewardship and decision
usefulness should be recognized as separate objectives. The assessment of how
management has fulfilled its stewardship responsibilities may require more
information that is not necessarily provided to achieve the objective stated in
paragraph OB2. Stewardship helps to increase the decision usefulness to the relevant
decision maker by imposing responsibility for management to take care of the
entity’s resources which will increase the relevance and faithful
representation of the financial report (Young, 1998). Stewardship helps to
accurately record, assess management performance, and provide information to
optimise firm value, thus improve investment decisions. Management stewardship
is meaningful to financial reports users who are interested in making resource
allocation decisions because managements performance in discharging its
stewardship responsibilities significantly affects an entities ability to
generate net cash inflows.

However, assessing the performance of management stewardship
through financial statements may prove difficult because of the agency problem.
Some of the concern about stewardship being a separate objective seems to stem
from the potential tension between the interests of management and those of
owners Agrawel and Koeber (1996). Fried (2003) states that managers have a lot
of influence and power over shareholders in different aspects, such as their
own salary as they have the ability to reduce the link between their
performance and their salary. Managers, whilst in office, have almost complete
freedom giving them plenty of opportunities to benefit their own private
interests. For example, it is possible for a manager to not distribute excess
cash when the firm does not have profitable investment opportunities,
therefore, making financial statements express an inaccurate reflection of managerial
allocation of resources. However, there are ways that the agency problem can be
solved, which would make financial statements more likely to represent accurate
information about a firm’s stewardship. Elliot et.al (2017) shows that
increasing managerial compensation will reduce the agency costs to
shareholders. Compensation helps align managerial and shareholder interests
together so that managers benefit when shareholders benefit.

 

Different opinions continue to exist about whether providing
information about management stewardship should be stated as an objective of
financial reporting. I believe that separate stewardship is not required
because it is comprised of the decision usefulness objective. Also, to provide
information useful in assessing management’s stewardship to be a broader
objective than decision usefulness may be mixing financial reporting and
corporate governance issues. The decision-usefulness objective is to provide
decision-useful information to current and prospective providers of finance.
Additionally, the same information about economic resources and claims, and
changes in them is the same information needed for assessing management
stewardship. Therefore, adding a discussion about the information that is
helpful in assessing stewardship would add nothing substantive to the objective
(Whittington, 2008)

 

To conclude, we have seen that the development of a
conceptual framework and accounting standards will lead to the improvement in
financial reporting practices, which will, in turn, lead to financial reports
that are deemed more useful for economic decision making. With a
well-formulated conceptual framework, there is an expectation that information
will be generated that is one or more relevance to report users, as well as
being more faithfully represented. The use of logically derived conceptual
framework will allow constituents to understand more fully how and why
particular accounting standard requires specific approaches to be adopted and
will provide prepares with guidance when no specific accounting standard exist.

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