Conceptual Framework For Financial Reporting

By Jackie, Researcher

Topic: Education

Area of discussion: Financial Accounting and Reporting

Chapter: Frameworks

The objectives of this research are to find out and critically explain: the brief history of what had happened in the past in financial reporting when the framework is not developed yet; what is a conceptual framework?; the functions of conceptual framework and benefits of having it; the limitations and barriers in establishing a global conceptual framework; and some proposed solutions on how to set up an international conceptual framework.

Research question:
Discuss why there is a need to have an international conceptual framework and the extent to which an international conceptual framework can be used to resolve practical accounting issues.

Research Essay

INTI International College Subang

                Historically, in the late 1960s, a plenty of negative feedback and complaints have been lodged by the unsatisfied companies’ stakeholders against the misleading accounting treatments and approaches which were best described as being unclear, irregular and confusing. For example, at that particular time, all the accountants were not using the similar or standardised methods to compute profits. As a result, the calculated profits tend to vary among each other and subject to manipulation too (Wood & Sangster 2005, p.106). Alexander and Nobes (2010, pp.71-79) state that the factors leading to the variation in international reporting approaches are the manners in which companies are financed by the providers of finance, the nature of national legal system in influencing the financial reporting’s regulations, the correlation between the tax and reporting systems, the competence of the accountancy profession and the development of accounting theories, as well as the globalisation of capital markets around the world. In actual fact, explicit detailed framework is still absent in most of the nations. Hence, financial statements are hardly comparable internationally as accounting is performed differently in different place (Alexander & Nobes 2010, p.36). Fortunately, this has hastened the development of conceptual framework as a solution to handle this situation. For instance, the establishment of IASB Framework in 1989, followed by subsequent changes to the requirements of particular IFRSs, and then recently the collaboration between the IASB and US FASB in running a project which aims to revise and conform their conceptual framework. Ideally, conceptual framework is a statement of generally accepted accounting principles (GAAP) which form the frame for reference for financial reporting; it provides the basis for evaluation of existing practices and the development of new accounting standards as well as forming ground for transactions’ treatment, measuring bases and communication to the respective users (Scott 2011, p.1). It is considered as the most appropriate treatment for certain transactions under the supervision of professional bodies and researches (Thomas & Ward 2012, p.38).

             Generally speaking, it is extremely crucial to have a proper international conceptual framework as it offers numerous benefits and carries out significant purposes. Firstly, it assists the IASB and International Financial Reporting Interpretations Committee (IFRIC) members in the development of future IFRSs and reviews existing standards by setting out the underlying concepts. This can be seen in Ernst & Young 2012’s publication regarding to the IFRS update of standards and interpretations. For example, one of the upcoming changes is effectively starting from 1 January 2013, entities are required to disclose information about rights of set-off and related arrangements like collateral arrangements with the aim of evaluating netting effect of arrangements towards an entity’s financial position under IFRS 7 Disclosures – Offsetting Financial Assets and Financial liabilities – Amendments to IFRS 7.

                Secondly, framework is also utilised to help the board of the IASB in promoting harmonisation of accounting regulations, standards and procedures in financial statements’ presentation by providing a basis in reducing the number of alternative accounting treatments permitted by IFRSs (Thomas & Ward 2012, p.40). Framework provides a sense of direction in resolving accounting questions without the necessity for an increment in specific standards. Similarly, this also means that it can avoid the preparers, auditors and financial statements’ users from exerting unnecessary pressure by requesting for more detailed standards. Besides, unpleasant situation like the need to answer each accounting question at a sudden for a particular purpose can also be prevented (Alfredson et al. 2007, p.63). Consequently, the risk of over-regulation will be mitigated and the issue of ‘overloaded standards’ can be potentially reduced (Riahi-Belkaoui & Jones 2000, p.134).

                Thirdly, framework serves as a ‘point of references’ to the preparers of financial statements by assisting them in applying IFRSs and IASs, including the handling of accounting transactions that have yet to form the subject of an accounting standard (Scott 2011, p.2). Frankly, it is difficult for any accounting standards to give clear-cut and precise answers to all accounting questions; situation will be worsen if the standards or interpretations do not even exist, or have not be formed specifically to deal with those issues yet. Hence, a sound judgement is crucial in answering such technical problems. Luckily, boundaries to apply sensible judgement were established in the framework which ever concern with the preparation of financial statements (Alfredson et al. 2007, p.63). 

             Fourthly, framework aids the users of financial statements in interpreting the content contained in financial reports prepared in conformity with IFRSs by increasing users’ understandability as presentation is done in simpler and summarised manner which is suitable for “layman usage”; technical jargons are minimised plus additional notes and disclosures are inserted to give extra explanations. Riahi-Belkaoui & Jones (2000, p.134) claim that this will indirectly lead to a better communication among all the stakeholders since all parties are using a common set of definition and criteria. Alfredson et al. (2007, p.64) add that it could even enhances the public confidence towards the financial report too.

                In addition, sometimes standards development (especially national standards) is subject to political interference. Experts believe that a framework can decrease political pressures in making accounting judgement as well as potentially reduce the activities of lobbies and interested parties (who may have personal interest’s motivations) in influencing the standard-setting process (Riahi-Belkaoui & Jones 2000, p.134). This is because whenever there is a conflict of interest between user groups in deciding which policies need to be chosen, policies taken from a conceptual framework will often be less open to criticism as it eliminates personal biases and external pressure.  

               Dangerous situations will arise if there is no conceptual framework.

            In the absence of a conceptual framework, standards tend to be produced in a ‘fire-fighting’ approach where serious defects in accounting standards were often produced as an end results. This means that countries or standard setters will only address or respond to problems when a catastrophic corporate scandal or failure arises, rather than being proactive in determining best policy, developing and maintaining a coherent set of rules (Scott 2011, p.2). For example, during the 1980s it became fashionable for organisations to value their brand names and incorporate them into their balance sheets; the ASB’s predecessor body was completely unprepared for this and struggled hardly to develop a standard. Apparently, it is enormously difficult task as there was no universal agreement about such fundamental issues as the reason for preparing financial statements as well as the definition of what constituted an asset (Ciancanelli et al. 2009, p.37).

             Scott (2011, p.2) argues that the lack of conceptual framework will cause proliferation of ‘rules-based’     accounting systems whose primary objective is that the treatment of all accounting transactions are ought to be dealt with by detailed specific rules or requirements; such a system is very prescriptive and rigid, but has the attraction of financial statements being more comparable and consistent. Real life example can be seen in USA where the Financial Accounting Standards Board (FASB) has produced a huge number of highly detailed standards and indirectly created a financial reporting environment governed by specific rules rather than general principles as cohesive set of principles were not in place. 

           Likewise, this also means that fundamental principles can be dealt more than once in different standards (duplication) and consequently, provoking problems especially in relevant to contradictions and inconsistencies in basic concepts. This can be seen in the arguments, disputes, and conflicts in between relevance and reliability, especially in property and real estate industry. For instance, there is always a tension in deciding the most appropriate way to record the value of assets, such as land and buildings in balance sheet. Some accountants suggest that it is better to use current valuation method or market-based price approach as it is more reflective and would gives more relevant information as compared to original cost due to appreciation (an increase in value of assets over time). However, some accountants disagree as they believe original cost or historical cost method could be more reliable, as current valuation method is just an estimation or prediction only, which might not be completely accurate and hence, cannot be fully trusted (Alexander & Nobes 2010, pp.40-43).

             Nevertheless, the capabilities of conceptual framework in solving each practical accounting issue will still   remain a question; Bullen and Crook (2005, p.1) voice out that the existing FASB Concepts Statement and IASB Framework for the Preparation and Presentation of Financial Statements can solve part, but not all of the problems. Even though, framework has succeed in supplying the fundamental principles for making a selection between alternatives as well as provides definitions which have formed the basis of accounting standards’ definitions, it would still be unlikely that it can answers all practical accounting questions. This is because in reality, financial statements are prepared for a variety of purposes and used by different kind of users. For example, banks and suppliers are interested in the company’s liquidity ratio and statement of cash flows to assess whether they will be paid; potential investors are interested in future growth prospect and earning ability such as Earnings Per Share (EPS) and Accounting Rate of Return (ARR); while managers of the firm will use it to measure performance and make financial decisions. Thus, it is uncertain and doubtful whether a single conceptual framework can suit all users. In addition, there is no clear indication or guarantee that conceptual framework will definitely ease the task of preparing and implementing standards than without having a framework.

                All in all, the duo efforts of IASB and US FASB in running a joint project with the intention to adopt one global conceptual framework is utmost important. Although there is still some minors flaws, it is undeniable and proven that the conceptual framework can eventually produce fruitful outcomes in promoting unity, handling controversial issues, and help decision makers to make a selection. Hopefully, they will consistently update, improve, and refine the framework from time to time in order to cope with the frequent changes in business environment, globalisation, and users’ needs.

Extra:

For more information and details about the collaboration between FASB and IASB, you may visit this website: 

http://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175818825710&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobs

Note: The picture below is a screen shot of that particular website.

References

Alexander, D & Nobes, C 2010, Financial Accounting – An International Introduction, 4^th edn, Prentice Hall, London.

Alfredson, K, Leo, K, Picker, R, Pacter, P, Radford, J & Wise, V 2007, Applying international financial reporting standards, John Wiley & Sons Australia Ltd, Milton.

Bullen, HG & Crook, K 2005, Revisiting the Concepts: A New Conceptual Framework Project, viewed 15 November 2012, <http://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175818825710&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobs>

Ciancanelli, P, Dunn, J, Koch, B & Stewart, M 2009, Financial and Management Accounting, University of Strathclyde, e-book, viewed 15 November 2012, <http://www.scribd.com/doc/54424572/7/The-statement-of-principles-for-%EF%AC%81nancial-reporting>

Ernst & Young 2012, IFRS Update of standards and interpretations in issue at 31 March 2012, viewed 12 November 2012, <http://www.ey.com/Publication/vwLUAssets/CTools_InterimUpdate_Apr2012/$FILE/CTools_InterimUpdate_Apr2012.pdf>

Riahi-Belkaoui, A & Jones, S 2000, Accounting Theory, 2^nd edn, Nelson Thomson Learning, Southbank Victoria.

Scott, S 2011, The need for and an understanding of a conceptual framework, viewed 14 November 2012, <http://www.accaglobal.com/content/dam/acca/global/PDF-students/2012/sa_oct11_framework.pdf>

Thomas, A &Ward, AM 2012, Introduction to Financial Accounting, 7^th edn, McGraw-Hill, Berkshire.

Wood, F & Sangster, A 2005, Business Accounting 1, 10^th edn, Prentice Hall, Harlow.

Business Combinations: Consolidated Financial Statements

By Jackie, Researcher

Topic: Education

Area of discussion: Financial Accounting and Reporting

Chapter: Business Combinations – Consolidated Financial Statements

The objective of this posting is to share a worked accounting question which is related to business combinations and consolidated accounts. In this example, clear step-by-step calculations with explanations are provided on: how to calculate the percentage of shareholding, how to compute goodwill, how to incorporate fair value adjustments, how to remove unrealised profit in inventory, how to find group retained earnings, how to compute non-controlling interest and finally, how to prepare consolidated financial statements. I believe this illustration will greatly help students to understand this topic and indirectly provides a solid ground for exam purposes.

Workings with explanations:

1). Percentage of shareholding

The first thing that ought to be done is to find out how much proportion has been acquired by the holding company, if it is not a wholly owned subsidiary. This is crucial as the other proportion may be held by many different shareholders and that kind of ownership is called as non-controlling interest (NCI).

Then, the NCI will be 20%. Always bear in mind that the number of shares used in the calculation of percentage shareholding must consists of voting shares only (i.e. ordinary shares) and not preference shares.

2). Computation of goodwill

Compare the price paid to acquire Cahaya Bhd (i.e. Investments: Shares in group company), with the ‘value’ of Cahaya Bhd at the date it was acquired (i.e. the date of acquisition). Goodwill is the excess of the cost of the investment over the ‘value’ of the proportion of the net assets acquired. Please note that the net assets acquired can be measured either as fixed assets plus net current assets, or as share capital plus reserves.

It is also very important to make clear that pre-acquisition profits are used in the calculation of the goodwill figure (i.e. capitalised), while post-acquisition profits become part of the group profit. Besides, at the date of acquisition the fair values of Cahaya’s property, plant & equipment were agreed as RM150,000 greater than their book values. Thus, a revaluation reserve of RM150,000 will need to be created. Likewise, since the fair values adjustment occurred at the date of acquisition, it will be treated as pre-acquisition and so, it will become part of the goodwill figure. On the other hand, impairment loss has to be deducted from the goodwill figure and charged in the statement of comprehensive income.

3). Necessary adjustment for property, plant & equipment

As Consolidated Statement of Financial Position was prepared at 30 September 2012, we have to sum up both property, plant & equipment owned by Surya Bhd and Cahaya Bhd as at that particular date too. In addition to that, we have to add revaluation surplus of RM150,000 inside that calculation as well, but additional care must be taken because the revaluation surplus was made on 1 October 2009 (i.e. 3 years ago). This mean that additional 3 years of accumulated depreciation has to be taken into account and since Cahaya Bhd has a 10% straight-line depreciation policy, the additional accumulated depreciation for the 3 years period will be RM150,000 x 10% x 3 years = RM45,000.

4). Unrealised profit in inventory

All of the group profit would only be realised, if the holding company which bought goods from subsidiary has subsequently sold all those goods to the third parties (i.e. the outsider). However, for this case, at the end of the year, the goods are not fully sold by the holding company as some goods are still remain in the inventory of Surya Bhd. Then, the amount of unrealised profit must be eliminated.

5). Group retained earnings / Accumulated profits

The retained earnings of the group will comprise the profits of Surya Bhd plus Surya Bhd’s share of profit of Cahaya Bhd which has been earned since acquisition. Adjustments for impairment loss, depreciation and unrealised profit have to be taken into account, if any.

6). Non-controlling interest to be recorded in Consolidated Statement of Comprehensive Income

The non-controlling interest is calculated as 20% of the profit for the year after tax of Cahaya Bhd. This equals: 20% of RM180,000 = RM36,000. We only need to record additional depreciation for one year instead of three because this is not Consolidated Statement of Financial Position. So, remember do not take the accumulated depreciation for 3 years. Meanwhile, unrealised profit needs to be eliminated according to its proportion (i.e 20%).

7). Non-controlling interest to be recorded in Consolidated Statement of Financial Position

Non-controlling interest will be entitled to 20% of the fair value of the company at the date of acquisition. Note: There is no need to divide reserves into pre- and post-acquisition as far as the non-controlling interest is concerned. Non-controlling interest is entitled to share in both pre- and post-acquisition profits. Unlike Consolidated Statement of Comprehensive Income, additional depreciation of 3 years needs to be recorded in Consolidated Statement of Financial Position. Meanwhile, the unrealised profits will have to be deducted according to its proportion (i.e 20%) as usual.

Answers:

Intra-group trading must be eliminated from the consolidated statement of comprehensive income. Therefore, intra-group sales of RM50,000 must be eliminated from both consolidated sales revenue and consolidated cost of sales figure. There are some intra-group goods sold that are still remain in the closing inventory. That unrealised profit must be removed, and this is usually done in practice by increasing the cost of sales figure. Impairment loss of RM8,000 and additional depreciation for one year have been included in the administrative expenses. Investment income is to be removed as it was fully came from dividend paid by Cahaya Bhd: 80% of RM50,000 = RM40,000. Any investment income shown in the consolidated statement of comprehensive income must only be from investments other than in a subsidiary.

Additional readings, related links and references:

This article explains how to prepare basic consolidated financial statements for a group with one subsidiary. It’s the second in a two-part series by the F1 examiner.

http://www.cimaglobal.com/Thought-leadership/Newsletters/Velocity-e-magazine/Velocity-2010/Velocity-August-2010/F1-preparing-consolidated-financial-statements/

Basic rules for preparing a consolidated balance sheet. Good explanations on all treatments and adjustments. Formulas and which items need to be debited or credited are fully displayed here.

http://www.angelfire.com/ab7/ankanbanerjee/CB.pdf

Another good exercise with detailed workings and clear explanations done by CIMA, which is good to be viewed by accounting students who are currently studying on this particular chapter.

http://www.cimaglobal.com/Documents/Thought_leadership_docs/Velocity/December%202009/modelanswerF2Baker.pdf

Preparing simple consolidated financial statements

http://www.accaglobal.com/content/dam/acca/global/PDF-students/2012s/sa_apr12_f3ffa_finstats.pdf

Preparation of group financial statements – ACCA

http://www2.accaglobal.com/archive/2888864/31273

Harvard Referencing Guide

By Admin

Uploaded content: Four pages of brief guide on how to apply Harvard referencing

This quick guide on referencing is very useful to tertiary students especially for those who have just stepped into college or university (for writing reports or doing assignments and researches purposes). Full in-text and end-text referencing formats were demonstrated in detail with relevant examples from different sources. It is highly recommended that if you are using this style of referencing, please download it and adjust the pictures until they can be fitted into A4 papers before you print them. Also, please keep it nicely for future usage purpose.

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