ACC307 – Accounting Theory Essay Example

4Accounting Theory

ACCOUNTING THEORY

Case I: Revisiting the Conceptual Framework

The Significance of Conceptual Frameworks for Principles-based Standards

Conceptual frameworks role-play in maintaining the consistency of standards. That is because they set a definitive trajectory for effecting agreements. According to Evans (2003, 34), frameworks are the set rules and standardization measures. That implies that they are the definitive procedures for materializing proposals. Notably, without these procedures, the propositions and standards would be based on individual’s perceived concepts, a factor that would result into variations and the lack of a uniform determinant for the set standards. The frameworks also ensure that the decisions and conclusions that are agreed upon by the standard-setting bodies are regular despite any differences that may result from the improvements to the valuation techniques. These projections illustrate the reasons for which the IASB and the FASB have been committed to the creation and observation of conceptual standards. Ideally, this factor has enhanced the bodies’ significance and credibility in the accounting society (Porwal 2001, 45).

The Reasons for which IASB and FASB should Share a Conceptual Framework

The IASB and FASB share objectives and purposes. Riahi-Belkaoui (2005, 74) explained that the two bodies, in their significance, have created a podium on which accounting standards can be evaluated without compromising the virtues of the subject. This similarity in purposes demands that the standards-setting groups must define a regular trajectory for determining the accounting standards. It is for this reason that it is imperative that they base their principles on factors and determinants that will ensure that their standard demands are regular and observable. According to Pandikumar (2007, 59), differences in the conceptual frameworks is a factor that causes a great inconstancy in standards, a factor that can consequently result into the undermining of the bodies’ authority. For instance, if the determining factors for a standard are far different, it would be difficult to observe the standards that have been set by both bodies. As such, organizations and individuals would prefer the use of the simpler and more concise standards while undermining the stipulations that have been outlined by the other organization (Evans 2003, 39).

The Reasons for which Conceptual Frameworks are Significant for all Parties

Conceptual frameworks are significant for all parties and should, therefore, be preferred and adhered to by all. This is despite the fact that some organizations and individuals may prefer to ignore the outlined stipulations within the frameworks. Pandikumar (2007, 78) noted that disparities in the observation of standards, a factor that results from the lack of observation and use of similar conceptual frameworks, is a factor that derails the propositions that define consistency. It is imperative for parties to use conceptual frameworks to guide their objectives, functionalities, and propositions. That is because they would benefit from consistency. Ideally, consistency is the factor that bolsters productivity and establishes a trajectory for matching the expected accounting standards.

Cross-cutting Issues

Cross-cutting issues are the topics and subjects that significantly impact on several operations or that determine and influence the manners in which more than one organization effects their operations. Pandikumar (2007, 78) defined cross-cutting issues as the bases upon which more than one operation is based thereby affecting the standards and expectations for those operations. A lucid illustration of a cross-cutting issue is the subject of conceptual frameworks for the standards-setting bodies. The operations of the IASB and the FASB are similarly influenced by conceptual frameworks which make it a cross-cutting issue to both the organizations. That also defines why there are a lot of similarities in their operatives and set standards. Besides, as had already been explained, conceptual frameworks are the subjects that define and influence the consistency for all accounting bodies, a factor that further illustrates that conceptual framework is a cross-cutting issue across the entire accounting field.

Case Study II: the Trend toward Fair Value Accounting

The Fundamental Problem with Financial Statements Based upon the Historic Cost Measurement Principle used under US GAAP

The fundamental problem for using the financial statements that are based on the principle measurement of the historic cost derives from the projection that the changes in the values of assets are not taken into consideration regardless of their magnitude and significance. Reddy (2004, 66) explained that the relying on the historical costs measurements would lead to the discrediting of the market values of dynamic elements of accounts, for instance, marketable securities. Though the second statement of the FASB Conceptual Framework illustrates that reliability is to be free from errors, little consideration is put by the factions that favor historical costs to the fact the historical documents do not represent the actual values that they purport to represent. For instance, indicating that a house that cost $100,000 ten years ago still has the same value regardless of its current cost of $250,000 makes the historical costs unreliable.

Why Accounts must Reflect Economic Reality

Economic reality was defined by Pandikumar (2007, 63) as the valuation of items in consideration to their values in the current economy. Pandikumar based this definition on the fact that economies change. Ideally, it is on the changing values of the economy that the principle ‘accounts must reflect economic reality’ has been based. In a sense, this principle refutes the projections of historical cost that fail to recognize that economies change. The values of products and items, as is idealized in the principle must be considered in accounts. A lucid illustration is the kind of example that has been illustrated in the section above; a house that cost $100,000 ten years ago, if the economy indicates that its current value is $250,000, should be accounted for as an asset with a $250,000 value. According to Bonin (2001, 45), it is at its current value that t he asset would be sold which is why it important to recognize the influence of the economy in accounts.

Measuring Economic Reality

To measure economic reality, it is important to quantify the value of assets with respect to both relevance and reliability. However, the historic costs will not be considered for they will not depict the asset’s value as it is in the current economy. That implies that reliability will be defined as being error-free as opposed to bearing the indications and values that define the assets’ dates of purchase. According to Porwal (2001, 45), economic reality should be an integration of both relevance and reliability. Every value will be quantified according to their comparative costs in the current economies.

Accounting Reliability

Reliability is definitive of the accuracy of the information that is projected in an accounting document. According to Reddy (2004, 78), a reliable document meets the value of the factors as it purports to represent. Accounting reliability, therefore, does not have omissions and misstatements in any financial document. Henderson, Peirson and Harris (2003, 13) who adversely covered the subject in his book the Financial accounting theory illustrated a situation that indicates how reliable accounting is conducted. In their illustration, he stated that given that a company A is subject to a legal accusation that may hamper its financial stability, it will practice reliable accounting by not practicing non-disclosure of information to its stakeholders. That implies that the information that it will project in its financial records will be indicative of the records’ true value. This is reliable accounting in that the provided information can be relied upon to produce accurate projections (Riahi-Belkaoui 2005, 74).

Case III: Disclosure of Environmental Liability

How to Estimate the Provision of Environmental Costs of Retiring an Asset

According to FASB, retiring assets is the conspicuous criterion that is employed by enterprises to defer the recognition of liabilities. Making it imperative that the enterprises must record the provisions that relate to retiring facilities is a measure that limits such indefinite deferrals. To meet these new FASB demands, enterprises will have to quantify the values of the facilities and their potential output/contribution to the enterprises’ profitability (Reddy 2004, 36). This will be regardless of the fact that they may not be contributing to such profitability. Additionally, they will have to evaluate the probable contaminants that may have affected the environment after the asset had been retired. It is from whence that environmental liability, and even other forms of liability, will be determined. Bonin (2001, 45) also explained this projection by stating that companies and enterprises would have to estimate the costs of retiring the assets by valuing their liability when active. For instance, estimating the cost of a retired asbestos store should be in consistence with the values and returns that the store would make when active.

Aspects used by US Companies to Defer the Recognition of Environmental Liability

The FASB provisions that demanded the valuation of environmental liability was focused on the income that the companies generated. However, it did not focus on the properties that did not generate income for the companies for periods that were considered as uncertain. This is the aspect that was exploited by the companies as they sought to indefinitely retire the property that would compel them to environmental liability (Porwal 2001, 45). Ideally, it is a factor that reduced the number of property that would be considered by the FASB in its calculations of environmental liability. When seeking to bolster its valuations of environmental liability, FASB offered a reinterpretation of its policies with regard to the disclosure of environmental liability by illustrating that companies have an obligation to reserve environmental liability even if the settlement of a property remains uncertain. This development sealed the loophole that had been relied upon by the companies to defer recognition of environmental liability and even placed them in situations in which they had to pay back the values that they had skipped.

How Recognition of Liability in Relation to Future Restoration Activities Affects:

The Net Profit

The recognition of a liability in relation to the future restoration activities greatly hampers the operatives of an enterprise as it increases the amount of spending. However, it is notable that this kind of spending has no returns and cannot be considered as investments. That implies the recognition of the liability reduces an enterprise’s net profit (Reddy 2004, 36). This is the kind of financial predicament that the companies that had been deferring the recognition of their liabilities had to face after the FASB had revised its policies that define enterprise’s disclosure of environmental liability.

Cash flow within the Current and Future Years

Cash flow is the value of money that is transferred from and into an enterprise in its daily operations. Notably, the recognition of liabilities that relate to future restoration activities creates a situation defined by increased amounts of money that flows from an enterprise. That implies that though the amount of cash that flows into the enterprise may remain the same, they may be superseded the amount of cash that flows out (Henderson, Peirson & Harris 2003, 13). This kind of imbalance in the cash flow also affects an enterprise’s daily operations and consequently affects its profitability.

The Significance of Recognizing Liability

Deferring liability, as had been a common in the past, is a fraudulent practice as it helps with tax evasion. However, recognizing liability ensures that the operatives to whom an enterprise may be committed remain profitable and sufficient. Wolk, Dodd, and Rozycki (2012, 65) stated that recognizing liability ensures that the company financial records remain balanced and stable. Failure to recognize liability indicates that the company has made profits which is not the case. That is because there are given times during which enterprises may be committed to the future restoration of activities. That implies that the enterprise may maintain steady net profits and cash flows.

The Extents of Disclosure of Liability

Sufficient disclosure of Liability should be targeted at ensuring that all accounting standards are observed. That implies that reliability and relevance must both be observed. According to Wolk, Dodd, and Rozycki (2012, 67), disclosure should also involve the inclusion of anticipated factors. That implies that every detail that relates to an asset shall have been covered.

References List

BONIN, H. (2001). Generational accounting: theory and application : with 33 tables. Berlin [u.a.], Springer.

EVANS, T. G. (2003). Accounting theory: contemporary accounting issues. Mason (Ohio), Thomson/South-Western.

HENDERSON, S., PEIRSON, G., & HARRIS, K. (2003). Financial accounting theory. Frenchs Forest, N.S.W., Prentice Hall.

PANDIKUMAR, M. P. (2007). Management accounting: theory and practice. New Delhi, Excel Books.

PORWAL, L. S. (2001). Accounting theory: an introduction. New Delhi, Tata McGraw-Hill.

REDDY, R. J. P. (2004). Advanced accounting: theory and practice. New Delhi, A.P.H. Publ.

RIAHI-BELKAOUI, A. (2005). Accounting theory. London, Thomson.

WOLK, H. I., DODD, J. L., & ROZYCKI, J. J. (2012). Accounting Theory: Conceptual Issues in a Political and Economic Environment.