Conceptual Framework of Accounting †Free Samples to Students

Question: Discuss about the Conceptual Framework of Accounting. Answer: Introduction: Accounting is the art which help in classifying the transactions, recording the same in the books of accounts, summarizing it, reporting in the form of financial statements and then analyzing and making interpretation out of the results. Thus, accounting plays very important role for the success of any form of organization (Deegan, 2014). Conceptual framework of accounting is defined as the framework which has been laid out with the objective and purpose to facilitates the correct and accurate measurement of assets and liabilities at the year end and the proper recognition of the income and expenses for the reporting year. The framework consists of the regulatory framework which is governed by the statutes, laws, acts, rules and regulations of the country. Conceptual framework of accounting has three main features: Faithful representation The financial statements shall be prepared and disclosed in the manner in the way it is required to be prepared. Relevance The financial statements shall be relevant for the users of the financial statements Reliability The financial statements so prepared shall be reliable enough so that the users of the financial statements including the stakeholders thereon can get maximum information out of it and will be able to make an effective and efficient decision (Capital Markets Advisory Committee Meeting, 2013). In the given case, it is said that the neutrality is considered as the key component of the faithful representation. Faithful representation is comprised of three components namely Neutrality - It means that is zero chances of getting the financial statements so prepared with bias or any one benefit. Complete It means that the financial statements so prepared and presented to the management and stakeholders of the company shall be complete whether dealing with the financial data or non financial data. Error free It means that the financial statements so prepared and presented are free from any type of mistakes Neutrality is a major key component which is linked with the faithful representation and it does not mean that there will be zero value information rather it encompasses that the financial statements should be unbiased and should not reflect that it is being prepared for some particular community (Nash,2010). In the todays scenario, it seems impossible to have the financial statements totally neutral or fully representational faithful. It is because of the following reasons: Remuneration paid to the executives or Key managerial personnel of the company consists of three components namely fixed remuneration, short term incentive and the long term incentive. These incentives are the risk based and depend on the performance of the key managerial personnel and the total shareholder return respectively. Thus, there are chances for the key managerial personnel of the company to manipulate the figures of the financial statements in order to have the maximum incentives. (Wesfarmers Limited Official Website) Earnings per share play very important role in attracting the customers. Therefore, in the urge to have more and more customers the company might tend to increase the net profit after tax so that the earning per share will automatically gets increased. Therefore, the standard setters and other regulatory bodies want to have faithful representation in the conceptual framework of accounting. As per the historical cost of accounting, the assets are measured at the cost price of the time at which the same is purchased from the vendor and includes all the other costs including installation and loading and unloading etc incurred and paid to bring the asset so purchased to the present location and condition where the assets is required to be used and installed. The historical cost of accounting depends upon the availability of the invoice and other corroborative evidence. The historical counting has advantages but is suffered by the following weaknesses: Change in price level: The historical cost method of accounting lay down that the company will record all its assets and liabilities on the historical cost and the company in no way takes the effect of changes in the price level on the asset and liabilities of the company. Wrong Valuation of Fixed Assets: In the historical cost of accounting the fixed assets are recorded at the acquired cost and are not restated with respect to the changes in value as per the prevailing market. Inadequate Depreciation Depreciation helps in accumulating the funds which will in turn help the company to replace the current equipment as and when the need for it arises. As the depreciation is charged on the historical cost which has decreased the value but in no case the company will be able to replace the assets Unreal Amount of Profit Statement of Income so prepared will not reflect the actual amount of profit. It is because the companys revenue is being booed at the current value but the expenses had already been incurred and booked depending upon the historical basis of accounting. Thus, the amount of profit so come will not provide the desired and effective results and will not facilitates the comparison with others. Does not represent true and fair view: Financial statements consist of two parts income statement and the balance sheet. This section deals with the balance sheet of the company. It entails that monetary assets like cash, advances to other parties, trade receivables and trade payables will not be affected but the non monetary assets like inventory and fixed assets including the land and building will be recorded at the historical cost of accounting. In the case of the boom in market, the comparison can never be made as the fixed assets of the company including stock cannot be ascertained. Thus, the change is required otherwise the auditor can issue the qualified report again as to comparability and the presentation of the true and fair view of the financial statements for the year end. Apart from these limitations, the historical cost accounting has the following advantages: Cost of the asset so purchased is available and the same can be checked with the invoice and The method of accounting in different ways facilitates the comparability within the company or outside the company. The method of accounting ensures that there will be stable pricing and is not subject to any market conditions (IASB,2010). It is still popular among many persons because of the fact that it does not give the accountant or any other person to manipulate the books of accounts in any manner and thus facilitates the true and fair view of the state of affairs of the company as well as financial performance of the company. For proceeding with and completing any kind of work, methods are required how to start with the works. In the accounting methods are also required within the conceptual framework which will give the idea to the company as to how the same can be applied. There are two methods of accounting. One is fair value of accounting and another one is historical cost accounting. Both the methods are equally important for the companies requiring the financial statements to be prepared and presented within the defined framework. This framework is known as conceptual framework. The first method of accounting ensures that the assets are recorded at the market value or fair value at the end of every reporting period. The necessary revaluations will be done accordingly in finalizing the financial statements. The second method of accounting entails that the assets and liabilities will be recorded at the historical cost and will not revalued on the basis of the changing market conditions and therefore the value will be the same. Since the year nineteen hundred and twenty there has been the debate as to whether the companys financial statements and books of accounts are required to be prepared and presented as per the fair value method of accounting or the historical cost method of accounting. In the current scenario, the International Financial Reporting Standards have given an option to the preparers of the financial statements and the books of accounts as to the adoption of fair value method or the historical cost method will be optional in case of the non financial assets (IASB,2015). It means that the power to adopt the method of accounting totally depends upon the discretion of the management. The International Financial Reporting Standards has not made it mandatory to use the particular method of accounting in the particular manner rather has given the full discretion to the management. Fair value method requires that the assets of the companies are to be valued at the price which the product will fetch from the market. For instance, the cost of furniture in the books of accounts is $100 but in the market if we sale it then the value come as $ 150 which means the revision in the price is automatically updated and increased in the market. To make these changes the company has to revalue the assets at all the reporting date either upwards or downwards depending up on the market value and take the corresponding effect in the financial statements. Historical cost method of accounting does not require any revaluation neither upwards nor downwards rather than the method states that the value of all the items of the financial statements shall be stated at the cost. Users of the financial statements will have more financial information if the financial statements are prepared as per the fair value method of accounting as it will detail what is status of the company in terms of the profit as well as in terms of the financial position whether the company will remain solvent in future or there are chance of insolvency (Whttington ,2014). Historical cost accounting method does not facilitate comparison. Due to disadvantages present in Fair Value Method, the method has not been applied uniformly. References Capital Markets Advisory Committee Meeting, (2013), Conceptual Framework available on https://www.ifrs.org/Meetings/MeetingDocs/Other%20Meeting/2013/March/AP%203%20conceptual%20framework.pdf accessed on 02/05/2017 Deegan C, (2014), Financial Accounting theory, available on https://www.sekoyen.com/DeeganFAT_3e_Chapter_01.pdf accessed on 02/05/2017. International Accounting Standards Board, (2010), Conceptual Framework for Financial Reporting 2010 , pages 16-21 IASB (2015), Historical Cost Vs Fair Value measurement, available ohttps://www.ifrs.org/Alerts/Conference/Documents/2015/Hans-Hoogervorst -speech-Paris-June-2015.pdf accessed on 02-05-2017. Nash H., (2010), Conceptual Framework for Financial Reporting, available on https://www.ifrs.org/Current-Projects/IASB-Projects/Conceptual -Framework/DPJul06/Comment-Letters/Documents/CL9.pdf accessed on 02/05/2017. Whttington G., (2014), Fair Value and the IASB / FASB Conceptual available on https://ritholtz.com/wp-content/uploads/2009/01/whittington-two-world-views -2008.pd fon 02/05/2017.