Need for a theoretical framework in accounting
Table of Contents
Production of reliable financial statements
Development of IFRS and laying out new concepts
Limitation of the current traditional model
Introduction
There is a need for a conceptual and theoretical framework in accounting to guide some of the decisions and practices in accounting. The aim of this would be to reduce defects that have been associated with the practice and which for a long time have been seen as the norm albeit discomfort and dissatisfaction from different squatters. These defects are listed in the essay below in the discussion of the need for a theoretical framework. The critical discussion illuminates a light on some of the challenges faced by accounting, what needs to be done, and the resulting impact of these actions.
Production of reliable financial statements
There was a need for the establishment of accounting rules and regulations to develop standards that covered a number of issues, especially on the treatment of financial statements. There has been a conflict on a number of issues such as how various components are viewed and treated by various users. Such conflicts led to principle-based rules where standards were set such as Accounting Standards Board’s (IASB) whose main background and purpose is to provide The Conceptual Framework for Financial Reporting, which now formed the accounting Framework. This Framework, which forms the basis of this discussion was formed with specific objectives that are discussed below:
Development of IFRS and laying out new concepts
The Framework of accounting should provide a basis for the treatment of financial transactions and other concepts that should make the discipline clear to all users. IFRS was formed to act as a universal reference on what to do with accounting statements and was supposed to be adopted by all users across all countries (Wittsiepe, 2008). IFRS has since been adopted by International Accounting Standards Board (IASB) because each country has its own procedure for handling financial statements and this led to confusion in the translation of accounting statements. There was a need to understand the nature and purpose of accounting and to do this, there have to be universal principles of accounting. This is the theoretical basis from which all users should have a single way of understanding accounting operations. The lack of this led to divergent handing of this information. A case in reference is one of the prime rules of prudence and accrual where each country had its way of approaching this issue.
Alexander and Britton (2004) noted that there are cases where conservative accounting is used and lower profits are preferred in some countries. In the case of the UK and the USA, the practice is often to capitalise on lease contracts and this is due to strong shareholder orientation. In some countries such as France, the company is not the legal owner of these assets and these are often not capitalised in the balance sheet. What this means is that these concepts get confusing and therefore need a framework to help in getting a common understanding among all users. According to Bebbington et al. (2001), there is a need to make financial statements comparable throughout. This would assist in having a comparable and sensible analysis of financial statements. There is a possibility of unscrupulous managers taking advantage of the lack of a framework where these facts are laid bare to manipulate financial data. Thus, the accounting framework is necessary to define the four basic concepts of going concern, accruals, consistency, and prudence. With different characteristics of different accounting models used in the UK, US, Australia, and Arab countries. In the development of a common accounting framework, all the country-specific frameworks are combined and all information from each collection. This will make it easier for all people to work on this formula.
It has to be noted that the need for a new accounting framework is not only for the sake of harmonising concepts for communication purposes. They will also assist IASB to develop policies on accounting reporting procedures that will be relevant and consistent with the needs of all stakeholders over time. The pronouncement will be more coherent as they will be developed on basis of individual members. There are different frameworks developed by different bodies and each emphasise certain points. Universal regulation from IASB would make it easier on what is necessary, and optional for the documents to be considered complete and valid. In other words, the need for an accounting framework will lessen cases of different conclusions yet comparable sources of data (Berry, 1999). This may lead and misguide stakeholders, especially novice investors who may not understand the background information on how the documents were prepared. It also means that people will be more confident in statements they get, locally and from multinational companies as they would be prepared with a common understanding of procedures and regulations.
Limitation of the current traditional model
Although there is no definite framework for accounting, there are definitions that have been established by various authors and practitioners in the field of accounting. The term has been defined by many in terms of purpose performed by the practice, or purpose-driven data, which is done for a particular purpose. However, accountants are rarely given specific data to generate the required information for stakeholders. Accountants are supposed to sift through a lot of data presented to understand what needs to be done and how best to present the information provided. Due to that, there is a need to understand the concepts and the background of what is being done to make it easier to present information regardless of the context, which usually varies between organisations and countries. There is hardly a chance that data will be labelled as “accounting data” but with a solid understanding of the general concept, and purpose rather than singling out transactions, it would be easier for all users to understand and perceive the right data. The development of a common framework will eliminate these different perceptions and make interpretation easier and error-free (Nikolai, et al., 2009). This problem is hardly solved with the current definition of basic accounting terms as it is given.
Another example is in the case of valuation, where the aim is to represent in monetary terms for given product or service. The problem is that there is no standard price or quantity that should be used to measure and present information in books of accounts and this results in a number of problems especially when translating savings into monetary terms. Related to this is the principle of recognition that is often applied differently among different companies. There are differences among organisations as to when expenses should be recognised. Ideally, this should be done as and when there are changes in net assets and liabilities. However, this is not the case. There is a lack of theory to lay a strong foundational guideline on how this should be done. Whereas this seems to apply to all costs, this is not often the case. Some costs are difficult to relate with revenue and therefore need an approach that should be anchored in the theoretical background. An example is Intel of USA and Nokia of Finland where costs of equipment are realised over their useful life rather than when it was acquired the premise of this is because, these would still be useful in income generation (Kinney & Raiborn, 2010). There are discrepancies over when costs are to be charged with some organisations carrying them to the future even though they have not been acquired or incurred. Stickney et al. (2010) explained further that different bodies define an asset differently and this also means there are differences in the way they are treated in financial statements. Some do not tell how contingent assets should be defined and therefore financial benefits resulting from the same is dependent on future events. Such differences need to be harmonised in a single framework where to avoid these disparities.
There are also proprietary and ownership theories in accounting, which are commonly used but hardly means the same thing to different users. Owners of a business are often placed at the at the centre of the model, even as it is defined by the accounting equation or model. Whereas there is a common understanding that owners should be separated from the accounting process, the inclusion of the same in the process of preparation of accounting statements includes only information that is relevant or important to the owner. This is because assets are all materials cash or tangible owned. There is a need to include other information such as non-business assets, liabilities, expenses, and revenue. Besides, market prices should be used in the valuation of accounting theory. This was the theory that was used in the industrial revolution era and well applies in some cases but this ought to change under the new accounting framework. This is because market prices are inaccurate in the presentation of transactions and valuations and business are businesses have since been seen as separate entities from owners. Such were weaknesses that necessitated the formation of accounting theory and defining further in a manner that will communicate coherently in how economic data is to be measured and communicated to stakeholders interested in it.
Response to emerging needs
The recent evolution of other aspects of accounting to include various organisations with non-profit interests have also necessitated the creation of a solid framework to cater to the needs of all stakeholders while still remaining relevant. According to Laasch and Conaway (2014 ) Profit is not the only goal for organisation as has been noted in social accounting where some large organisations still have the need to report and account for their operations to their sponsors, customers, governments, and other interested stakeholders. In recent years, there has been a call to include social costs through the environmental impact of organisations. Much as relevant as these issues are, there is no common ground in the procedure to account for them. There is a need to agree on scope and methodologies and for these to be included in the theoretical framework of accounting where all assumptions and doctrines will be laid bare and clear for all practitioners to understand. Besides, these methodologies will need to be flexible to accommodate variations in the industry.
Response to emerging can be beyond the social and environmental accounting needs that were named above. There are possibilities for the development of future needs which may not be foreseen in the current scenario of the present accounting frameworks. There is no telling where it may occur but it would similar needs to be accented for in business reporting. A new robust accounting model is supposed to cushion these future cases from confusion and uncertainty on how to go about these challenges. A case in example is where a mining company in the USA, Sunshine Mining sold its two bonds and was allowed to redeem using two options: cash in $1000 or 50 ounces of silver at maturity, considering the higher value of the two options (Kieso, et al., 2010). This is a case where one cannot tell a number of questions such as how much to record, the selling price, or the selling price of the bonds? How much should be amortised from the sale of silver? The company does not know when this silver was issued, among other questions. Whereas IASB cannot proscribe how such cases are to be handled, the presence of a sound and robust framework will make it easier to develop acceptable and credible financial statements. The framework to be developed should be meaningful to the current and future needs and organisations. The key reason for this is for them to have credible information to make the right investment decisions. The lack of this would make the process of making investments inefficient. This is information that should be useful to various stakeholders such as lenders and creditors.
Conclusion
A profession such as accounting needs a robust and solid theoretical foundation to guide decisions relating to its goals and objectives. There is a need to move towards a principle-based reporting process to be applicable to all countries. As it is now, there are disparities in several aspects such as recognition, the definition of key elements, and the process of identifying them in the books of accounts. These differences make it hard for various users to make decisions, the very purpose expected from these financial statements. A universal theoretical framework is needed to take care of current users, and unknown events in the future. This will instill confidence in users of these reports.
References
Alexander, D. & Britton, A., 2004. Financial Reporting. New York: Cengage Learning EMEA.
Bebbington, J., Gray, R. & Laughlin, R., 2001. Financial Accounting: Practice and Principles. New York: Cengage Learning EMEA.
Berry, A., 1999. Financial Accounting: An Introduction. New York: Cengage Learning.
Kieso, D. E., Weygandt, . J. & Warfield, . D., 2010. Intermediate Accounting: IFRS Edition, Volume 1. New York: John Wiley & Sons.
Kinney, M. R. & Raiborn, . A., 2010. Cost Accounting: Foundations and Evolutions. New York: Cengage Learning..
Laasch, O. & Conaway, . N., 2014 . Principles of Responsible Management: Global Sustainability. New York: Cengage Learning.
Nikolai, L. A., Bazley, . D. & Jones, . P., 2009. Intermediate Accounting (Book Only). New York: Cengage Learning..
Stickney, C. P., Weil, R. L., Schipper, K. & Francis, J., 2010. Financial Accounting: An Introduction to Concepts, Methods and Uses. New York: Cengage Learning.
Wittsiepe, R., 2008. IFRS for Small and Medium-Sized Enterprises: Structuring the Transition Process. New York: Springer Science & Business Media.
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