The (Financial Accounting Standards Board, 2008). These decisions

The IASB conceptual framework sets out the concepts and idea’s that underline the preparation and presentation of financial statements for external users (Wahlen, Jones and Pagach, 2013). The objective of these general purpose financial reports (statements) is to provide financial information, useful to existing and potential investors, lenders and other creditors (i.e. primary users) when making rational investment and credit decisions (Financial Accounting Standards Board, 2010) (Burton and Jermakowicz, 2014). These primary users rarely have the ability to prescribe the information they desire from an entity, and so rely on the information provided when making decisions on whether to; buy, sell, or hold equity or debt instruments and on the provision or settlement of loans and other forms of credit (Financial Accounting Standards Board, 2008). These decisions regarding the provision of resources to an entity depend on the returns expected by primary users, such as dividends and interest payments, from an investment in those instruments, relative to the riskiness of those investments (Wahlen, Jones and Pagach, 2013). The returns that primary users expect to receive depend on the resources and the prospective cash flows of the entity, financial reporting should therefore provide financial information that aides assessments on the amounts, timing, and uncertainty of the prospective net cash inflows to the entity (Wahlen, Jones and Pagach, 2013).

 

To aide these assessments on prospective net cash inflows to an entity the conceptual framework for financial reporting facilitates the reporting of information about an entity’s economic resources and claims against the entity; changes in these resources and claims that result from that entity’s financial performance as well as other events or transactions; and the change in the entity’s cash flows from operating, investing and financing activities (Burton and Jermakowicz, 2014). Information regarding an entity’s economic resources and claims allows for identification of the entity’s financial strengths and weaknesses, needed when assessing the reporting entity’s liquidity and solving, and its need for and ability to obtain additional financing (Burton and Jermakowicz, 2014). Furthermore, information about changes to an entity’s resources and claims revolving around its financial performance helps primary users assess the return an entity has earned from its economic resources and form expectations about its future performance, allowing for estimations of “earning power” and assessments of the riskiness of investments (Wahlen, Jones and Pagach, 2013). This information on an entity’s financial performance is also useful when assessing the efficiency and effectiveness on how the management discharged their responsibilities to use the entity’s resources (Wahlen, Jones and Pagach, 2013). The use of accrual accounting is an important basis for assessing an entity’s past and future economic performance as changes in resources and claims are recorded in the period they occur and not when the resulting cash receipts and payments occur (Burton and Jermakowicz, 2014). When used in conjunction, the information provided allows primary users to assess risk, financial flexibility, liquidity, operating capability and return on investment, thus aiding them in assessing the amounts, timing, and uncertainty of expected future cash flows to an entity (Wahlen, Jones and Pagach, 2013).

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

 

As stated, information regarding an entity’s financial performance helps users to understand how well management has discharged its responsibilities to make efficient and effective use of an entity’s resources (Wahlen, Jones and Pagach, 2013). The management of an entity is responsible to shareholders of said entity for the custody and safekeeping of its resources, their efficient and profitable use, and their protection against unfavourable economic factors such as; market price change, technological and social advancements and the political environment (Wahlen, Jones and Pagach, 2013) (Kieso, Weygandt and Warfield, 2011). The need of shareholders to be able to keep check of the management of an entity goes along with agency theory, that states that managers act in their own interests at the expense of shareholders and not stewardship theory which assumes that left on their own, managers will act as responsible stewards of the assets they control (Shim, 2008). The information provided on an entity’s past performance, how management discharged its responsibilities, and assessments on likely future performance, is useful for decisions made by existing and primary primary users regarding the whether to buy, sell or hold and for existing users, whether to intervene in the management of the business (Wahlen, Jones and Pagach, 2013) (Accounting Standards Board, 2007).

 

 

The information made available by the conceptual framework for financial reporting aimed at providing information about the resources of an entity, claims against the entity, and how efficiently and effectively the entity’s management have discharged their responsibilities to use the entity’s resources, is made available through financial statements (Financial Accounting Standards Board, 2010). While there are various sources identified by the conceptual framework from which primary users may obtain useful information for decision making, the four basic financial statements are identified as core sources of useful information (Wahlen, Jones and Pagach, 2013). The statement of financial position summarises the amount of assets, liabilities, and shareholder equity at the end of a period, the only one of the four statements to do so, with the others highlighting the changes in financial position of an entity and not the financial positon at a point in time (Deloitte, n.d.) (Wahlen, Jones and Pagach, 2013). As such the statement of financial positon is seen most useful in assessing the resources and claims of an entity and so it’s; strengths and weaknesses; liquidity and solvency; and ability and need to gain additional financing (Deloitte, n.d.) (Wahlen, Jones and Pagach, 2013). The statement of comprehensive income summarises the results of the income-producing activities, like the issuing in debt, over an accounting period. (Deloitte, n.d.) This is seen to represent the changes in the economic resources and claims of an entity and thus is able to assist users in their assessment of risk, future cash flows and management performance (Wahlen, Jones and Pagach, 2013). Information about an entity’s past cash flows assists users when assessing an entity’s ability to generate future net cash flow, and indicates how the entity obtains and spends cash, including information about its borrowing and repayment of debt, cash dividend to shareholders, etc. (Deloitte, n.d.). This information is presented by general purpose reports through the statement of cash flows which reports the net cash flow of an entity from operating, investing, and financing activities over the accounting period (Deloitte, n.d.) (Wahlen, Jones and Pagach, 2013). The final statement given through the conceptual framework for financial reporting is the statement of changes in equity which provides information on changes in economic resources and claims not resulting from financial performance, like the issuing of debt instruments or the distribution of cash or other assets to shareholders (Deloitte, n.d.). The statement of changes in equity completes the picture of the total changes of an entity’s economic resources and claims (Deloitte, n.d.).  When used together, these financial statements are seen as the best source of information in aiding primary user’s assessments of net cash inflows to an entity and thus its decisions relating to the provision of resources to an entity through investment or credit decisions.

 

For the information produced through financial statements to be useful in decisions made by primary users, it must abide by the fundamental qualitative characteristics laid out by the conceptual framework, relevance and faithful representation; thus a level of importance should be put on the measurement basis used to present the information (Deloitte, n.d.) (Financial Accounting Standards Board, 2010). Relevant information has the ability to make a difference in the decision’s made by primary users, achievable through information having predictive value, confirmatory value, or both (Deloitte, n.d.). In order to be faithfully represented information must “faithfully represent the phenomena it purports to represent”, achieved through the information produced being complete, neutral and free from error (Burton and Jermakowicz, 2014).  When these fundamental qualities are abided by, information usefulness can be improved through enhancing qualitative characteristics, including; comparability, verifiability, timeliness and Understandability (Burton and Jermakowicz, 2014). When information abides by the, for example, comparability characteristic it means that the information can be compared with similar information about other reporting entity’s, and the same entity at different period’s, allowing primary users to identify and understand similarities in and differences among items (Deloitte, n.d.). These enhancing characteristics should be maximised to the extent necessary, however the cost of reporting such information should never exceed the benefits expected by the entity (Burton and Jermakowicz, 2014).

 

When reporting on financial information entity’s must abide by mandatory standards and concepts (Elliot and Elliot, 2012). These standards are needed to define the way in which the financial information reported is presented so that their measurement and presentation are less subjective (Elliot and Elliot, 2012). It is the International Accounting Standards Board (IASB) that is responsible for all technical matters including the preparation and implementation of standards (Elliot and Elliot, 2012). The going concern assumption is one highlighted by the conceptual framework and it assumes that an entity will continue in operations indefinitely (Deloitte, n.d.).  

 

The need for these accounting standards and the continued need to enhance them can be seen by historical events, and is thus a limitation of the conceptual framework for financial reporting and accounting standards reporting of “relevant and faithfully represented” information (Elliot and Elliot, 2012). It was the GEC takeover of AEI in 1967 where profits by AEI were estimated at £10m and -£4.5m by GEC, but both true and fair, and the audited accounts of Pergamon Press Ltd.’s suggested 75% reduction in estimated profit by an independent investigation that led to a supporting view of a statement of standard accounting practice to define what was true and fair (Elliot and Elliot, 2012). It was then the Enron scandal where they had off-balance sheet debts concealed and profits overstated by more than $500m in 2001 that led to the introduction of the Sabanes-Oxley Act (SOX) in 2002 (Elliot and Elliot, 2012). Before this, the fraud performed by Enron made it the 7th largest USA company by the end of the 20th century, misleading primary users in investment and credit decisions (Elliot and Elliot, 2012). The SOX objective is to reduce the risk of fraud for primary users since before this, weaknesses such as FASB inadequate disclosure rules and an under-funding of the enforcement agencies were being exploited (Elliot and Elliot, 2012). The continued need for updates on these standards can be highlighted by the Tesco scandal in 2014 where profits were found to be inflated by nearly £250m (Croft, 2017). The results of this led to new powers for the Financial Conduct Authority (FCA) allowing them to force companies to pay compensation over market abuse, demanding Tesco pay £85m to investors misled by its flawed profit numbers (Binham and Vandevelde, 2017). Companies will always be finding ways to ‘game the system’, the Harvard Business review suggests that “managers and executives routinely encounter strong incentives to deliberately inject error into financial statements” (Sherman and Young, 2016).

 

The information provided through general purpose financial reports can also be deemed to have restraints when used in assessing the prospect for future net cash inflows to an entity. The information produced often results from approximates that can be wifely off the mark even when made in good faith, rather than exact measures (Burton and Jermakowicz, 2014) (Sherman and Young, 2016). This information also often lacks predictive value as it largely reflects the financial effect of transactions and events that happened in the past (Financial Accounting Standards Board, 2008). Furthermore, the information is produced at a cost to the reporting entity, which will only report to the point where the economic benefits they expect to receive from the information exceeds the cost of producing it (Financial Accounting Standards Board, 2008). Therefore, cost is a pervasive constraint on an entity’s ability to provide useful information (Financial Accounting Standards Board, 2010). As well as this, primary users, unlinked internal management, often lack the ability to prescribe the information they want, leading to financial information produced that is directed towards a “common interest” rather than the tailored information received by internal management (Financial Accounting Standards Board, 2008).

 

An objective of the conceptual framework for financial reporting is to provide information useful to primary users in their assessment of an entity’s managements stewardship. However, this information, provided through general purpose financial reports, does not usually separate management performance from that of the entity (Financial Accounting Standards Board, 2008). While the performance of management is a contributing factor to the financial performance of an entity, there are many factors beyond the control of management that affect the success or failures of an entity (Financial Accounting Standards Board, 2008). Factors such as general economic conditions, political events, and the actions of past management can affect the current management’s ability to generate favourable cash flows for the entity (Financial Accounting Standards Board, 2008). Financial reporting therefore, gives information of an entity’s performance under management during a period but not directly that management’s performance and is therefore limited for purposes of assessing management performance (Financial Accounting Standards Board, 2008).

 

The conceptual framework for financial reporting and accounting standards is facilitating the reporting of “relevant and faithfully represented information”. Through information provided through general purpose financial reports, such as; information on an entity’s resources and claims, and the stewardship of the entity, the primary users are able to make assessments on the prospect for future net cash inflow to an entity. Accounting standards and assumptions are continuing to make the information reported as relevant and faithfully represented as possible and thus as useful to primary users as possible. This allows primary users to make rational investment and credit decisions regarding the provision of resources to an entity (Burton and Jermakowicz, 2014). While there are limitations to the information produced, the financial reports are not immutable, they are affected by the; economic, legal, political and social environment (Burton and Jermakowicz, 2014). Neither do they intend to provide all the information necessary to make financial decisions (Burton and Jermakowicz, 2014). The Harvard business review reports that “we will never reach a world in which all reports are perfectly and reliably true”, all the conceptual framework can do is adapt to the ever changing world and continue to react to breaches to its standards as it has been doing (Sherman and Young, 2016).