Accounting Theory

Case Study 1: Revisiting the Conceptual Framework

Answer1: Requirement of Conceptual Framework

According to the given case study the revisiting of the conceptual framework begins in the year 2002, the revision of the conceptual framework of both the boards depends heavily upon objectives, characteristics and criteria of the existing conceptual framework. While revising the conceptual framework the focus of both the boards were to develop a common framework that can be used by both the boards. The given case study has also highlighted that one of the goals of the two boards was to develop accounting standards based on principles. Therefore, the prime objective of both the board is also to root the fundamental concepts of accounting in the accounting conceptual framework. Whittington (2008 a) explains that the conceptual framework is found to be essential for financial reporting as it helps in the preparation and the in the presentation of the financial statements. Whittington (2008 b) added that the preliminary views of IASB regarding conceptual framework is that it helps in assisting the IASB board in the identification of different accounting related concepts and in developing IFRS. McGregor and Street (2007) added that revisiting the conceptual framework is also found to be important because the current conceptual framework has although helped in assisting the IASB, however, some of the main issues are still uncovered. Some of the uncovered issues include presentation and disclosure related to the identification of the reporting entity.

Answer 2: Importance of Common Conceptual Framework for IASB and FASB

According to the report of Whittington (2005), the US is moving towards the adoption of IFRS, whereas the IASB and the FASB has also been working together since years on the convergence of the two accounting standards. Jones and Wolnizer (2003) explained that since different yeas different countries were using their own accounting standards, some of the accountings standards were based on rules, whereas some were business and tax oriented, hence it can be stated that all the accounting standards were entirely different from each other. Barth (2007) added with the advent of globalisation the need of standardising the accounting standards becomes a necessity.

According to the given case study, the purpose of IASB framework is not only to assist the standard setters but it also intends to guide the preparers of the financial statements which is incompliance with the international financial reporting standards. Furthermore, the presented case study has also highlighted that the conceptual framework developed by the IASB is also found useful for the auditors and for the users of the financial statements. On the other hand, conceptual statement presented by the FASB is based on personal interpretation of the accounting concepts, and the board of FASB is also not willing to change this concept, which is one of the biggest differences between the two frameworks. The case study has also reflected that one of the reason behind the need of common conceptual framework is both the boards such as FASB and IASB have been pursuing different common projects that aims at converging specific issues of accounting.

Answer 3: Importance of Conceptual Framework for Different Parties

A conceptual framework is defined as a body of interrelated fundamental objectives. These objectives help in the identification of the goals and the reasons behind preparing financial statements. Furthermore, the conceptual framework also helps in the selecting transactions for accounting and in identifying the criteria of reporting these transactions (Xia, Monroe, and Cox, 2004). Muradian, Corbera, Pascual, Kosoy, and May (2010) added that a concept statement does not affect the transactions in a direct manner, as the conceptual framework does not require amendments in the accounting principles, the framework only affects the practice while developing of new accounting standards.

In the view of Jones and Wolnizer (2003), the direct beneficiaries of the accounting conceptual frameworks are FASB and the IASB. These frameworks provides the two boards the foundation of standard settings, furthermore, it also provides them with the concepts through which the accounting tools can be used for resolving reporting and presentation issues. On the other hand, Muradian, Corbera, Pascual, Kosoy, and May (2010) reported that the conceptual framework also provides the board different reasons while choosing the alternatives based on merit. . McGregor and Street (2007) explained that although the conceptual framework does not provide answer to all the questions, however, it facilitates in eliminating some of the inconsistent alternatives from the list. Jones and Wolnizer (2003) explained that with the help of conceptual framework the communication between the different parties have also become much efficient as the framework has provided general language and reference terms due to which the board can now debate over different technical terms.

Answer 4: Cross Cutting Issues

OECD (2014) reviewed that cross cutting issues are defined as that immensely effects the operations of a given field due to their nature, therefore, special attention is provided to such issues. Some of the examples of cross cutting issues in the contemporary business include sustainability of the environment, gender equality and health related issues. Hollander, Kim, Braun, Simeon, and Zohar (2009) added that issues such as environment and gender equality are crucial from all the perspectives of development, most of the societies and business consider environment and the development to be a similar thing. Since, the business as well as societal development is affected adversely if the rivers are contaminated, subtle changes in the weather, and due to depletion in the soil. In the same manner, Narrow, Clarke, Kuramoto, Kraemer, Kupfer, Greiner, Regier (2013) stated that people cannot take care of the environment if they are financially unstable. Thus gender equality has also emerged out as a goal in its self. However, according to Hák, Moldan, and Dahl (2012), countries cannot reach their potential without utilising 50% of their labour force and talent. Moser and Ekstrom (2010) stated that if women are provided with the similar resources financial services and technological equipments as men, the production of agriculture across the world will increase which will eventually decrease the hungry people by 100 million. Therefore, Narrow, Clarke, Kuramoto, Kraemer, Kupfer, Greiner, Regier (2013) stated that the mainstream cross cutting issue suggest that the developmental initiatives shall have a positive effect on the consideration that are termed as mainstream cross cutting issues.

Case Study 2: The Trend towards Fair Value Accounting

Answer1: Problems with Financial Statements used under US GAAP

According to the given case study the US financial accounting standard i.e. GAAP has been criticised badly for being flawed. Some of the financial analyst also considers the financial statements made under US gap to be completely irrelevant. The reason, behind this irrelevancy is that US accounting standards are based on historic cost rather than the actual value of the asset. Therefore, it is argued that the fair value of accounting standards shall be used in order to make the financial statements more relevant. As per the given case study, the use of fair value of accounting system will be able to provide the users with clearer picture of the company’s financial health. Laux and Leuz, (2009) explained some of the limitations in using the historical cost, according to the researcher, the financial statement that are prepared using the historical cost only reflect the historic facts about the company, and thus the current situation and the future prospects cannot be determined using the historical cost method. In the same manner, Hollander, Kim, Braun, Simeon, and Zohar (2009) added that one of the other problem associated with historical accounting is that they ignore the changes occurring the market, sine the price of a fixed assets are rebred at which it was bought. In the same manner, the income statement that is prepared under historic cost method fails to reveal the true profit earned by the company. Since the revenues are eroded on the current earnings, however, the expenses are recorded using the historical value.

Answer 2: Economic Reality as a Core Principal of Accounting

In the view of Scott, Leboyer, Hickie, Berk, Kapczinski, Frank, and McGorry, (2013), accounting and economic reality might differ and conflict sometimes, the situation might create issues for the CFO of the company while dealing the investors, lenders and the analyst of the company. It has also been stated that a company that uses fair means of accounting mostly confuses ort misleads its market participants. While creating the applicable standards for the board, policy makers have made rule that undermines the principles of accounting, it provides a true picture of country’s economic condition. It has also been stated that the problem in the reliability occurs in determining which item shall be included in the asset and in the balance sheet of a company. Bezemer (2010) added that assets and liabilities of a company are used to calculate the true value of the company and also in interpreting the financial ratios of the company. Daly and Farley (2011) stated that choice of a company in financing can change the appearance of its financial statement, the standards of GAAP mostly disregards the effect of economic reality.

Answer 3: Measurement of Economic Reality

In the view of Vollmer, Mennicken, and Preda (2009), although most of the concerns of reliability are associated with the fair measure value, most of this measure is not observed clearly in the market. However Speich (2011), much dependence is shown towards such measures, currently the financial statements are replaced with the measures that are considered to reliable. Furthermore, the given case has also highlighted that in the contemporary business practice, the estimates of the assets and the liabilities are based upon estimations. These estimations generally include the receivable collections, selling potential of the inventories, life of useful equipment, cash flows to be generated from the investments and litigation in the environment.

Furthermore, the case study has also highlighted that the precision used in the calculation of such measures such as depreciation is not a measure issue, however the reliability of the accounting standards used are considered questionable for most of the auditors and users of the financial statements. However, Csikszentmihalyi and Larson (2014) stated that it shall also be noted that as the nature of the busies differs widely therefore, the accounting measures used in different companies might also differ, and thus building up an accounting system that can reflect the true, fair and the real economic value might be a challenging task.

Answer 4: The Concept of Reliability in Accounting

As per the case study, reliability is defined as the information quality, stating that the information provided is free from errors and biases; furthermore, it is also necessary that the information clearly represents what it actually intends to present. In the same manner, the given case has also highlighted that the reliability of the information also lies upon the loyalty with which the information has been presented and on the verification quality of the information, thus from the given case it can be stated that faithful and verifiability are the two core components of reliability.

In the similar manner, Power (2010) defined accounting reliability as recording information that be verified with the evidences. Some of the example of reliability in accounting includes presentation of the purchased receipts, statements of bank, appraisal reports, cancelled checks etc. Csikszentmihalyi and Larson (2014) stated that documents generated from the third party such as the banks, suppliers and the customers are verified critically under reliability. This is because the documents generated from the third party are objected highly as compared to the documents presented inside the company. Zio (2009) on the other hand added that it is difficult to meet the reliability of the information while recording the reserves, such as reserves related to sales return, inventory obsolesce and of doubtful debts, because these reserves are based on opinion and are hard to verify. Therefore, it is also stated that only those transactions shall be recorded that can be verified easily by the auditors.

Case Study 3: Disclosure of Environmental Liability

Answer 1: Provision of Environmental Liability for Companies

Considering the increasing environmental concerns and awareness, it has been highlighted that the organizations around the globe are forced to take into consideration the environmental issues that are confronted by the general individuals of the society. Therefore, it is imperative that the organizations make specific provisions for the identification of these elements within their business processes. To effectively record these activities and present them in front of the stakeholders, there are some provisions that are needed to be adopted by the accountants of different organizations in order to record the elements of environmental liability.

In the view of Mellino, Protano, Buonocore, De Angelis, Liu, Xu, and Ulgiati (2015) provisions made for the environmental liability are concerned with the current and the future gains and losses of business along with the fair evaluation and the management of finances that is involved in the business. Some of the provisions that are involved in this process are planning for and costing of different activities along with making provisions on the basis of on-demand performance along with the guarantees provided by the company. Moreover, it has been analyzed that the provisions in this respect are needed to be made keeping in view the overall impact that these activities have on the overall profitability of the club.

Answer 2: Requirement of Liability Recognition

It highlighted in the case study that the companies in the United States are obliged to follow the standards developed by US Financial Accounting Standard Board that issued different provisions in the year 2002 with respect to recognition of the environmental liability of the business. In accordance to this provision, the companies who were conducting practices with respect to asset retirement obligations were required to reserve environmental liabilities that are associated to the eventual retirement of an asset. It has been further highlighted in the case study that environmental liabilities are reserved if the fair value of the asset can be estimated in an appropriate manner. The development of these provisions has been directed towards the improvement of the process of environmental liability within the process of business. Moreover, it has also been analyzed through the case study that the development and the implementation of these policies is essential for the organizations in the US for the development and establishment of their business in the country.

Answer 3: The Effect of Recognition of Liability

In the view of Glasson, Therivel and Chadwick (2013) the implementation of environmental sustainability measures lead towards increase in the overall cost of the organization at the initial stage. It is further stated that the increased amount of expenditure is incurred due to undertaking different measures such as reporting of the CSR measures in the annual reports of the organization along with taking stakeholders of the organization into confidence with respect to the measures taken by the management with respect to CSR activities. As it is analyzed that high cost is incurred in the implementation of environmental sustainability measures; therefore, it is expected that the net profit in the current year will decline as a result of increase in expenditure. However, it is expected that the overall net profit of the firm will increase due to the fact that the overall goodwill of the organization is expected to rise in the future years due to the increase in the CSR measures adopted by firm. In the view of Pearce, Barbier and Markandya (2013) the execution and the implementation of the CSR measures is significant in increasing sales and profitability of the organization due to overall increase in its goodwill.

As far as the aspect of cash flow is concerned, then as it has been analyzed above that initially CSR activities such as reporting of the environmental liability costs substantial amount of expenditure; therefore, it is expected that the cash flow of the business will move outwards at the start. However, it is expected that the as the profitability will rise; therefore, the movement of the cash flow will in the favour of the organization. The significant impact of these practices on profitability and cash flow indicates the importance of the recognition of environmental liability for the organizations.

Answer 4: Importance of Disclosure of Environmental Liability

In the view of Arena, Conte and Melacini (2015) environmental liability refers to the obligation on the manufacturers with respect to emission of the large amount of waste as a result of the manufacturing process. In other words, it is the cost that is incurred by the organization for polluting the environment. According to Evangelinos, Nikolao and Leal Filho (2015) the increasing concerns among the individuals of the society have forced the management of different business organizations to take effective measures to improve their performance in terms of environmental sustainability. Substantial amount of budget is maintained by the policy makers of different organizations to execute measures to improve their environmental performance. Considering the increase in the importance of environmental issues, the importance for the organizations to recognize environmental liability has gained significance in the recent times. Therefore, it has become imperative for the organizations to recognize environmental liability within their processes. In the view of Uno and Bartelmus (2013) recognition of the environmental liability has also become one of the major sources of CSR that is displayed by an organization. According to Manfredi, Allacker, Pelletier, Schau, Chomkhamsri, Pant and Pennington (2015) proper recognition of the process of environmental liability helps in increase in the overall goodwill of the organization.


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