ACC307 Accounting Theory Business and Social Sciences

Write a report of 2000 words to the chairpersons of the Financial Reporting Council and the Australian Accounting Standards Board, commenting on the following argument:
Attempts to bring about radical change through the introduction of a conceptual framework have failed. When it appeared as though SAC 4 would require firms to report a greater number of liabilities, lobbying began in earnest and business ensured that any innovation was quashed. As such, the best that can be hoped for from a conceptual framework is that it legitimises current practice, maintains existing social and economic status, and staves off public sector attempts to control accounting standard setting.

In accounting, a conceptual framework is developed to set standards, rules and principles that applied during the creation and interpretation of financial statements. Financial statements that are prepared in accordance with the framework are effective in communicating to different stakeholders. The investors are able to compare financial statements of different firms when the statements are produced in accordance to the framework (Craswell, 2016).  It is the authorized bodies in that specific country or region prepares the framework. For instance, in Australia the Australian Accounting Standards Board, Financial Reporting Council and the Public Sector Accounting Standards Board are responsible for regulating the accounting profession by creating the necessary framework. The process of standard setting is political with different entities putting effort to influence the outcomes of the process. Various economic and political forces play to determine what is included or excluded in the agenda by the various regulatory bodies.  A conceptual accounting framework is necessary in standardizing the accounting reports of an entity within a specified region (Deegan, 2013).

The SAC4 dealt with the definition and recognition of the elements of the financial statements. It considered the measurements of assets and liabilities. Primarily the framework was not accepted since it did not improve the efficiency of accounting reports rather it aimed to achieve improvements in the recognition of assets and liabilities. However, the cost of implementing such a framework proved to be more costly to practitioners compared to its further implementation which led to its resistance (Samkin and Deega, 2012). Although the conceptual framework is intended to bring radical improvements in the accounting field, different stakeholders are opposed to any changes proposed by the regulatory bodies.

The resistance by firms seems to be counterintuitive considering the changes are meant to be beneficial to the stakeholders; however, they are certain factors that lead the strong resistance to bring innovation. The firms become rigid after a long period of applying certain guidelines and hence the natural urge to resist new changes. In other cases, the proposed changes are usually in conflict with the already existing accounting standards; this situation creates confusion (Deegan, 2012).

Since the standards apply to a wide range of stakeholders, some of the users might feel the changes do not benefit them while the same changes benefits other users who might be their competitor. The cost involved in implementing the proposed changes is usually high and the end users of the innovation feel the cost is not worth the benefits brought about by the change. The various reasons for resisting the changes motivate economic entities to lobby stakeholders not to accept the changes (Walker, 2012). They lobby through formal and informal meetings with stakeholders, funding and sponsoring the regulatory bodies operations and in some cases, appoint board members of the bodies responsible for setting the standards (van Dijk, 2014).

The essay will discuss the above and other reasons why the firms resist changes made in the conceptual framework. On the other hand, the conceptual framework does not face huge resistance alter the current practice but make it legal. When the changes do not have any economic and social implications, the stakeholders status quo is not threaten and therefore the firms do not quash the innovations. The essay will also discuss what conceptual framework can achieve without too much resistance.

Reasons a Conceptual Framework Fails

1. Inadequate measurement

The SAC 4 was criticized because despite it led to the recognition of certain assets, it did not determine or provide guidance on how those assets were to be measured. Individuals revealed the difficulty they experienced since the framework did not provide for an explicit form of measurement required for financial reporting. The statement was therefore reported to be structured in a neutral style which provided ambiguity that could be used for a wide range of future and existing approaches to measurement with the aim of exhibiting financial information. The conceptual framework was inadequate in accommodating a mandatory application due to the unique nature of firms in various industries and sectors. In addition, the measurement models allowed the use of other permutations, combinations and recommendations which deviate from the historical cost methods commonly used and accepted that generate different figures than expected (Horngren, 2012).

 The historical methods were generally accepted since they were perceived to be more objective and factual with regard to recording transactions. Therefore the main premise of using the historical cost is that despite the value of an asset changing, it might not be true that the measurement should change and therefore depreciation and amortization account for the change of the value of the asset or liability over the period of the item (Henderson and Howieson, 2015). Therefore in a more general sense most preferred accounting practices use the historical cost method in measurement on the current value basis while the SAC4 does not quite make the distinction between the current value and those that are indeed noncurrent.  Due to these deviations in measurement, it becomes difficult for companies to derive comparable and logical financial information from the financial reports obtained (Bonner, 2008).

1. Does not favor some firms

First, the proposed framework changes elicit varied reactions from the different firms affected.  Since different parties use financial statements of a firm to make economic decisions, the firms want to portray its financial position in a certain favorable way. Guidelines that deflate the profitability or general performance of the firm are rejected since it is considered a hindrance to increasing the share price of the firm. For example, the concept of historical cost does not reflect the recent prices and therefore it could understand revenues or the real value of capital (Bodle and Monem, 2016). Although the history cost concept could bring consistency in the production of statements, some firms could lobby against such a change due to the implications on their accounting operations.

1. Insufficiency of conceptual framework

Since it is really difficult to develop a conceptual framework that address all challenges, some firms that are generally opposed to any kind of regulation, be it in accounting or any other part of the business, use the natural weakness of a framework to fight any kind of regulation. For example, the fact money is used as the unit of measurement in statements brings the setback of instability because of inflation. Firms not satisfied with regulation will fight changes with such setbacks even though inflation is not under the control of the accounting bodies and is difficult problem to solve worldwide.

     Some firms are not ready to report a greater number of liabilities and uncertainties of the future. Radical changes in accounting can be brought by adopting accounting under uncertainty concepts. When the demand for the company’s product is declining the uncertainty of the enterprise continuing its operations increases. The proposed accounting standards might capture the declining reasonable net income that would not be accounted for in the traditional approaches (Brüggen and Dao, 2009) 

 Conflict with previous standards

Since the conceptual framework is a work in progress, addition of certain rules can lead to conflict with previously set rules.  The ambiguity and confusion that arise due to principles contradicting each other lead to a section of firms resisting the changes. For Example, if the accounting regulatory board administers both the Realization concept and historical cost concept, a conflict arises when applying both concepts. The revenue recognition principle (realization) implies that revenue is recognized when collectability is reasonably certain. However there is provision for bad and doubtful debts, which are not made at historical costs (Cairns and Tarca, 2011).

Another example is the conflict between the going concern and historical cost principles. In some instances, the accountants the value stock using market value while the historical cost concept advocate using the original prices to measure the value. In this case, the conflict arises because using one concept breaks the standards set.  

1. The cost of changes is higher than benefits

Introduction of conceptual framework is costly and takes a lot of time to fully adopt it. The firms bear the costs of training their accountants on how to apply the new rules and concepts in their work. Adopting the conceptual framework also require changes in peoples operations in the firm. They might be a need to hire new employees to ensure the standards are practiced to the letter. The costs that are incurred in the process might be too high for some firms depending on their size. Small firms will oppose the changes due to the extra costs due to hiring new employees, training and restructuring their operations (Capalbo and Sorrentino, 2013).

Indirectly the firms incur extra costs paid to the regulating bodies. The extra fees paid to the board are used to carry out research on the areas of the conceptual framework to improve. The costs are viewed too high than the expected benefits derived from adopting the proposed changes.  

1. Availability of various forms of lobbying

Firms have access to the resources and channels to lobby against proposed changes that they feel are not favorable to their business. The firms are usually responsible for appointing board members of the various regulatory bodies. These firms usually have influence over the appointed board members and therefore the board members might not be determined to push for radical changes by developing conceptual framework.

In Australia, the accounting board and the accounting research foundation organize public sessions with the different stakeholders during the initial stages of developing guidelines. Through these sessions, the firms have a chance to air their opinion, which could be opposed to the radical changes in the conceptual framework. The outreach to the stakeholders becomes a hindrance to any attempt to bring new changes and innovation (Farneti and Gurthrie, 2009).

The senior leadership of many firms prefers accounting standards that reduce transparency and public scrutiny whereas the guidelines that can bring radical changes advocate for transparency in operations and political scrutiny.  Some monopoly firms prefer to understate profits so as to avoid attention from the regulators and the general public. Therefore any accounting methods that remove the flexibility are likely to be opposed by the big firms. Abnormally high profits could lead to the firms’ practices being questioned by consumer groups, regulators and environmental conservation groups. In firms where the managers are paid in bonus due to high performance, they prefer accounting methods that result in future profits being reported as the present profits. The larger the stated present profits the larger the bonus (Jones and Wolnizer, 2003).

Conclusion

It is therefore necessary than an accounting framework provides a measurement system that is unique and logical that can provide for a consistent adaptation of accounting theory concepts across the board. In this way the conceptual framework reduces the level of ambiguity experienced in its application. It is therefore necessary that the concepts of measurement are derived from theory in order to provide relevant, consistent and comparable financial information (Deegan, 2012). In this way the accounting standard is bound to be relevant across all business models, sectors and industries. For example the standard should specify a certain concept of capital that can be utilized by all entities. In addition, the reliance on theory such as the historical cost model reduces the deviations for which the accounting standard can be applied.

It is clear that the deviations from the historical cost approach often have implications on the financial information available to practitioners with regards to income calculation in the financial reports of entities. The measures present are therefore inconsistent to the historical cost method which deviates from the current value methods adopted by entities with regard to the Australian Accounting Standards. It is therefore apparent that there has been permissiveness with regard to the adaptation of current value methods for financial reporting purposes despite there being no formal standard to its regard. it I therefore necessary that the Board allow for the use of judgment in the choice of reporting measure for assets by entities from the conceptual and theoretical ones in existence, in this way, the Board shall be able to achieve more compliance and less resistance from practitioners with regard to their applicability and the provision of valuable financial information from the individual entities. The conceptual framework needs to not only consider the need for the regulatory body to provide sufficient control but also to accommodate the interest of the parties using the framework.

References

Bodle, K.A., Bodle, K.A., Cybinski, P.J., Cybinski, P.J., Monem, R. and Monem, R., 2016. Effect of IFRS adoption on financial reporting quality: Evidence from bankruptcy prediction. Accounting Research Journal, 29(3), pp.292-312.

Bonner, S.E., 2008. Judgment and decision making in accounting. Prentice Hall.

Brüggen, A., Vergauwen, P. and Dao, M., 2009. Determinants of intellectual capital disclosure: evidence from Australia. Management decision, 47(2), pp.233-245.

Cairns, D., Massoudi, D., Taplin, R. and Tarca, A., 2011. IFRS fair value measurement and accounting policy choice in the United Kingdom and Australia. The British Accounting Review, 43(1), pp.1-21.

Capalbo, F. and Sorrentino, M., 2013. Cash to Accrual accounting: Does it mean more control for the public sector? The case of revenue from non-exchange transactions. Risk Governance & Control: Financial Markets & Institutions, 3(4), pp.28-35.

Craswell, A., 2016. INDIVIDUAL ACCOUNTS. Transnational Accounting, p.70.

Deegan, C., 2012. Australian financial accounting. McGraw-Hill Education Australia.

Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.

Farneti, F. and Guthrie, J., 2009, June. Sustainability reporting by Australian public sector organisations: Why they report. In Accounting forum (Vol. 33, No. 2, pp. 89-98). Elsevier.

Henderson, S., Peirson, G., Herbohn, K. and Howieson, B., 2015. Issues in financial accounting. Pearson Higher Education AU.

Horngren, C., Harrison, W., Oliver, S., Best, P., Fraser, D. and Tan, R., 2012. Financial accounting. Pearson Higher Education AU.

Jones, S. and Wolnizer, P.W., 2003. Harmonization and the conceptual framework: An international perspective. Abacus, 39(3), pp.375-387.

Samkin, G. and Deegan, C., 2012. New Zealand financial accounting. McGraw-Hill Education Australia.

van Dijk, A., Mount, R., Gibbons, P., Vardon, M. and Canadell, P., 2014. Environmental reporting and accounting in Australia: progress, prospects and research priorities. Science of the Total Environment, 473, pp.338-349.

Walker, R.G., 2012. Permissive and Uninformative Reporting of Clean-Up Costs. Contemporary Issues in Mining: Leading Practice in Australia, p.143.