Current Development in Accounting Thought for Normative Theory

Question: Discuss about theCurrent Development in Accounting Thought for Normative Theory. Answer: In the current era, for measuring income, normative theory is highly significant. This is because it utilises a formula for determining income depending on value and not cost. Thus, normative theory is not reliant on observation; however, it depends on the process of accounting to be made (Mathews Perera, 1996). Historical cost accounting: One of the theories of normative accounting is historical cost accounting, which is a measure of value where the price of an asset on the balance sheet statement depends on nominal cost at the time of acquisition. This measure is beneficial, since it is unbiased and independently verifiable. As a result, it helps in increasing the overall reliability of the investors and other external users (Deegan, 2014). However, the historical cost accounting does not accommodate the effect of inflation and thus, the price of the asset declines. Normative alternatives to historical cost accounting and their underlying assumptions: There are several alternatives to historical cost accounting; three of them are described briefly as follows: Current Purchasing Power Accounting (CPPA): CPPA implies recording and updating the items of accounting based on daily consumer price index. In case of inflation, prices would increase and hence, accounts need to be kept up to date for adjusting all monetary items. This theory is based on the assumptions of both accrual basis and going concern concepts (Mathews Perera, 1996). The main advantage of this method is that as CPPA statements are prepared on supplementary basis, the historical accounts are maintained effectively. However, this method takes into account the variations in general purchasing power, while ignoring the variations in individual item values and thus, all the loopholes in the historical cost accounting could not be eliminated. For instance, ABC Limited purchased machinery on 1st July 2016 for $140,000. The straight-line depreciation method is followed over four-year period having zero residual value. The indices for the general price level are 130 on 1st July 2016 and 140 on 1st July 2017; thus, leading to an average of 135 for the year. The depreciation expense would be $35,000 ($140,000/4). However, the depreciation amount that would be reflected in the income statement of ABC Limited for the period ended 30th June 2017 would be $37,692 ($35,000 x 140/130). Current cost accounting (CCA): CCA realises the change in the price of an individual item due to variation in the general price level. This is the technique that takes into account the process of developing and analysing financial statements in a manner that the pertinent price change is taken into account significantly (Henderson et al., 2015).This method assumes that fixed assets are recorded at the cost of replacement and inventories are shown at market values. The main advantage of this system is that profit could be computed without any variation in historical profit. However, this method does not provide adequate information, which would be beneficial from the viewpoint of the investors. For example, it is assumed that a machine having economic life of ten years could be procured for $80,000. It is further assumed that the machine has further economic life of five years with no scrap value. As a result, the machine replacement cost would be $40,000 ($80,000 less depreciation for five years). Fair Value Accounting (FVA): FVA is an unbiased and balanced projection of the potential market price of an asset, product or service. This method considers the objective factors like demand and supply, acquisition, production, distribution cost, replacement cost along with subjective factors like risk features, cost and return on capital and individually perceived utility. However, this method minimises the book values of all the assets. Viability of the normative alternatives to historical cost accounting: Based on the above evaluation, it could be stated that even though there are several alternatives to historical cost accounting, all methods are subject to manipulation in setting norms to gauge corporate performance. In case of CPPA, the changes are made in the general price level and it does not lay adequate emphasis on the particular price level. As a result, the current value of the organisational resources is not reflected in the financial reports. CCA could not determine tax liabilities and thus, it fails to provide detailed analysis of the true costs of a business. In case of FVA, the investors always do not notice that a firm uses FVA approach. As a result, it leads to investor dissatisfaction, since the loss of value in net profit becomes loss of income for the investors. Hence, none of the approaches are viable to eliminate all the loopholes in historical cost accounting. IASB conceptual framework and its objective of general purpose financial reporting: IASB conceptual framework develops the accounting standards for ensuring their consistency with each other along with enhancing the credibility of accounting information. The primary objective of general purpose financial reporting is to provide financial information useful to the existing and future potential investors, lenders and other stakeholders for making resource-related decisions regarding the organisation. Main users of general purpose financial reporting: The following are the users of the financial statements and their implications for accounting measurements as laid out in the conceptual framework: Creditors and suppliers: These users would be interested in information, which would enable them in ascertaining whether the amounts that are owed to them would be paid in a timely manner. Lenders: The lenders would seek to obtain information that would help them in determining the payment of loans when they become due for deciding whether or not to provide new loans to the organisation. Investors: The investors are involved in supplying risk capital as funding. In addition, these stakeholders are worried regarding the inherent risk and the return they could expect from their overall investments (IFRS, 2010). Customers: The customers would be interested in the continuance of business operations, particularly if they are highly reliant on the products and services of the organisation. Employees: The staffs might intend to gain an overview about the profit level and stability of their employers. This might result in confidence regarding their jobs and as a result, they could be utilised for discussing salary and employment conditions. Government: The government and its related agencies are interested to know about the resource allocation and the business operations of the general organisations. General public: An organisation has direct impact on this group of stakeholder in a variety of ways, particularly the technique that might contribute to the local economy. Implications for accounting measurement to the identified users of general purpose financial reporting: The identification of specific users has direct implications on the formation of future accounting standards and its review of current standards of accounting to present the financial statements in an effective manner (IFRS, 2013). Both fair value and historical cost are now considered in fair value accounting, as fair value represents the real values of those assets, which increase the reliability of the financial system. There are five measurement bases and their user requirements vary from each other, which are demonstrated briefly as follows: Historical cost: Historical cost is a measure of value where the price of an asset on the balance sheet statement depends on nominal cost at the time of acquisition. This measure is beneficial, since it is unbiased and independently verifiable. As a result, it helps in increasing the overall reliability of the investors and other external users. However, the users could not trust historical cost accounting fully; as this measure fails to take into account the effect on inflation on the asset, which might minimise the value of the asset. Fair value: FVA is an unbiased and balanced projection of the potential market price of an asset, product or service. This method considers the objective factors like demand and supply, acquisition, production, distribution cost, replacement cost along with subjective factors like risk features, cost and return on capital and individually perceived utility. However, this method minimises the book values of all the assets despite the fact that most of the users prefer this measure for valuing the assets of the organisations. Current cost: Current cost realises the change in the price of an individual item due to variation in the general price level. This is the technique that takes into account the process of developing and analysing financial statements in a manner that the pertinent price change is taken into account significantly. Realisable value: Realisable value could be defined as the asset value, which could be recognised at the time of asset sale minus reasonable projection of the cost related to either eventual sale or asset disposal (IFRS, 2015a). In this case, the managers are needed to post those transactions that generate lower profits potentially along with restricting the overstatement of profit. Hence, the investors might not be able to obtain actual overview of the financial position of the business organisations. Value-in-use: The value-in-use of an asset is its current net worth, which is computed by estimating the net future value comprising of the disposable value, if the asset is impaired. The purpose is that assets need not be assessed at above their recoverable amount values. This value does not consider the acquisition price and hence, it is based on the current market value, which would help the investors to make effective decisions (ICAEW, 2006). Advantages that could arise from the development of conceptual frameworks and relevant beneficiaries: With the help of conceptual framework, it is possible to deal with the matters of financial reporting such as uses and objectives of financial statements and advantages of accounting information to the users. In addition, it helps in identifying different elements of financial statements along with measurement methods and realisation of such elements in developing financial statements (Ifrs.org, 2018). The main benefits for accounting resulting from the preparation of conceptual framework are described as follows: With the help of conceptual framework, the standard setters could form a specific framework for developing financial statements in such a manner that the accounting doctrines and practices are reliant on common ideology. This framework helps in guiding the preparers and users of financial statements regarding the unusual transactions. The conceptual framework assures that haphazard and random decisions are not undertaken for resolving issues related to accounting. As a result, the users are restricted to use approach of inconsistent accounting in identical instances. In the absence of a common framework, the organisations might be involved in creative depiction of the financial statements, which might not reveal the fair and true view of the state of affairs of the organisation (mof.gov.cn, 2018). Disadvantages that could arise from the development of conceptual framework after considering the work of Hines: Based on the opinion of Hines, the formation of conceptual framework would be highly beneficial for the accounting profession and the accountants able to accomplish considerable success level in their profession. This statement could be validated with the help of the fact that the conceptual frameworks have helped the accounting experts in having a body of knowledge regarding accounting (Mathews Perera, 1996). Furthermore, it could be stated that this framework helps in providing transparency to the preparers as well as the users of accounting information. However, there are certain drawbacks associated with the conceptual framework for financial reporting. One of the primary weaknesses of this particular framework is that the set-up process is not easy. In addition, the set-up process is time consuming as well and it would be expensive. The developing nations might not afford to develop a conceptual framework of accounting. Along with this, there is lot of rigidity in the conceptual framework for financial reporting (IFRS, 2015b). Some of the characteristics of conceptual framework fail to provide adequate guidance to accounting. Even though the concept of conceptual is encouraging, it is rigid as well, which restricts the incorporation of new ideas into the same. Another drawback is the conflict between the conceptual framework and the standards developed in the past. The standards established before have various dissimilarities with the features laid down in the conceptual framework (IFRS Foundation 2017). Even though the conceptual framework for financial reporting provides benefits to few users only, it might not be effective or acceptable to all the parties. Comparison between the views of Hines and the identified advantages of the conceptual framework: The comparison between the viewpoints of Hines and the benefits identified in the conceptual framework are demonstrated briefly as follows: Points of dissimilarities Perspective of Hines Arguments for conceptual framework Concept According to Hines (1989), the formation of conceptual framework would be highly beneficial for the accounting profession and the accountants able to accomplish considerable success level in their profession. It might not be beneficial for all the users of the financial statements. With the help of conceptual framework, it is possible to deal with the matters of financial reporting such as uses and objectives of financial statements and advantages of accounting information to the users. Common ideology Even though the concept of conceptual is encouraging, it is rigid as well, which restricts the incorporation of new ideas into the same. The standard setters could form a specific framework for developing financial statements in such a manner that the accounting doctrines and practices are reliant on common ideology. Decision-making The set-up process is time consuming as well and it would be expensive. The developing nations might not afford to develop a conceptual framework of accounting. The conceptual framework assures that haphazard and random decisions are not undertaken for resolving issues related to accounting. References: Deegan, C. (2014). Financial Accounting Theory (4th ed.). McGraw-Hill: Sydney. IFRS Foundation.(2010). Conceptual Framework for Financial Reporting 2010. Retrieved from https://www.ifrs.org/News/Press-Releases/Documents/ConceptualFW2010vb.pdf IFRS Foundation.(2013). A Review of the Conceptual Framework for Financial Reporting: Discussion Paper DP/2013/1. Retrieved from https://www.ifrs.org/Current-Projects/IASB-Projects/Conceptual-Framework/Discussion-Paper-July-2013/Documents/Discussion-Paper-Conceptual-Framework-July-2013.pdf Henderson, S., Peirson, G., Herbohn, K., Howieson, B. (2015).Issues in financial accounting. Pearson Higher Education AU. Hines, R.D. (1989). Financial accounting knowledge, conceptual framework projects and the social construction of the accounting profession.Accounting, Auditing Accountability Journal,2(2). Institute of Chartered Accountants in England and Wales [ICAEW].(2006).Measurement in Financial Reporting: Information for better markets initiative. Retrieved fromhttps://www.icaew.com/-/media/corporate/files/technical/financial-reporting/information-for-better-markets/ifbm/measurement-in-financial-reporting.ashx Mathews, M. R., Perera, M. H. B. (1996). The history of accounting to 1900. In Accounting theory and development (3rd ed.) (pp. 8-18). Melbourne : Thomas Nelson. IFRS Foundation.(2015b). Basis for Conclusions Exposure Draft ED/2015/3: Conceptual Framework for Financial Reporting, May 2015. Retrieved from https://www.ifrs.org/-/media/project/conceptual-framework/exposure-draft/published-documents/ed-conceptual-framework-basis-conclusions.pdf IFRS Foundation.(2017). Summary of Tentative Decisions: Conceptual Framework for Financial Reporting, June 2017. Retrieved from https://www.ifrs.org/-/media/project/conceptual-framework/current-stage/summary-of-tentative-decisions-june-2017.pdf IFRS Foundation.(2015a). Exposure Draft ED/2015/3: Conceptual Framework for Financial Reporting, May 2015. Retrieved from https://www.ifrs.org/-/media/project/conceptual-framework/exposure-draft/published-documents/ed-conceptual-framework.pdf