Financial Accounting Standards Board Framework Analysis

Financial Accounting Standards Board Framework AnalysisIntroductionThe account abstract model has been criticized for not providing an able basis for hackneyed get upting. This inadequacy is evidenced through the FASBs standards becoming more and more rule-based. Neverthe slight, no empirical evidence has been gathered to support the criticisms of the abstract role model. We meditate the five soft characteristics of method of accounting schooling from the conceptual textile in conjunction with an individuals heading to use/ trust on pecuniary assertions. Using geomorphologic equation modeling, we found that except one qualitative characteristic, dependableness, affected a persons intention to use pecuniary statements. Addition all(prenominal)y, it appears that the greatest factor that influences whether an individual rely on monetary statements is their familiarity with accounting. Based on our findings, it appears that not only does the conceptual framework consi der to be altered, entirely it also needs to be changed to servicing cause principle-based accounting standards that atomic number 18 useful to all people, regardless of their background.The Financial Accounting Standards Board (FASB) has been criticized for not requiring firms to report information that is interpretable and useful for monetary statements users (CICA, 1980). The FASBs conceptual framework is the core in which all accounting standards argon derived. Therefore, the accounting conceptual framework must embody a set of qualitative characteristics that manipulate financial reporting provides users of financial statements with adequate information for decision making. The U.S. financial accounting conceptual framework was formal between late 1970s and primal 1980s. Statement of Financial Accounting Concepts (SFAC) nary(prenominal) 2 (1980) indicates that there be five main qualitative characteristics of accounting information translateability, relevance, reliab ility, comparability, and consistency.Nature and Purpose of the abstract FrameworkThe conceptual framework was formed with the intention of providing the backbone for principle-based accounting standards ( zero(prenominal)es, 2005). However, the Securities and Exchange Commission (SEC) has recently criticized the accounting standards setting board for becoming to a fault rules-based, which paves the way for the structuring of transactions in the comp eithers favor (SEC 108(d)). Critics of the framework have stressed that the move towards rule-based standards are a consequence of inadequacies in the accounting conceptual foundation. Nobes (2005) argues that the need for rule-based accounting standards is a direct result of the FASB trying to force a fit between standards and a conceptual framework that is not fully create. A coherent and strong conceptual framework is vital for the development of principle-based accounting standards and the progression towards convergence in inter national accounting standards.However, researchers are unaware of any empirical evidence that supports the criticisms of the topical conceptual framework. Additionally, none of the critics have looked at the conceptual framework from the most important viewpoint, the users perspective. Therefore, the purpose of this paper is to empirically analyze the adequacy of the conceptual framework, from a users perspective, in relation to an individuals reliance on financial statements for decision making. We developed a survey instrument to analyze an individuals intention to rely on financial statements using Ajzens (1991) Theory of Planned Behavior. We found that the reliability characteristic of the conceptual framework represented the only signifi flockt symmetry of a persons attitude affecting their intention to rely on financial statements. However, the deriveability characteristic was approaching significance. Within the context of the theory of planned behavior, brotherly pressur es was not significant influence on the intention to use/rely on financial statements, yet familiarity with accounting was found to significantly influence intention.The conceptual framework and potential financial statement users intentions can be analyzed within the context of Ajzens (1991) Theory of Planned Behavior. Ajzen (1991) indicates that empirical evidence suggests that we can take in an individuals intention to perform a behavior through analyzing their attitude, subjective norms, and perceived behavioral control. Within this perspective, we adapted Ajzens (1991) theory of planned behavior to an individuals propensity to rely on accounting financial statements.The purpose of this study was to provide an empirical analysis to the criticism against the FASBs conceptual framework. Our oerall results suggest that the current conceptual framework does not adequately align the purposes of financing reporting with the users of financial statements. Nevertheless, available find ings have some interesting implications for the conceptual framework and future standard setting. reliability is the only qualitative characteristic that has a positive statistical significant relationship with intention. The accounting profession is facing a choice between reliability and relevance in financial reporting, as there is an inherent trade-off between reliability and relevance (Paton and Littleton, 1940 Vatter, 1947). Reliable information possesses the characteristic of objectivity and verifiability, which is associated with diachronic cost accounting. Relevance, on the other hand, pertains to any information that will influence the users financial decision.Many times the most relevant information is often current or prospective in nature. Thus, we cannot have accounting information that maximizes the characteristics of both relevant and reliable because relevant information is not always verifiable. We would have judge to see relevance as a significant factor in use rs intention to use financial statements since the recent accounting standards have moved toward sane value accounting measures, which are considered to be more relevant than reliable information (Ciesielski Weirich, 2006). However, our results show that reliability is a significant factor. The current accounting programme could be the cause of our results since it is rooted in Paton and Littletons historical cost approach, which focuses on reliability of information.In the context of the Theory of Planned Behavior, we found that familiarity to be a statistically significant factor to an individuals intention to use financial statements. Thus, as an individual finds more familiar with financial statements, he or she is more likely to have the intention to use or rely on them when making decision. An ANOVA analysis provides further support for this as it indicates that intention to use or rely on financial statements is significantly different between accounting majors and non-a ccounting majors. This provides evidence that accounting could be becoming too difficult for individuals who are not proficient in accounting to understand.It appears that the movement towards rule-based accounting standards could be a contributing cause of this disparity in intention. That is, the accounting standards have become so technical upon their execution that the average reader of accounting can no longer discern the main objective of each financial statement element. This finding is troubling to accounting since it contradicts the primary objective of accounting, which is to provide useful accounting information for decision making. Accounting information should be useful for all people who want to use it rather than only being useful to those who understand it. Additionally, under no circumstances, should accounting information provide an advantage to individuals who come across to be experts within the field. Accounting should be a tool and not a barrierAt the-present, the accounting profession is grappling with a problem, which it has determine as the need for a conceptual framework of accounting. This framework has been painstakingly developed over centuries, and it is merely the professions task to fine tune the existing conceptual framework because of the need for continual development due to changing characterizes. This conceptual framework has never been laid come to the fore in explicit terms consequently, it is continually overlooked. A conceptual framework has been described as a constitution, a coherent system of interrelated objectives and organics that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting and financial statements.For many accountants, the conceptual framework project is difficult to come to grips with because the subject matter is abstract and accountants are accustomed to dealing with particular(prenominal) problems. In resolving those problems, accountants may unconsciously rely on their own conceptual frameworks, but CPAs have not previously been called on to spell out their frameworks in systematic, cohesive fashion so that others can understand and evaluate them. It is essential that a framework be expressly established so that the FASB and those evaluating its standards are basing their judgments on the same set of objectives and concepts. An expressly established framework is also essential for preparers and auditors to make decisions about accounting issues that are not specifically cover by FASB standards or other authoritative literature.It is considered that if the conceptual framework makes sense and leads to relevant information, and if financial statement users make the necessary effort to fully understand it, their confidence in financial statements and their ability to use them effectively will also be enhanced. No one who supports the establishment of a conceptual framework should be laboring under the illusion that su ch a framework will automatically lead to a single definitive answer to every specific financial accounting problem. A conceptual framework can only provide guidance in identifying the relevant factors to be considered by standard setters and managers and auditors in making the judgments that are inevitable in financial reporting decisions.A Classical Model of Accounting The Framework ExpandedHistorically, the particularized information, which be the emergence of accounting, was embedded in a framework for control of human behavior. With the advent of exchange replacing a sustenance society, and with exchange ultimately producing a private economy, accounting derived its second, and in modern times considered its most important, function as a planning instrument. The classical model simply states that behavioral patterns do exist in the geomorphological development of accounting that is, given a stimulus there will be a answer which is direct reaction (an expected reaction) to t hat stimulus. One can relate this model to the classical model in sparings, in which supply and demand for a commodity react in an expected manner due to a change in price. Figure 3 is a geometric illustration of the classical model. The special features of the model are(a) Stimulus (S) = Demand Response (R) = Supply(b) Equilibrium (E) = Stimulus = Response(c) Environmental Condition (EC) = Price(d) Accounting Concept (AC) = ProductA stress of the Validity of the ModelIf the classical model does exist in accounting, the historical observations (see table I) should then bear testimony to its existence. The evidence to support this model is stringently historical. However, no parallel should be drawn between this thesis (stimulus/Response) and Toynbees (1946, 88) line of examination Can we say that the stimulus towards civilization grows positively stronger in straightlacedtyality as the environment grows more difficult? Consequently, the criticism directed at his work should n ot be considered even remotely as applicable to this inquiry (Walsh 1951, 164-169).On the other hand, only in the extreme can the accusation leveled at Kuhn 1962 be directed here, that the conceptual framework (classical model of accounting) as presented may subsume too many possibilities under a single formula (Buchner 1966, 137). More appropriately, this study is undertaken along the lines suggested by Einthoven (1973, 21) Accounting has passed through many stages These phases have been mostly the responses to frugalal and social environments. Accounting has adapted itself in the past fairly easily to the changing demands of society. Therefore, the history of commerce, industry and organization is reflected to a large fulfilment in the history of accounting.What is of par come importance is to realize that accounting, if it is to play a useful and effective role in society, must not pursue independent goals. It must continue to aid the objectives of its economic environme nt. The historical record in this connection is very encouraging. Although accounting generally has responded to the needs of its surroundings, at times it has appeared to be out of touch with them. The purpose of this line of inquiry is to put into perspective concepts which have emerged out of certain historical events. (In this treatise, accounting concepts are considered to be betrothal with accounting measurement and communication processes thus, whenever the term concept is used herein, it is to be understood that accounting measurement and communication processes are subsumed under this heading.)These concepts collectively constitute, or at least suggest, a conceptual framework of accounting. The classical model is postulated as fol small-scales For any given environmental state, there is a given response function which maximizes the prevailing socio-economic objective function. This response function cannot precede the environmental stimulus but is predicated upon it when s uch response function is suboptimal, the then existing objective function will not be maximized. In a dysfunctional state, a state in which environmental stimulus is at a low level a level below pre-existing environmental stimuli, disequilibrium would ensue. In any given environment, the warranted response may be greater or less than the natural or actual response.When environmental stimuli cease to evoke response, then the socio-economic climate will be characterized by stagnation as the least invalidating impact of disequilibrium conditions, and decline when such environmental stimuli are countercyclical.Stage 1 In this period, (1901 to 1920) the environmental stimulus was corporate policy of retaining a high proportion of earnings (Grant 1967, 196-197) (Kuznets 1951, 31) (Mills 1935, 361,386-187). This period is the beginning of corporate capitalism. The term corporate capitalism is used because it emphasizes the role in capital formation which batchs have ascribed to themsel ves. Hoarding of gold by corporations has reduced the role and importance of the primary equity securities market. The resource allocation process has been usurped by corporations (Donaldson 1961, 51-52, 56-63). The implication of such a condition is accentuated in the following statement It is the capital markets rather than intermediate or consumer markets that have been absorbed into the infrastructure of the new type of corporation. (Rumelt 1974,153).The hard empirical evidence of this condition was revealed by several tests of the Linter Dividend Model, which maintains that dividends are a function of profit, and are adjusted to accommodate investment requirements (Kuh 1962,48) (Meyer and Kuh 1959,191) (Brittain 1966,195) (Dhrymes and Kurz 1967, 447). Given the new role assumed by the corporation in capital formation, the investment community (investing public) became concerned with the accounting measurement process.The accounting response was verifiability (auditing) to dem onstrate the soundness of the discipline. Productivity of existing measurements had to be confirm to pay off the investors and creditors. The Companies Act 1907 required the filing of an audited annual balance sheet with the Registrar of Companies (Freer 1977, 18) (Edey and Panitpadki 1956, 373) (Chatfield 1956, 118). Thus, auditing became firmly established. The function of auditing measurements is the process of replication of prior accounting.Accounting is place from other scientific disciplines in this aspect of replication. Replication is a necessary condition in sound disciplines however, replication is generally undertaken in rare instances. In accounting, on the other hand, replication is undertaken very frequently for specified experiments personal credit line operations at the completion of the experiments business (operating) cycle. These experiments business operations, cover one year at the end of the year, the experiments are reconstructed on a sampling basis. Auditing is the process by which replication of accounting measurements are undertaken. Publicly held and some in private held corporations are required to furnish audited annual financial statements which cover their business activities on an annual basis.Stage 2- This period, (1921 to 1970) witnessed the reinforcement of corporate retention policy. This condition shifted the violence of the investor to focus on the Securities market in the hope of capital gains, because of the limited return on investment in the form of dividends. Indubitably, investors concern was shifted to market gustatory modality through stock price changes reflecting the earnings potential of the underlying securities (Brown 1971, 36-37, 40-41, and 44-51).With the securities market valuation of a companys share (equity) inextricably linked to the earnings per share, the emphasis is pose on the dynamics of accounting as reflected in the income statement. The Companies Act of 1928 and 1929 explicitly refle ct this accounting response by requiring an income statement as a fundamental part of a set of financial statements (Freer 1977, 18) (Chatfield 1974, 118) Although an audit of such statement was not explicitly stipulated, it was implied. The accounting response of this period is extension of accounting revealing (Chatfield 1974, 118) (Blough 1974, 4-17).The Wall Street Crash of 1929 and subsequent market failures constitutes the environmental stimulus. In the U.S.A., the Securities Act of 1933 and then the Securities and Exchange Act of 1934 were enacted, providing for a significant involvement of the government in accounting. Stage 3- This period is characterized by the social awareness that business as well as government must be held socially accountable for their actions. Business can transfer certain costs to other segments of society, thus business benefits at the expense of society and government can not only squander hard earned dollars but through its policies affect advers ely the welfare of various segments of society.This awareness is epitomized in the thesis posited by Mobley 1970, 763 The technology of an economic system imposes a structure on its society which not only determines its economic activities but also influences its social well-being. Therefore, a measure limited to economic consequences is inadequate as an appraisal of the cause-effect relationships of the total system it neglects the social effects.The environmental stimulus of corporate social responsibility evoked the accounting response of socio-economic accounting a further extension of accounting disclosure. The term socio-economic accounting gained prominence in 1970, when Mobley broadly defined it as the ordering, measuring and analysis of the social and economic consequences of governmental and entrepreneurial behavior. Accounting disclosure was to be expanded beyond its existing boundaries beyond the normal economic consequences to include social consequences as well as ec onomic effects which are not presently considered (Mob1ey 1970, 762).Approaches to dealing with the problems of the extension of the systemic information are being attempted. It has been demonstrated that the accounting framework is capable of generating the extended disclosures on management for public scrutiny and evaluations (Charnels, Co1antoni, Cooper, and Kortanek 1972) (Aiken, Blackett, Isaacs 1975). However, many measurement problems have been exposed in this search process for means to satisfy the systemic information requirement of this new environmental stimulus (Estes 1972, 284) (Francis 1973). Welfare economics, as a discipline, has always been concerned with the social consequences of governmental and entrepreneurial actions, but the measurement and communication problems are, and always have been that of the discipline of accounting (Linowes 1968 1973).The Conceptual Framework A Continuing ProcessPresented above, the stimulus/response framework exhibiting structural adequacy, internal consistency and implemental practicality has demonstrated, unequivocally, its effectiveness over the centuries. The systemic information of financial accounting is the connective tissue of time in a financial perspective. The systemic information of managerial accounting is non-connective, but rather reflects events in a decision-making perspective. This can be best illustrated in the table below(Draw a table)The process of concept-formation is a special type of learning. The formation takes time and requires a variety of stimuli and reinforcements. The process is never fully determinate for even when the concept is well, it can suffer neglect or inhibition and it can be revived by further reinforcement or modified by new arousal (Emphasis added.) (Meredith 1966, 79-80). A body of concepts and involution measurement and communication processes (types of information stocks and flows constraints on information allowable values and methods of measurement media o f communication quantitative and qualitative) has been developed over the centuries.This set of concepts and interlocking measurement and communication processes has emerged as responses to specific stimuli at specific points in time to satisfy specific information needs. It is this body of concepts and interlocking measurement and communication processes, which is subject to amplification and modification that constitutes the conceptual framework of accounting. Possibly, with other modifications or amplifications deemed necessary, the conceptual framework as presented above can serve as an expressly established framework to enable preparers and auditors to make decisions, which would conform and be upheld, about accounting issues that are not specifically covered by FASB standards or authoritative literature.A conceptual framework is necessary because in the first place, to be useful, standard setting should build on and relate to an established body of concepts and objectives. A soundly developed conceptual framework should enable the FASB to issue more useful and consistent standards over time. A coherent set of standards and rules should be the result, because they would be built upon the same foundation. The framework should increase financial statement users understanding of and confidence in financial reporting, and it should enhance comparability among companies financial statements. Secondly, new and emerging practical problems should be more quickly solved by reference to an existing framework of basic theory. It is difficult, if not impossible, for the FASB to prescribe the proper accounting treatment quickly for situations like this. Practicing accountants, however, must resolve such problems on a day-to-day basis.Through the exercise of good judgment and with the help of a universally accepted conceptual framework, practitioners can dismiss certain alternatives quickly and then focus on an acceptable treatment. Over the years legion(predicate) o rganizations, committees, and interested individuals developed and published their own conceptual frameworks. But no single framework was universally accepted and relied on in practice. Recognizing the need for a generally accepted framework, the FASB in 1976 began work to develop a conceptual framework that would be a basis for setting accounting standards and for resolving financial reporting controversies. The FASB has issued six Statements of Financial Accounting Concepts that relate to financial reporting for business enterprises. They are_ SFAC No. 1, Objectives of Financial Reporting by Business Enterprises, presentsgoals and purposes of accounting._ SFAC No. 2, Qualitative Characteristics of Accounting Information, examines thecharacteristics that make accounting information useful._ SFAC No. 3, Elements of Financial Statements of Business Enterprises, providesdefinitions of items in financial statements, such as assets, liabilities, revenues, andExpenses_ SFAC No. 5, Recogn ition and measuring rod in Financial Statements of BusinessEnterprises, sets forth fundamental recognition and measurement criteria andGuidance on what information should be formally incorporated into financial statementsand when._ SFAC No. 6, Elements of Financial Statements, replaces SFAC No. 3 and expandsits scope to include not-for-profit organizations._ SFAC No. 7, Using Cash Flow Information and Present Value in Accounting Measurements, provides a framework for using expected future cash flows and present values as a basis for measurement.At the first level, the objectives identify the goals and purposes of accounting. Ideally, accounting standards developed according to a conceptual framework will result in accounting reports that are more useful. At the second level are the qualitative characteristics that make accounting information useful and the elements of financial statements (assets, liabilities, and so on). At the third level are the measurement and recognition conce pts used in establishing and applying accounting standards. These concepts include assumptions, principles, and constraints that describe the present reporting environment.First Level Basic ObjectivesAs we discussed in Chapter 1, the objectives of financial reporting are to provide information that is (1). reclaimable to those making investment and credit decisions who have a reasonable understanding of business and economic activities. (2). Helpful to present and potential investors, creditors, and other users in assessing the amounts, timing, and distrust of future cash flows and (3). about economic resources, the claims to those resources, and the changes in them. The objectives therefore, begin with a broad concern about information that is useful to investor and creditor decisions. That concern narrows to the investors and creditors interest in the prospect of receiving cash from their investments or loans to business enterprises. Finally, the objectives focus on the financia l statements that provide information useful in the assessment of prospective cash flows to the business enterprise. This approach is referred to as decision usefulness. It has been said that the golden rule is the central message in many religions and the rest is elaboration.Similarly, decision usefulness is the message of the conceptual framework and the rest is elaboration. In providing information to users of financial statements, general-purpose financial statements are prepared. These statements provide the most useful information possible at minimal cost to various user groups. Underlying these objectives is the notion that users need reasonable knowledge of business and financial accounting matters to understand the information contained in financial statements. This point is important. It means that in the preparation of financial statements, a level of reasonable competence on the part of users can be assumed. This has an impact on the way and the extent to which informati on is reported.Second Level Fundamental ConceptsThe objectives of the first level are concerned with the goals and purposes of accounting. Later, we will discuss the ways these goals and purposes are employ in the third level. Between these two levels it is necessary to provide certain conceptual building blocks that explain the qualitative characteristics of accounting information and define the elements of financial statements. These conceptual building blocks form a bridge between the why of accounting (the objectives) and the how of accounting (recognition and measurement).Qualitative Characteristics of Accounting InformationChoosing an acceptable accounting method, the amount and types of information to be disclosed, and the format in which information should be presented involves determining which alternative provides the most useful information for decision making purposes (decision usefulness). The FASB has identified the qualitative characteristics of accounting informatio n that distinguish better (more useful) information from inferior (less useful) information for decision making purposes. In addition, the FASB has identified certain constraints (cost-benefit and materiality) as part of the conceptual framework. These are discussed later in the chapter. The characteristics may be viewed as a hierarchy.Decision Makers (Users) and UnderstandabilityDecision makers vary widely in the types of decisions they make, how they make decisions, the information they already possess or can obtain from other sources, and their ability to process the information. For information to be useful there must be a connection (linkage) between these users and the decisions they make. This link, understandability, is the quality of information that permits middling informed users to perceive its significance. To illustrate the importance of this linkage assume that IBM Corp. issues a three-month earnings report ( temporary report) that shows retardation earnings way dow n. This report provides relevant and reliable information for decision making purposes. Some users, upon reading the report, decide to sell their stock. Other users do not understand the reports content and significance. They are surprised when IBM declares a smaller year-end dividend and the value of the stock declines. Thus, although the information presented was highly relevant and reliable, it was useless to those who did not understand it.Primary Qualities Relevance and ReliabilityRelevance and reliability are the two primary qualities that make accounting information useful for decision making. As tell in FASB Concepts Statement No. 2, the qualities that distinguish better (more useful) information from inferior (less useful) information are primarily the qualities of relevance and reliability, with some other characteristics that those qualities imply.RelevanceTo be relevant, accounting information must be capable of making a difference in a decision. If certain information has no bearing on a decision, it is irrelevant to that decision. Relevant information helps users make predictions about the ultimate outcome of past, present, and future events that is, it has prognostic value. Relevant information also helps users confirm or correct prior expectations it has feedback value. For example, when UPS (United Parcel Service) issues an interim report, this information is considered relevant because it provides a basis for forecasting annual earnings and provides feedback on past performance. For information to be relevant, it must also be available to decision makers before it loses its capacity to influence their decisions. Thus timeliness is a primary ingredient. If UPS did not report its interim results until six months after the end of the period, the information would be much less useful for decision making purposes. For information to be relevant it should have predictive or feedback value and it must be presented on a timely basis.ReliabilityAcco unting information is reliable to the extent that it is verifiable, is a faithful representation, and is reasonably free of error and bias. Reliability is a necessity for individuals who have neither the time nor the