Why is a conceptual framework necessary Essay


International Accounting Standards Board ( IASB ) has begun a common undertaking with US Financial Accounting Standards Board ( FASB ) to reconstruct the bing models and meet them into a common model. First, some background. The US Securities and Exchange Commission ( SEC ) has proposed that companies required to register fiscal statements with the SEC get down replacing U.S General Accepted Accounting Principles ( US GAAP ) with International Financial Reporting Standards ( IFRS ) get downing in 2014. For all practical intents this means the eventual acceptance of IFRS ( principles-based ) for all companies in the United States ( U.S. accounting criterions are considered to be rule-based theoretical account ) . The displacement aims to harmonise US accounting criterions to an international one in tandem with the globalisation of capital markets. ‘Norwalk ‘ understanding between the FASB and the IASB was signed paving the manner for the creative activity of more principles-based accounting criterions for planetary fiscal coverage ( Wikipedia, 2010 ) .

What is Conceptual Framework?

International Conceptual Framework of Financial Reporting is a system of synergistic aims and basicss which lays out a set of consistent criterions in fixing fiscal reports.A conceptual model is kindred to a fundamental law that prescribes the nature, map and bounds of fiscal accounting and fiscal statements.

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Why is a conceptual model necessary? First, to be utile, standard puting shouldbuild on and associate to an established organic structure of constructs and aims. A soundly developed conceptual model should enable the IASB or FASB to publish more utile and consistent criterions over clip. A consistent set of criterions and regulations should be theresult, because they would be built upon the same foundation. The model should increase fiscal statement users ‘ apprehension of and assurance in fiscal coverage, and it should heighten comparison among companies ‘ fiscal statements. Second, new and emerging practical jobs should be more rapidly solved byreference to an bing model of basic theory. For illustration, PandaCorporation sold two issues of bonds that it would deliver either with $ 1,000 in hard currency or with 50 ounces of Ag, whichever was worth more at adulthood. Both bond issues had a stated involvement rate of 9 per centum. At what sums should the bondshave been recorded by Panda or the purchasers of the bonds? What is the sum ofpremium or price reduction on the bonds and how should it be amortized, if the bond redemptionpayments are to be made in Ag ( the hereafter value of which was unknownat the day of the month of issue ) ? It is hard, if non impossible, for the FASB or IASB to order the proper accountingtreatment rapidly for state of affairss like this. Rehearsing comptrollers, nevertheless, must resolvesuch jobs on a daily footing. Through the exercising of good judgement and withthe aid of a universally-accepted conceptual model, practicians can disregard certainalternatives rapidly and so concentrate on an acceptable intervention.

Harmonization of accounting criterions is really of import. For case, Multinational companies making concern in more than one state will happen that it is hard to follow with more than one set of accounting criterions established by governments in different states.

Harmonization of accounting criterions will assist the universe economic system in the undermentioned ways: by easing international minutess and minimising exchange costs by supplying progressively “ perfect ” information ; by standardising information to global economic policy-makers ; by bettering fiscal markets information ; and by bettering authorities answerability. International investing determinations and financial-based direction determinations are so made with less hazard.

Furthermore, harmonisation of accounting policy would assist supply a “ flat playing field ” globally. Regulators and hearers will be having the same information, easing the rating procedure.

In today ‘s accounting environment, there are two formats of accounting systems, viz. principles-based system and rules-based system.Almost all companies are required to fix their fiscal statements harmonizing to one of the two criterions. Recently, there has been much argument on whether principle-based accounting would be more efficient than the popular rules-based accounting, in the aftermath of accounting dirts, such asA Enron. As a consequence of the Enron saga, the current manner of accounting has been come under a great trade of examination.

Rules-based Accounting

Rules-based accounting such as US GAAP is fundamentally a list of elaborate regulations that must be followed when fixing fiscal statements. ManyA comptrollers favor the chance of utilizing rules-based criterions, because in the absence of regulations they could be brought to tribunal if their judgements of the fiscal statements were wrong. When there are rigorous regulations that need to be adhered to, the possibility of cases is diminished ( Investopedia, 2009 ) . Having a set of regulations can increase truth and cut down the ambiguity that can trip aggressive coverage determinations by direction. The matrix of regulations, nevertheless, can do unneeded complexness in the readying of fiscal statement

Principles-based Accounting

Principles-based accounting such asIFRS is adopted as a conceptual footing for comptrollers. A simple set of cardinal aims are set out to guarantee good coverage, e.g. qualitative features, faithful representation. Common illustrations are provided as guidelines and explicate the aims. Although some regulations are ineluctable, the guidelines are non meant to be used for every state of affairs ( Investopedia, 2009 ) . Precise demands can sometimes oblige directors to pull strings the statements to suit what is compulsory. The job with principles-based accounting is that deficiency of guidelines can give undependable and inconsistent information that makes it hard to compare one organisation with another.

When contemplating whichA accounting method is best, A it must be made certainA that the information provided in the fiscal statements is relevant, dependable and comparable across describing periods and entities. Increased treatment has pushed comptrollers towards principle-based accounting, A butA it isA recognized that the method needs to be modified to do it more effectual and efficient.

To exemplify thecomparison, for illustration, depreciation disbursal for all fixed assets is to be set at 10 per centum per annum of the original cost of the plus until the plus is to the full depreciated.Such a regulation leaves no room for judgement or statement about the sum of depreciation disbursal to be recognized. Comparability and consistence across houses and through clip is virtually assured under such a regulation. This is a rules-based system.In contrast, under the principles-based system, depreciation disbursal for the coverage period should reflect the diminution in the economic value of the plus over the period. Such a standard requires the application of judgement and rating by both directors and hearers. The end is to register the realistic value of the plus harmonizing to “ as is ” footing.

Differences between IFRS and U.S. GAAP

Statement of Income – Under IFRS, extraordinary points are non segregated in the income statement, while, under US GAAP, they are shown below the net income.

Consolidation – IFRS favors a control theoretical account whereas U.S. GAAP prefers a risks-and-rewards theoretical account. Some entities consolidated in conformity with FIN 46 ( R ) may hold to be shown individually under IFRS.

Inventory – Under IFRS, LIFO ( Last In, First out ) can non be used while under U.S. GAAP, companies have the pick between LIFO and FIFO ( First In, First Out ) . Using the LIFO method consequences in lower gross net income, which allows a company tobe taxed less.

Earning-per-Share – Under IFRS, the earning-per-share computation does non average the single interim period computations, whereas under U.S. GAAP the calculation averages the single interim period incremental portions.

Development Costs – These costs can be capitalized under IFRS if certain standards are met, while it is considered as “ disbursals ” under U.S. GAAP ( Remi Forgeas, 2008 ) .


Rules-based System

Increasedaccuracy, reduced ambiguity and a lessened possibility of cases.

Rule-based criterions are by and large considered easier to scrutinize for conformity intents, and may bring forth more consistent and comparable fiscal studies across entities.

Auditor show higher confident in determination devising because they have a bright-light guidelines.

Principles-based System

The cardinal advantage of principles-based accounting is that its wide guidelines can be practical for a assortment of fortunes

Potentially really flexible with respect to new and changing merchandises and environments. As such, they should besides necessitate less care.

Another advantage of a principles-based system is that it would ensue in simpler criterions. Principles-based system would take to criterions that would be less than 12 pages long, alternatively of over 100 pages.

Accountants are afforded the flexibleness to input their expertness and judgement more freely in line with the professional codification in bring forthing the fiscal statements. Such deployment of their accomplishments and experience will heighten their professionalism.


Rules-based System

Lack of transparence of revelation. In the aftermath of recent accounting dirts, such as Enron and Worldcom, investors are becominghypersensitive to the dependability of published histories and leery of the possibility of hyperbolic net incomes.

The major drawback to a rules-based system is the complexness in the readying of fiscal statements

May include a deficiency of flexibleness with respect to altering conditions and new merchandises, hence necessitating about continual care at times.

Frequently subjectto use as entities may seek for loopholes that meet the actual diction of the criterion but violate the purpose of the criterion.

Principles-based System

Critics of a principles-based attack argue that fiscal statements are more hard to scrutinize andwould probably lose their comparison and consistence across industries and issues sing income measuring and acknowledgment would stay controversial. For illustration, how much income will General Electric really acknowledge on a multi-year defence contract under the per centum of completion method of accounting? Will this be comparable to the income reported by its rivals?

To the extent that they rely on single judgement to construe and implement the criterions, there is a danger that they can be used to pull strings fiscal consequences. For illustration, what ifthe hearers acting severely? Abuse their trust and fail to use the rules in “ good religion consistent with the purpose and spirit of the criterions. ”

Hearers display less assurance in their determinations.

Between the rules-based and principles-based faculties, it is felt that the latter will be more practical and preferred by the planetary community, given its cosmopolitan entreaty based on moralss, sound judgement, transparence, credibleness and even downright common sense factors. Furthermore, in the globalised concern sphere, this system would be easier to follow, grok

and acceptable as against stiff regulations that may be interpreted otherwise from one state to another.

Example Cases

Enron Case

U.S. accounting criterions are considered to be rule-based theoretical account. For illustration, we look at the Enron dirt, which broke in October 2001 and finally led to the prostration of the Enron Corporation. Through the usage of accounting loopholes, particular purpose entities ( SPE ) , and hapless fiscal coverage, Enron was able to cover up one million millions of dollars in debt from failed trades and projects.In the U.S, Accounting jurisprudence allows a company to except a SPE from its ain fiscal statements if an independent party has control of the SPE, and if this independent party owns at least 3 per centum of the SPE.

Enron needed to happen a manner to conceal the debt since high debt degrees would take down the investing class and trigger Bankss to remember loanings. Using the Enron ‘s stock as collateral, the SPE, which was headed by the CFO Fastow, borrowed big amounts of money. And this money wasused to equilibrate Enron ‘s overvalued contracts. Therefore, the SPE enabled Enron to change over loans and assets burdened with debt duties into income. In add-on, the pickings over by the SPE made Enron reassign more stock to SPE. However, the debt and assets purchased by the SPE, which was really burdened with big sum of debts, were non reported on Enron ‘s fiscal histories.

Enron was besides guilty of utilizing a doubtful mark-to-market accounting system in its forward gas contract gross revenues whereby income was estimated as the present value of net hereafter cashflows to bespeak “ true economic value ” . When these undertakings faltered, income was still recorded based on the initial value which of class was wrong. As a consequence more undertakings had to be “ created ” to prolong a steady income influx to pacify the stockholders.

Beginning: www.enron.com

Stockholders lost about $ 11 billion when Enron ‘s stock monetary value, which hit a high of US $ 90 per portion in mid 2000, plummeted to less than $ 1 by the terminal of November 2001.

Transmile instance

A particular audit carried out by Douglas moores Rowland Risk Management Sdn. Bhd, showed that Transmile made pre-tax losingss of RM126 million and RM77 million for 2006 and 2005, severally, alternatively of pre-tax net incomes of RM207 million and RM120 million as originally reported – a sum of RM530 million in exaggeration. Their hearers Deloitte & A ; Touche declined to O.K. the histories when the company failed to supply them proof to confirm certain trade receivables. However, the loss was non detected by Deloitte & A ; Touche.

Worldcom instance

This instance unveils how one of the universe ‘s largest Mississippi telecommunicationproviders managed to do $ 3.8 billion disappear? The reply lies in the company ‘s CFO Scott Sullivan ‘s intervention of capital outgos and the accrual method, one of the basic rules of accounting.Sullivan, fraudulently took one million millions of dollars in operating disbursals and distribute them out across alleged “ belongings ” histories, which is a type of capital disbursal histories. This allowed Worldcom to bear down the disbursals off easy, and in smaller sums, alternatively of describing them instantly to investors. The U.S ‘s rules-based accounting system is deficiency of transparency.Transparency is going a affair of endurance instead than pick. The manner toaddress at least some of the defects mentioned supra is to recommend more transparence in fiscal coverage. This basically means that companies would get down supplying all the information the market considers to be relevant instead than merely carry throughing their compulsory regulative demands.

Southern Bank Bhd ( SBB ) instance

In the reappraisal of Southern Bank Bhd ‘s audited fiscal statements for the twelvemonth ended Dec 31, 2005 there was inappropriate accounting intervention amounting to RM 160 million as follows:

Inappropriately valuing certain derivative fiscal instruments and non composing down in full the collateral value.

Wrongly composing back specific commissariats made on certain foreclosed belongingss.

Capitalizing alternatively of write offing certain costs which is similar to Worldcom fiscal dirt.

It appears that the accounting and scrutinizing criterion in Malaysia is really low. In order to protect the involvement of the little investors and stockholders, the accounting and scrutinizing criterion should be upgraded.


Personally, I do notfavor trusting on either rules. Without believable rules, the regulations are nonmeaningful. Without regulations the comptrollers are non protected.

We had principle-based regulations up until the IASB/FASB was created. The more specific regulations or counsel were issued following cases against hearers or comptrollers, oppugning their professional judgement. The profession felt that to publish specific regulations would cut down the likeliness of cases against the comptroller ‘s professional judgement. Interestingly, we are now coming full circle and looking to simplify how accounting is interpreted. We will do this switch and so in another 10-20 old ages, if another accounting dirt arises and everyone will inquire for more regulations once more?

However, we may be good served by admiting that neither a strictly rules-based nor a strictly principles-based system will be the best option on its ain. Possibly a mostly principles-based system policed by a simple regulations codifications could be the ideal solution.Any set of regulations will be capable to person ‘s reading. The regulations will merely be every bit good as those who use them.

( 2,490 words )


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