Accounting is often defined as "the language of business", because it plays a vital role in maintaining and processing financial information that an entity requires for its managing and reporting purposes. Shareholders of a company need information to make decisions. Financial statements should be provided to keep internal and external users updated. However, many companies use the different financial statements due to different counties have differing laws, economics and cultures. This led to the use of different criteria in identifying the items in financial statements. Thus it becomes important to develop the conceptual framework (CF) of accounting.
Tracing the manner used to form conceptual framework
Numerous bodies attempted to construct a conceptual framework. The common steps in generating a typical conceptual framework, which will be described five steps as following list. The first one is to determine who is user and what they need. Then ensure the quantity of information in financial statement. Thirdly, elements definitions, elements should be reported in statements. Fourthly, after element are defined, it is necessary to know when these factors should be recorded. Lastly, specify measurement for elements to know how these should be published.( Richard,L., David,P.)
Financial Accounting Standard Board (FASB) mentioned the framework first. Since the mid- 1970s, the US FASB has started to develop 'in a 'conceptual framework 'for accounting and issued statements of financial accounting concepts (SFACs) from step to step to revise and improve it.
The SFAC No.1 is a list of objectives of financial reporting by business enterprises in November 1978. "Financial reporting is not an end in itself but is intended to provide information that is useful in making business and economic decisions...(para 9) It is necessary to know who will use the information and do what. Different shareholders like managers, employees, investors and the government, use the information of financial statement do different things. The followed one is N0.2 was provided in May 1980. Qualitative Characteristics of accounting information, it ensure that financial information should be relevance and reliable. The SFAC N0.3 is replaced by SFAC NO.6 which is the elements of Financial Statements in Dec 1985. It provides definition of what elements could be reported in financial statements. SFAC No.5 describes about recognition and measurement in Financial Statements of business enterprises in Dec 1984. Criteria of recognition determine when data should be reported in the financial statement and how it be measured. In February 2000, FASB published No.7 that is using Cash Flow Information and Present Value in Accounting Measures.
Going for IASC, it be took over by IASB in 2001, faced more difficult to make CF due to it includes 100 country members. It published framework for the preparation and presentation of financial statements in July 1989. It is similar with SFAC except in its 'underlying assumptions' and 'concepts of capital maintenance'. The first one describes the accruals basis and going concern concepts and another describe basis concept s which one is using financial capital or physical capital maintenance.
ASB has been committed to the development of a statement of principles for financial reporting. In 1995 it attempted to publish a statement of principles that contained seven points. The differences from the two regulatory bodies are presentation in financial statements and the reporting entity. In March 1999, it revised statement of principle for financial reporting and in December 1999, it permitted the issue public that includes an introductory booklet and technical supplement.
As the globalization developed it became important to promote a framework as guidance in the world. In the October 20, 2004, FASB and IASB took this project and added it to their own schedule. The goal was to raise a common conceptual framework based the FASB and IASB accounting standards .In June 2005, this joint project was discussed on the financial reporting objectives and qualitative characteristics of accounting information.(Bullen,H., Crook,K., 2005)
Relationship between fair value and economic income
Under the SFAC No.5, measurements include historical cost, current cost, current market value, net realisable value and present value of future cash flow. In this essay, fair value would be discussed in detail. Fair value accounting, also known as market value accounting, refers to the market value or the present value of future cash flows of assets and liabilities as a key measurement in modern accounting models. With the development of transportation and communication technology in the industrial society, fair value ?80has been increasingly widely used.(FASB)(fresh-staxt measurements) In recent years, the U.S FASB statement 157 disclosed how to use fair value to measure assets and liabilities. This statement was focused on that fair value is a market-based measurement instead of an entity-specific measurement. It should be based on assumption that market participants evaluate assets and liability in fair value. That is relative to the FASB No.2, it emphasizes that quantity of information of financial statement and it should be relevant, reliable and comparable. 'The definition of fair value considers the concepts relating to assets and liabilities in FASB concepts Statement No.6 that definition of elements of financial statement, in the context of market participants. A fair value measurement reflects current market participant assumptions about the future inflows associated with an asset (future economic benefits) and the future outflows associated with a liability (future sacrifices of economic benefits).' Using fair value evaluate assets and liabilities of financial statement for stockholders ( investor, creditors and others ) to make investments and credit, which is link the FASB No.1. (financial accounting series , 2006)
Under the SFAC157, the definition of fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 'Fair value measurement influences the price of transaction of assets among traders.
Economic income is an economic concept, which definition is to keep valuation of income from beginning to the end, it include to maximum amount of consumption and gains.,,Take a simple example, without transaction, the net assets of an enterprise is 70,000 at the end and the opening net assets is 66,000. We could calculate its income is 4,000.10 000?,[(80 000-76 000-(10 000-8 000))? If the enterprise issued new shares 5000 during the period, and payment of dividends 3,000, then the economic income of 2,000 [(70,000-66,000 - (5,000-3,000)).
As this essay mentioned before, the elements of financial statements are characteristic by FASB. The assets are the 'probable future economic benefits obtained or controlled by a particular entity as the result of past transactions or other events'. Consider other elements linked with assets , like income that defined as 'in which income is a measure of the increase in the net resources of the enterprise during a period, defined primarily in terms of increases in assets and decreases in liabilities' . It is indicates that the framework tried to define these based on the foundation of economics. And the framework characteristics that an 'entity's income can be objectively determined from the change in its wealth plus what it consumed during a period' and Hicks (1946, pp. 178-9) is cited. It is seems that the conceptual view of assets is better than 'revenue and expense view'.( Bronwich, M., Macve, R., & Sunder, S., 2008)
The fair value is a method to evaluate assets and liabilities that influences economic income. It is difficult to record accounting based on economic income. Because of economic income only considers the changing of capital during a period. Suck like Hicks No.1 that is 'Income number 1 is the maximum amount which can be spent during a period if there is to be an expectation of maintaining intact the capital value of prospective receipts (in money terms).' In general, it means to maintain capital of individuals or companies interval. It will affect jthe amount of assets and liabilities that use fair value to book in the financial statement.
In December 1980, the United FASB's SFAC No.3, Comprehensive income is defined as "the change in equity [net assets] of a business enterprise during a period from transactions and other events and circumstances from non owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.
1997?,FASB In 1997, FASB formally announced the Financial Accounting Standards No. 130 "report comprehensive income." Comprehensive income includes net income and other comprehensive income. Net income still is recorded in the profit and loss statement that reflects identified and realized income (profits) and expenses (losses). While other comprehensive income would cover these have not been realized, which including like foreign currency translation adjustments (gains or losses)
Comprehensive Income broke through the limitations of income statement, which it also includes these changing assets have been identified but not realized gains or losses. It not only consider the current operating profit and it broke through the implementation of the principles of the traditional accounting earnings. It introduces the definition of fair value and makes it become a new measurement. It builds on the economics concept of income. (Anon, 2007)
Consequent income facing problem is how to make the accounting practices fit with the theory as far as possible. It is difficult to operate the principle of objectivity in practice. It is a challenge of historical cost and introduce the new concept of fair value used in record accounting. Compared with reliability, it focuses on relevance of information. Besides, consequent income is not proper use of prudence that is a basic principle of accounting. It could cause the subjective and arbitrary when reporting financial statements.
Even so, the theory of comprehensive income stills an entirely new concept of income.' Instead of 'revenue and expenses' , 'assets and liabilities' view confirm the benefit and break the limited of traditional accounting measurement. It explores a new road for not realized gains and losses. Comprehensive income provides accrual information and timely prediction of future cash flow. It also improves integrity and usefulness of information in the financial statements.
On the view of external user, the information from financial statement should be questioned if it has not guidence. In order to reduce the information asymmetry as much as possible, the accounting policy need an effective constraint that allowing outsiders access to relevant and reliable, reflecting the economic realities of business information. CF generated for guidance the financial and accounting information to be standardized has become a kind of an inevitable choice .According to provide of standard-setting theory and support from the conceptual framework , it ensure the information accrual Therefore, it is no exaggeration that the conceptual framework has become a very important development and characteristics for the development of financial accounting. However, academics and practitioners argue that the control of accounting information disclosure cause many problems such as "market failure and "signal theory leads information of financial statement leave away from external environment .The CF provides a useful starting point, but the political nature of accounting standard setting is such that a purely technical solution may be unacceptable (Beresford, 1988; Kirk, 1988; Brown, 1990; Wyatt, 1990).Nonetheless,1980?12?,(Comprehensive Income)with the development of environment, FASB has been improving its' statement to suite for the changing.
- ANON ,2007, [online] Available at <http://hi.baidu.com/eardsion/blog/item/cb4a763837a86ef1b311c761.html>[Accessed 12 Dec 2009]
- Brown, V., 'Commentary on Accounting Standards: Their Economic and Social Consequences',
- Accounting Horizons,September 1990. (?:Scott(1997),Financial Accounting Theory,P328~P348;Wolk and Tearney, (1997)Accounting Theory Aconceptual and Institutional Approach,P89~P101.),
- Bromwich, M., Macve, R., Sunder, S., the conceptual framework : revisiting the basics , a comment on Hicks and the concept of 'income' in the conceptual framework . the future of financial reporting 2008
- FASB Statement 130: Reporting Comprehensive Income (June 1997)
- Scott (1997), "Financial Accounting Theory, P328-348; Wolk and Tearney ( 1997)
- Financial accounting series statement of financial accounting standards No.157.No.284-A September 2006 financial accounting standard Broad of financial accounting foundation
- Kieso.D, E.,Wey grandt, JJ (1995). Intermediate Accounting, 8thed, P401, John Wiley & Sons, Inc
- Macve, R.H.1981.A Conceptual Framework for Financial Accounting and Reporting: The Possibillities for an Agreed Structure.London: Institute of Chartered Accountants in England and Wales.
- Richard,L., David,P., Advanced Financial Accounting seventh edition. Prentice hall ,financial times person education.
If you are the original writer of this essay and would like it removed from UKEssays please email the URL of this essay to us via the link below.