Accounting is a purposeful activity and is directed towards the specific end of producing financial reports, which contain information which is used by specific individuals such as investors. Investors provide financial resources to the organization. In order for the investor to invest in a specific company he needs information and this information must be true and fair by reflecting the actual financial position of the company. Limited companies are required by law (the Companies Act 1985 or CA 1985) to prepare and publish accounts annually. Many figures in financial statements are derived from the application of judgement in putting those concepts into practice. As a result of that, every one exercising his own judgement on the same facts often comes up with his own conclusions.
Accounting practice has developed gradually over centuries. There are many concepts which are taken for granted in preparing accounts. Accounting concepts and conventions as used in accountancy are the rules and guidelines by which the accountant is guided. All formal accounting statements should be created, preserved and presented according to the concepts and conventions that follow. There are many accounting concepts. In the United Kingdom, the following accounting concepts are laid down in the Statement of Standard Accounting Practice number 2 (SSAP2):
The Going Concern Concept implies that the business will continue in operational existence for the foreseeable future, and that there is no intention to put the company into liquidation or to make drastic cutbacks to the scale of operations. Without this concept, accounts would have to be drawn up on the 'winding up' basis. That is, on what the business is likely to be worth if it is sold piecemeal at the date of the accounts. The winding up value would almost certainly be different from the going concern value .
The Accruals Concept or Matching Concept The purpose of this concept is to make sure that all revenues and costs are recorded in the appropriate statements at the appropriate time.
The Consistency Concept states that with all similar items, similar accounting treatments must be used.
The Prudence Concept states if there are different procedures or different ways of valuations that can be used we must chose the most cautions ones.
There are also The Entity, The Money Measurement, The materiality and The Historical Cost concepts.
From 1970 to 1990, the Accounting Standards Committee (ASC) developed accounting standards with the aim of narrowing the areas of differences and variety in accounting practices. The ASC published 25 statements of standard accounting practice (SSAPs).The SSAPs (Old Regime) applied in particular to the accounts of limited companies in order to give a true and fair view of an enterprise’s results and financial position .
In 1990 a new system came into being for producing standards, following the recommendations of the Dearing Reports, produced for the Consultative Committee of Accountancy Bodies (CCAB) in 1988.This proposed that a two-tier system should be established. The Accounting Standards Board (ASB) is much better staffed and financed than the ASC. New standards issued will no longer be called SSAPs but Financial Reporting Standards (FRSs) in the new regime. In time, all standards will be replaced by or converted to FRSs.
Generally Accepted Accounting Practice (GAAP) is a term that has sprung up in recent years and it covers all the rules, from whatever source, which govern accounting. Most countries have their own GAAP. GAAP is in fact a dynamic concept. This idea that GAAP is constantly changing is recognised by the ASB in its Statement of Aims where it states that it expects to issue new standards and amend old ones in response to ‘evolving business practices, new economic development and deficiencies identified in current practice ’.
The strengths of the regulatory framework:
(a) They reduce or eliminate confusing variations in the methods used to prepare account.
If we take, for example, a company that purchases a new building, we can see many different methods of recording it in the financial reports and the way it records depends on the judgements of the accountant. This could be confusing for everybody. If we take two identical companies and both of them purchased new buildings with the same value we could well see two different financial statements. The regulatory framework did solve this problem which was causing a lot of confusion.
(b) They provide a focal point for debate and discussions about accounting practices.
In this information age, accounting has become more important than ever. For this reason, accounting practices need a focal point for debate and discussions and this problem is being solved by the regulatory framework.
(c) They oblige companies to disclose the accounting policies used in the preparation of accounts.
In accounting there are different methods of recording inventory and also how to record a newly purchased property. The regulatory framework has solved this problem by obliging companies to disclose the accounting policies used in the preparation of accounts. The way that this information will be recorded will affect the bottom line of financial statements of the organization.
(d) They are a less rigid alternative to enforcing conformity by means of legislation.
There were rigid legislations before the regulatory framework. The pressures that the companies faced from those rigid legislations were huge. The regulatory framework has solved this by less rigid alternatives.
(e) They have obliged companies to disclose more accounting information than they would otherwise have done if accounting standards did not exist.
There were very few companies before the regulatory framework who chose to report the cost of sales in their accounts. Such useful information was needed by the investors but many companies did not disclose it before the regulatory framework. This problem, after introducing the regulatory framework, no longer exists.
The weaknesses of the regulatory framework:
(a) A set of rules which give backing to one method of preparing accounts might be inappropriate in some circumstances.
This is a major weakness in the regulatory framework. An example of the inappropriate circumstances is when a company purchases investment properties. In this case applying depreciation is not acceptable.
(b) Standards may be subject to lobbying or government pressure.
The government and the lobbying from some industries did put pressure on formulating the standards. This pressure did cause some standards to be suspended like what happened in USA with FAS 19 as a result of the powerful lobbying by huge oil companies to serve their interests.
(c) They are not currently based on a conceptual framework of accounting.
The regulatory framework is changing constantly as circumstances alter through new legislation, standards and practice. The conceptual framework of accounting is no longer the base for the regulatory framework due to new economic developments and deficiencies identified in current practices.The emphasis has shifted from ‘principles’ to ‘practice’.
(d) There may be a trend towards rigidity, and away from flexibility in applying the rules.
The reliance on judgements in technical accounting matters seems to have gone. Every thing in technical accounting now is relying on the regulations produced by the regulatory framework.
Q. Do the criticisms of the concepts and the regulatory framework mean that published financial statements do not provide investors with useful information?
A. No, they do not.
Much useful information is provided in published financial statements as a result of the regulatory framework. The regulatory framework obliges companies to disclose the accounting policies used in the preparation of accounts. Before the regulatory framework investors were facing difficulties to get full information about the company they wanted to invest in. Much critical information was needed by the investors but the companies did not disclose this before the regulatory framework. Cost of sales data is very important for investors but many companies chose not to disclose that cost before the regulatory framework. More disclosure of non-financial information, more forward-looking information and more information about intangible assets was a result of the regulatory framework. For sure, the investors are still asking for more information. The regulatory framework has helped the investors by obliging the companies to disclose more information than before. Regulatory framework is reviewed regularly for development.
Members of the Financial Accounting Standards Board (FASB) and its staff have been active participants in several efforts to improve the quality of business reporting, which encompasses the broad spectrum of information that a company provides to investors and creditors. The most recent effort was the FASB Business Reporting Research Project. The Steering Committee directing that project published three reports during 2000 and 2001, including Improving Business Reporting: Insights into Enhancing Voluntary Disclosures. This Special Report is another step in that process .
By the information now published in the financial statements, investors now can analyze the company they want to invest in a much better manner.
If we take a look at Enron Corporation and what happened to it, we will find that they published financial statements but with wrong information to look good in front of the investors.
A survey by McKinsey & Company of over 200 institutional investors in 31countries found that over 90% of them want a single unified set of global accounting standards. Out of this study we can find that the investors believe in the regulatory framework. The study also found that ‘accounting disclosure’ is the single most significant factor affecting their investment decisions. If we take a deep a look to the result of this study we understand up to what extent the investors depend on the accounting disclosures in their investment decisions.
As a result, the criticism of the concepts and the regulatory framework does not mean that published financial statements do not provide investors with useful information but it helps the investors more than ever. We can’t say that what happened to some companies like Enron that was caused by the regulatory framework. Investors had gained a lot of benefits from the regulatory framework and they are still asking for more. The development of the regulatory framework is trying to supply investors with what they need.
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