Decision Usefulness and Stewardship Functions of Financial Reporting

Decision usefulness is the important theory of financial reporting that emphasises on the individuals or group of individuals who use the financial information and their information requirements. This approach is adopted to fulfil the information requirements of the key users of financial reports. The primary users of such information are the investor and creditors. However, the usefulness of the financial information must not be confined to the investors and creditors of the reporting entity (Cordery & Sinclair, 2016). Rather, the other stakeholders such as governmental agencies, employees, customers, business communities etc. must also require such information for the decision making. The decision usefulness theory assumes that rational decision making in relation to allocation of economic resources is facilitated by the adequate availability of appropriate financial information (Shagari & Dandago, 2013).

The stewardship is the ethical term of accounting that casts responsibility on the management of the entity to carefully handle the business and provide the reliable and necessary information to the key stakeholders of the company about the economic resources of the business of such company. The basic objective of the financial information is to act as the steward between the management of the company and the other interested parties.

The stewardship function is mainly concerned with the past performance of the business so as to assess its future performance whereas decision usefulness theory provides information by focusing on the present situation of business of the reporting entity (Dandago & Hassan, 2013). Stewardship influences the decision usefulness of the general purpose financial statements in direct or indirect manner.

In the recent years, decision usefulness function of financial reporting is considered more important years. The exclusive emphasise on decision usefulness function has resulted in an excessive focus on forecasting of future cash flows and also it has led to putting insufficient focus on the reliability of the financial information which is deemed as the important qualitative characteristic of the financial information. There is no point of conflict in decision usefulness and stewardship function. The exclusion of function of stewardship has involved the risk that those who have argued to include the information necessary for the assessment of stewardship had been placed at the disadvantageous position.

Therefore, the approach adopted by the International Accounting Standard Board to set decision usefulness as the prime objective and to encompass the information that is relevant for the assessment of stewardship in the decision usefulness objective. The approach of IASB has been set out in the Preliminary View paper of the board. This paper also proposed the substitution of one of the important qualitative characteristic of financial information i.e. verifiability. Therefore the approach adopted by IASB will not completely lead to the provision of relevant and reliable information for all the interest user groups of the company. The IASB must consider the stewardship function as the separate function and it must not be included in the decision usefulness objective in order to achieve the purpose of dissemination of relevant and reliable information among different users of such information so that they can make informed decision making.

Weaknesses of Historical Cost Accounting

If stewardship is not kept as the separate function, there will always be the possibility that the information that is necessary for the stewardship purpose will not be covered in the financial statements on the ground that such information is not considered to be decision usefulness for the capital allocation objectives (Europe, 2007).

Historical cost accounting is also recognised with the name of conventional accounting as it involves conventional approach of recording the transactions in the books of accounts. Under this type of accounting, the main elements such as assets and liabilities held by the entity are reported at their cost in the financial statements (Zeff, 2007).

Negligence towards price level changes: The financial statements that are prepared taking historical costs of different items as the base are merely the historical fact sheets. This type of accounting does not take into consideration the change in the money value which occurs due to various economic factors such as inflation. The changes in the levels of prices of the items that constitute important elements of the financial statements are not accounted for in HCA.

Unrealistic values for the fixed assets:  In historical cost accounting the assets that are generally non-current in nature are recorded at the values at which they were purchased. However, the market faces significant fluctuations in the prices of such assets with the changing economic conditions. Hence, the current market value of the fixed assets is ignored. The current market value of an asset tells about the price which can be obtained by the transfer of such asset in the market and is necessary to be considered in order to find the true state of company’s financial position.

Insufficient depreciation provision: The main purpose of charging depreciation to any asset is to maintain a provision of funds to replace such asset in the subsequent periods when such replacement becomes necessary. In HCA, depreciation is charged on the historical costs of those assets. As HCA leads to under or over valuation of assets, depreciation expense in relation to assets also gets under or over charged which disturbs the true profitability position of the entity (Deegan, 2013).

No fair view: When financial statements are created on the basis of historical cost accounting, the items that are non-current in nature are recorded at the historical costs and not at their fair value in the market. During the inflationary periods, such non-current items remains understated due the fact that their actual realisable value in the market increases because of increase in price levels but they are still stated at their acquired values (Accounting Management, 2011).

Alternatives to Historical Cost Accounting

The major factor that undermines the worth of HCA is the ignorance of inflation on the key elements of financial statement. This problem could be solved using the indexation technique, the current purchasing power accounting the prices indices are multiplied by the historical cost figures. This type of accounting is undertaken to adjust the historical costs for the changes in the purchasing power accounting. CPPA is definitely the improvement upon HCA however CPPA could not resolve the all the limitations of historical costing even after allowing for the adjustments for the inflation. The other alternative theory of accounting is the current cost accounting where financial statements are created using the current market values of individual items and not at the historical costs. The current cost accounting method is also preferred over CPPA as CCA provides the full system of inflationary accounting and also it adequately deals with the limitations of HCA (Laux & Leuz, 2009). Moreover, the financial statements prepared under CCA offers more realistic picture as it clearly differentiates between the profits from normal business operations and gains from price level changes (Schroeder, Clark & Cathey, 2001).

Conceptual framework of accounting is the coherent system with interrelated objectives as well as fundamental of financial reporting. It provides structured theory for financial accounting (Draft, 2015). The key building blocks of conceptual frameworks are discussed below:

Financial Reporting-Definition: The first issue that is addressed by the conceptual frameworks of financial reporting is defining the term financial reporting. This area basically outlines the boundaries of different financial reporting concepts.

Reporting Entity-Definition: This part of conceptual frameworks deals with establishing the criteria to determine such entities that are reporting entities and hence therefore require generation of the financial reports. The statement of accounting concepts (SAC 1) deals with this aspect of the said framework.

Objectives of financial reporting: This aspect of conceptual framework deals with setting out of the broad objectives of the general purpose financial reporting function. SAC 2 deals with this part of the framework. Further, it determines the main readers of financial reports as well as the sort of the information needs of those different users and also the approach of financial reporting that is suitable to different information needs of the users (AASB, 2001).

Qualitative characteristics- Financial Statements:  This aspect of conceptual framework deals with identification of various qualitative characteristics of accounting information. These characteristics should be present in the financial information of the entity so as to achieve the core purpose of financial reporting. Qualitative characteristics are those features of financial information which makes it useful for the readers of financial reports. The qualitative characteristics of information are the relevance, reliability, comparability, fair representation, timeliness etc. The SAC 3 of the conceptual framework of accounting deals with this part.

Key Building Blocks of Conceptual Frameworks in Accounting

Elements- Financial Statements: This part of conceptual framework deals with the major elements of financial statements: assets, liabilities, incomes, expenses and equity. It deals with identification, definition of these elements in the financial statements. This aspect of the said framework is dealt by SAC 4.

Recognition Criteria: There are primarily two criteria to be met in order to recognise the above discussed element in the financial statements. They are:

• It is probable that there will an outflow or inflow of funds of the entity, in relation to such as item.
• The value of such item can be measured consistently.

Those elements that meet the above criteria are to be recognised in the financial statements in order to meet the objectives of financial reporting (ACCA, 2018).

Measurement Criteria and Techniques:  This aspect of conceptual framework deals with the basis for the measurement of different key elements of the financial statements. It also suggests the techniques of measuring those elements.

Measurement is one among the most undeveloped aspect of the conceptual framework. It discusses the alternative of measuring the elements of financial statements such as historical costing, current costing and other alternatives but does not specify which alternative to be selected in which situation. Also, there is no guidance on selection of measuring unit or measurement attributes from the list provided by such frameworks (Schipper & Trombetta, 2010).

Since, there are two different conceptual frameworks as regulated by two different bodies i.e. FASB and IASB, it is necessary to harmonise the conceptual frameworks of both the issues to resolve various management issues that arises due to difference in the definitions, views and treatments of various elements of financial statements (Barth, 2007).

The basic objective of the conceptual framework is to provide decision useful information to the users of financial reports so that they can undertake informed decisions. There are various trade-offs between the qualitative characteristics of the information as defined by conceptual frameworks. Therefore, the conceptual framework cannot be said to have achieved fully their basic objectives. These issues are further required to be resolved so as to achieve the true financial reporting objectives (IASB, 2005).

References:

AASB. (2001). The Nature and Purpose of Statements of Accounting Concepts. Retrieved from: < https://www.aasb.gov.au/admin/file/content102/c3/ACCPS5_07-01.pdf>

ACCA. (2018). The need for and an understanding of a conceptual framework. Retrieved from: < https://www.accaglobal.com/in/en/student/exam-support-resources/fundamentals-exams-study-resources/f7/technical-articles/conceptual-framework-need.html>

Accounting Management. (2011). Limitation of Historical Cost Accounting (HCA). Retrieved from: < https://accountlearning.blogspot.com/2011/06/limitation-of-historical-cost.html>

Barth, M. E. (2007). Standard-setting measurement issues and the relevance of research. Accounting and Business Research, 37(sup1), 7-15.

Cordery, C. J., & Sinclair, R. (2016). Decision-Usefulness and Stewardship As Conceptual Framework Objectives: Continuing Challenges. Retrieved from: https://www.researchgate.net/profile/Carolyn_Cordery/publication/318004562_Decision-Usefulness_and_Stewardship_As_Conceptual_Framework_Objectives_Continuing_Challenges/links/59ca55ada6fdcc451d57eef3/Decision-Usefulness-and-Stewardship-As-Conceptual-Framework-Objectives-Continuing-Challenges.pdf

Dandago, K. I., & Hassan, N. I. B. (2013). Decision Usefulness Approach to Financial Reporting: A Case for Malaysian Inland Revenue Board. Asian Economic and Financial Review, 3(6), 772.

Deegan, C. (2013). Financial accounting theory. McGraw-Hill Education Australia.

Draft, I. E. (2015). Conceptual Framework for Financial Reporting. Retrieved from: < https://eifrs.ifrs.org/eifrs/comment_letters/50/50_5914_PranavHVariavaSecuritiesandExchangeBoardofIndiaSEBI_0_CommentLetterConceptualFrameworkSEBI.pdf>  

EUROPE, (2007). Stewardship/Accountability as an objective of financial reporting. A comment on the IASB/FASB Conceptual Framework Project. Retrieved from: < https://www.efrag.org/Assets/Download?assetUrl=%2Fsites%2Fwebpublishing%2FSiteAssets%2F070823%2520%2520PAAinE%2520Stewardship%2520paper%2520final%2520version.pdf>

IASB. (2005). Revisiting the Concepts: A New Conceptual Framework Project. Retrieved from: < file:///C:/Users/System04091/Downloads/814%255C918%255Ccommunications_paper.pdf>

Laux, C., & Leuz, C. (2009). The crisis of fair-value accounting: Making sense of the recent debate. Accounting, organizations and society, 34(6-7), 826-834.

Schipper, K., & Trombetta, M. (2010). Measurement Issues in Financial Reporting. European Accounting Review, 19(3), 425-428.

Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2001). Accounting: Theory and Analysis. John Wiley & Sons.

Shagari, S. L., & Dandago, K. I. (2013). Decision Usefulness Approach To Financial Reporting: A Case For The General Public. Retrieved from: < https://www.researchgate.net/publication/296607962_DECISION_USEFULNESS_APPROACH_TO_FINANCIAL_REPORTING_A_CASE_FOR_THE_GENERAL_PUBLIC>

Zeff, S. A. (2007). The SEC rules historical cost accounting: 1934 to the 1970s. Accounting and Business Research, 37(sup1), 49-62.