Decision Usefulness vs. Stewardship Function of Financial Reports

Financial reports (and the conceptual frameworks on which they are based) can either embrace a ‘decision usefulness’ or ‘stewardship’ function. Define these two terms. Which of these functions has the IASB deemed more important in recent years? Critically evaluate whether the approach adopted by the IASB will lead to the provision of relevant and reliable information for all users (Ouchi, 2015). 

The main purpose of this framework involves giving assistance to the IASB in the development and the revision of the IFRSs. This process involves the preparation of consistent policies of accounting for the capacities that have not be addressed by the standard accounting models or in areas that have choices for accounting policy as well as in areas assisting all the involved parties to understand and interpret the IFRS.

Under the circumstances, there is great need to have facts to interpret the standard financial information. More that, in such cases, the managements has to apply their judgmental concepts in developing and applying their accounting policies that will end up giving information which are reliable and relevant.  It is also important to understand that the financial management departments has to make judgments with the understanding the recognized criteria, the concepts of measurements for assets, liabilities, income, as well as expense frameworks.

It is also vital to note that the framework in discussion does not override the fundamental aspects of any particular IFRS, but addresses the areas of conflicts within the framework. Therefore, the approach adopted by the IASB addresses the objectives of the general purpose of financial reporting, the qualitative characteristics of useful financial information, the various elements of financial statements and the concepts of capital and capital maintenance.

According to the facts given by Sharma & Kelly (2016), since 2006, the accounting standards board has been in positions of holding on the decision that is useful to the fundamental objective for reporting financial and accounting issues with the parties involved calling for the stewardship and accountability of a subjective one.

With the intense lobbying for these amends this financial reporting objective by increasing the stewardship prominence, most Europeans favored this amend (Füssel, 2007). Due to this, there have been two sharply differing opinions, surrounding the stewardship or accountability with a possibility of IASB putting the dual objectives as a priority for the overall financial reporting for both monetary as well as the non-monetary information (Mabogunje, 2015).

Decision usefulness is, therefore, involves helping the investors in making decisions and doing business with a specific entity (Williams & Ravenscroft, 2015). As an essential segment of the accounting framework within which financial standards are developed, decision usefulness provides the best strategic choice for making proper accounting decisions for the users.

IASB’s Approach and its Implications

The stewardship accounting, on the other hand, involves keeping the records by a business enterprise befitting all the operations, transaction, the debts that are outstanding as well as the manner in which the capital employed by the entity is being invested (Pavan, Dessalvi & Paglietti, 2018). This is why it is possible to argue that the company directors have the stewardship role to the company resources and they manage the affairs of a company on behalf of the shareholders of the same company.

The decision usefulness, as indicated above, involves a re-evaluation of decisions in accounting procedures, coming from the perspective that some accounting decisions were made in the wrong pattern (Beattie, 2014). The stewardship perspective, on the other hand, involves having the mindset that all resources of a company do not belong to the managers or directors, but they are taking the management role on behalf of the owners of the firm (Sharma & Kelly, 2016). Therefore, regarding importance, the two functions have been proven to be used by the IASB, all being deemed more important in recent years.

The approach taken by IASB group involves a measurement perspective for financial reporting whereby the accounting practitioners like the accountants take responsibility upon all of their actions in a manner to incorporate values that are financially fair and proper for accounting standards (Sandberg & Tsoukas, 2015). There is every hope on the evaluation of these standards that responsibility is taken reasonably for reliability and recognition of an increased obligation to assist investors to predict future firm performance based on the clarity in the financial reporting and management.

Based on the analysis above, it is clear that the basic motive of the approach taken by IASB group was very relevant and reliable in addressing the contemporary issues affecting accounting and developments in financial reporting.

Identify the weaknesses of historical cost accounting. Were any of the alternatives to historical cost (CPPA/CCA/CoCoA) successful? In your response, you will need to outline your criteria for success. 

For so many years, the historical cost accounting method has been used in the world in matters of accounting and financial reporting. This method has been used in the provision of the necessary financial information for positioning a reporting company regarding performance and changes in financial position. However, based on the levels of price changes in the contemporary issues, this approach has been deemed by some deficiencies and weaknesses (Aras & Crowther, 2016).

Weaknesses of Historical Cost Accounting

In the adoption of the historical cost accounting models, it is important to note that in times of inflation, the value of money declines and, therefore, the monetary unit which is used as a standard of measurement does not have a constant value and shrinks in value as the prices rise.

In the case above, the use of historical cost accounting assumes the decline in the value of money but keeps adding transactions acquired at different dates with money of varying purchasing power (Whittington, 2008). Thus, in historical accounts, the monetary unit used to measure incomes and expenditures, assets and liabilities, has a mixture of values depending on the date at which each item was originally brought into the accounts.

The other weakness of the historical cost accounting model is that it is based on some dangerous assumptions (Lightweis, 2014). For instance, the historical cost accounting model uses the assumption of stable monetary unit which states that there is no inflation and ignore the changes in the rate of inflation in the general economy that have ripple effects on the accounting processes. This assumption does not prove true during inflation because of the change in general purchasing power of the monetary unit (Rankin, Ferlauto, McGowan, & Stanton, 2012). This creates serious problems in measuring and communicating results of a business enterprise.

More than that, it is also critical to realize that the historical cost accounting models do not match the current revenues with the current costs of operations. Revenues are measured in inflated (current) values whereas production costs are a mix of current and historical costs (McCarthy, 2012). Some costs are measured in old values (e.g., depreciation), other tend to be in more recent rupees (e.g., inventories), while still others reflect current values (e.g., wages, salary, selling expenses and similar current operating expenses).

For so many years, the accounting records were done through the asset valuations based on their historical costs. In this case, the historical cost accounting was done based on the social construction and inductively developed (Rankin, Ferlauto, McGowan, & Stanton, 2012). However, in the wake of 70’s and 80’s, during the economic changing conditions, there were some accounting principle movements that eventually developed alternative measurements models (Greene, Caracelli, & Graham, 2015).

In the face of competition, the historical cost accounting changed to suit the contemporary accounting standards from being positive in nature to being normative in nature. In this case, the accounting standards, rather than merely implying that measuring the value of an asset at its historical cost is ‘the way things are’, it countered that this measurement method outlines ‘the way things should be’ as much as CPPA, CCA and CoCoA offered themselves as valid alternatives to HCA, so too HCA offered itself as a valid alternative to CPPA, CCA and CoCoA. It is also worth noting that despite early support, none of CPPA, CCA or CoCoA ever became an accounting standard.

Alternative Accounting Methods

That said, there is clear evidence of their characteristics in the accounting concept ‘fair value’ (FVA), a measurement base that is increasingly utilized by various accounting standard-setting bodies all around the world (Mayston, 2012). HCA has, and still remains in widespread use globally, with its modified form (MHCA) regarded as contemporary accounting best-practice.

In understanding the principle of normative theory, it is also prudent to understand the principles of accounting decision making processes. Thus, normative theory involves outlining things the way things should be. Since the 80’s, the  normative accounting theory has driven methodological debate through deductive reasoning, particularly in terms of the development of various measurement models (McCarthy, 2012). The following are some of the shortcomings in the historical cost accounting method:

1. Outdated figures: based on the historical cost accounting method, the asset figures are usually contained in the financial statements of the position of a company based on the cost determined at the time of acquiring the asset (Andon, Baxter, & Chua, 2015). Due to this, it is impossible to present the value of the asset since these figures cannot come together. In this way, it will be challenging to realistically predict the future cash flows that are related to the assets among the users of financial statements (Lamberton, 2005, March).
2. Overstatement of figures: under the historical cost accounting method, there is every possibility of overvaluation of the statistics. The background of this statement is that if the profit is dependent on the measure of capital at various dates, the profit measurement is generally considered as the result after the comparison of totals that have no meaning, since the figure on the figure does not demonstrate the purchasing power of the shareholders (Caskey & Laux, 2016). Thus, the resultant value is an overstatement as the same as the return on capital.

• Misleading operational levels: The historical cost gives a misleading impression of the ability of a company to continue to operate at a given level since the assets are undervalued. By adjusting for inflation and net realizable value, accountants attempt to maintain the shareholders’ capital regarding the general or consumer purchasing power (Solomon,  Solomon, Norton,  & Joseph, 2010).

1. Incomparability: Most of the historical cost accounts can give a misleading impression of the financial trends of a company. Only if the results of different years are restated by adjusting to general price levels can comparability between years be valid. All items in the profit and loss account are expressed regarding year-end purchasing power, while the same will be right in the balance sheet.

Outline the critical building blocks of conceptual frameworks. Conceptual Frameworks are yet to provide a significant prescription about measurement issues in accounting. Why do you think this is the case? Would you consider theoretical frameworks to have been successful in achieving their objectives? Justify your response. 

The fundamental building blocks of conceptual frameworks address the objective of general purpose financial reporting, qualitative characteristics of useful financial information, financial statements and the reporting entity, the elements of financial statements, recognition and derecognizing, measurement, presentation and disclosure, and the concept of capital and capital maintenance (Oulasvirta, 2014).

Information about the nature and amounts of a reporting entity’s economic resources and claims assists users to assess that entity’s financial strengths and weaknesses; to evaluate liquidity and solvency, and its need and ability to obtain financing (Yen, Lai, & Chen, 2016). Information about the claims and payment requirements assists users to predict how future cash flows will be distributed among those with an application on the reporting entity (Pavan, Dessalvi, & Paglietti, 2018).

Information about a reporting entity’s financial performance during a period, representing changes in economic resources and claims other than those obtained directly from investors and creditors, is useful in assessing the entity’s past and future ability to generate net cash inflows (Williams & Ravenscroft, 2015). Such information may also indicate the extent to which general economic events have changed the entity’s ability to generate future cash inflows.

Cost is a pervasive constraint on the information that can be provided by general purpose financial reporting (Modell & Lukka, 2017). Reporting such information imposes costs and those costs should be justified by the benefits of communicating that information. The IASB assesses costs and benefits about financial reporting generally, and not solely with regard to individual reporting entities. The IASB will consider whether different sizes of entities and other factors justify different reporting requirements in certain situations.

Key Building Blocks of Conceptual Frameworks

The view often promoted by various advocates of conceptual framework projects is that it is difficult and perhaps illogical to develop systems of financial accounting if we do not initially agree on the most fundamental issues such as: ‘ What is general purpose financial reporting?’, and ‘What is the objective of a general purpose financial reporting system?’ (Beattie, 2014). Further, to make the system consistent we need to agree on how we define, recognise and measure the elements of that system. The view taken is that there are a number of building blocks involved in developing a logical system of accounting and that a conceptual framework develops such building blocks in a logical order. For example, we initially need some consensus on the definition of general purpose financial reporting and of a reporting entity, before we can consider the objective of financial reporting.

Once we have considered the objective of financial reporting, it is possible afterwards then consider defining the qualitative characteristics of financial reporting, how to define the elements of financial reporting, measurement principles, etc. Without some consensus on issues such as those mentioned above, it is likely that the development of rules of accounting will be undertaken in a rather piecemeal manner with limited consistency between the various rules (Lightweis, 2014).

This inconsistency appeared to be the case in many countries prior to the development of conceptual frameworks. There was a great deal of inconsistency between the various standards in terms of definitions (often implied) of the elements of accounting, as well as inconsistencies in determining when the elements should be recognized and how they should be measured (Whittington, 2008). With a conceptual framework, the accounting standards are expected to be more consistent.

It has long been acknowledged that measurement is a critical element of accounting: ‘Measurement is one of the most underdeveloped areas of the framework’ (Hail, Leuz, & Wysocki, 2010). And yet, according to the literature, it has not been afforded the clarity of purpose that priority demands. In determining whether they have achieved these objectives, there are a number of factors to consider: inconsistencies across standards, the extended timeframe for the development of standards, lack of prescription provided by the CF, avoidance of the most difficult accounting issues.

The success of the approach taken by IASB group in installing the contemporary accounting frameworks can be determined through the financial reporting progress in areas of finance and accounting.  The general aim of the financial reporting involves presenting investors and potential investors, the lender, as well as the creditors about the current dictates of a company (Andon, Baxter, & Chua, 2015).

Under such financial disclosures, the various stakeholders are in a position to make informed decision concerning the equity, stocks, among other aspects of the company. The contemporary accounting principles is levying for transparency, accountability, and fair disclosures of the financial positions of any global firm. Therefore, by the present trend in financial reporting, it is sensible to narrate the success of the approach taken by IASB group.

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