Lin (2015) put forth that investors, lenders and creditors rely on financial reports to get vital information about financial position and risks of companies. Additionally, the average investor, lender or creditor does not have inside access of the company’s day-to-day operations but instead rely on financial reports to provide comparable and accurate information. Furthermore, financial information that is adequate is essential in maintaining efficient market system. Transparency and disclosure of a company, protect investors, thereby enhancing investors’ confidence in market. Nevertheless, some academics and other stakeholders maintain that the major objective of financial reporting should not be to provide information to these users (Kabir and Rahman, 2018). As such, this essay aims to establish the benefits and shortcomings of the objective of financial reporting as per the IASB conceptual framework.
Arguments for IASB’s conceptual framework
Firstly, Kabir and Rahman (2018) explains that the development of IASB conceptual framework which asserts that the objective of financial reporting is to provide relevant information, has led IASB to produce a body of a world-class standards benefiting firms that adopt them for example, firms that have adopted IFRS have enhanced status and reputation and this lowers their cost of raising capital. Furthermore, firms that use IFRS will have their results compared more easily with those of firms using IFRS (Ernest and Young 2018).
Secondly, Barker (2015) opine that investors of a company wants to know the amount of return they get from their investments, how their capital investment is efficiently used and how the company’s cash is reinvested. Additionally, Bauer et al. (2014) holds that the potential investors also wants to know the way the company was in the past performing whey it presently plan to invest the investors’ funds and whether making the investment is worth it. As such, financial reports help present investors and potential investors to decide whether a company is worth their money or not. For example, Kvatashidze (2019) puts forth that profit and loss statement shows amount of the net profit the company has earned and profit available for shareholders to get as divided during the current year and details of the previous years.
Thirdly, Barker and Penman (2017) elucidates that financial reports offers creditors a comprehensive insight at the financial standing of a business. Information such as existing debt obligations, income, salaries, expenses, cash flow and profit all factor into financial profile of a business. Further, creditors rely on financial reports to determine if a company represents a credit risk that is sound, as well as ability of the company to repay debt it owes as agreed. This stand point is shared by Lin (2015) who maintain that an entity’s financial condition is a big concern to both creditors and investors. As sources of capital, they rely on financial reporting to measure conditions for their investments safety and profitability. More specifically, creditors and investors need to know and understand where their cash went and where their cash is now.
Fourthly, Abela et al.(2014) elucidates that to operate effectively and efficiently, the stock market should satisfy capital providers’ needs. As such, lenders look for good opportunities in order to increase capital value, while companies hope to raise more capital by attracting investors for their operation in order to make profit. Thus, with no accounting information, the market would not operate effectively causing potential investors to be reluctant to carry out trading activities because they have insufficient information to determine the value of investment. As a result, it is vital for the main objective of financial reporting to be to provide useful information to its lenders (Bauer et al.2015).
Fifthly, Kvatashidze (2019) posits that providing reliable information to financial institutions helps reporting entity to raise capital easily and at a lower cost. These financial institutions rely on financial statements to make decision on whether it will grant credit or a loan to an entity. Additionally, financial institutions measure the financial strength of a business in order to determine probability of bad loans. As such, any decision on lending must be based on sufficient liquidity and asset base.
Arguments against IASB’s conceptual framework
Some stakeholders are of the opinion that the objective of financial reporting as asserted by IASB’s conceptual framework is of little or no use.
First, the objective of financial reporting as per its framework is criticized for lacking clarity, exclusion of various important concepts and being out dated as far as IASB’s current thinking is concerned (Ernest and Young, 2018). This view is shared by Barth (2014), who posits that most of the weakness of the current conceptual framework is attributed to various factors of which the most significant reason is failure to dealing with fundamental issues of measurement and recognition. As a result of this weakness, the information provided to users is not useful or it may provide misleading information.
Second, proponents of the objective of financial reporting as per IASB’s conceptual framework are of the opinion that it has led to better IFRS standards and as such argue that publicly listed companies must use one set of accounting standards that is of high quality so as to contribute to capital markets that are better functioning. Further, they argue that mandatory IFRS adoption will facilitate cross-border comparability, decrease information costs, increase reporting transparency, reduce information asymmetry, therefore resulting in competitiveness, increase in liquidity and markets efficiency. However, Brouwer et al.(2015) espouses that there is very little and often empirical evidence which conflicts the above assertion that this is usually the case. Moreover, while these potential benefits makes a strong case for adoption of IFRS the cost which is associated with such a transition should not be ignored. A case in point Ball (2006) explains that IFRS orientation of fair value could cause volatility to the financial statements. This volatility will more often take the form of good and also bad information, the bad information consisting of the noise that results from inherent estimation errors and likely managerial manipulation (Gebhardt et al. 2014)
Thirdly, financial statements are in practice prepared for different users and one set of principles can hardly be agreed by all. In addition, it is not possible to provide useful financial information to all users. For instance, some users think that what they need is reliable information and they therefore prefer to obtain financial information evaluated by historical cost. But historical cost is not relevant for certain kind of assets like financial instruments. On the contrary, since a firm’s market price is vital to investors, some investors would as a result prefer value relevant information thereby preferring financial reports measured by the fair value. However, Abela et al. (2014) hold that historical cost is less relevant to financial information users than fair value. Some have been tempted to think that using a mixed measurement system that include historical cost, fair value and deprival value might be the solution to measure different types of assets and liabilities but as Barker (2015) has shown, this causes mismatch issues where different items that are in the same set of account are measured on different basis. Therefore, that aggregation misleads and also causes the problems of inconsistency and incomparability. As such, no matter what evaluation system IASB consider using in measuring assets and liabilities, all users demands cannot be met.
Fourthly, the objective being to provide useful information as Bamber and Mc Meeking (2016) explains, does not address the question of which information will help lenders, investors and other creditors estimate value of reporting entity. Furthermore, financial statements do not reflect an entity’s present financial position as they are disclosed during the end of a financial year. A case in point, assets and liabilities value changes when purchasing power of money fluctuates.
Fifthly, Young (2006) opine that connection between users of financial statements, standard settings and decision usefulness was forged very recently and was initially controversial as it is even today. The controversy as Young explains arose due to more emphasis on what accounts are supposed to do, with little effort put on examining logic of accounting practices. As such, prominent academics rejected and continue to reject usefulness as the purpose of accounting reports.
In closing, presuming the objective of financial reporting as asserted by IASB’s conceptual framework can be perfect is unrealistic. Nevertheless it is possible to identify areas in which this framework can be better designed to address its purpose. We should acknowledge that IASB revision of its framework are a good work in progress, and the fact that IASB acknowledge that this objective remain less developed than it like, is a sign that it welcomes constructive criticism. After weighing both sides of the argument for and against IASB’s accounting objective, I agree fully with assertion of IASB since the existence of many accounting concepts demands a need to have a picture of what is in practice done and how the concepts are used in actual working environment. Its main aim is to put forth what accounting is about and help stakeholders see overall picture of the accounting.
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