Why Accounting Used and Provides a Framework for Predicting Accounting Choices - Coursework Example

Name Course Lecturer Date Why Accounting Used and Provides A Framework for Predicting Accounting Choices Accounting provides a logical reasoning in form of broad set of principles that provide a general framework of reference by which accounting practice can be assessed. It also provides a wide set of principles that that guide the development of new procedures and practices. This general frame of reference provides a set of propositions and statements that are connected by rules of inferential or logic reasoning (Brown & Alistair, 2006 p. 89). Accounting provides a framework for predicting accounting choices because its flexibility. Accounting regulation permits a choice of principle. For instance, ion respect of valuation of assets, the international accounting standards permits choice between carrying non-current assets at either depreciated historical cost or revalued amounts. In this case, it gives business entities an opportunity to change their accounting policies. This indicates how it used and still provides a framework for predicting accounting choices. Notably, such changes by a business entity may be fairly easy to change in the year the change was effected; however, they are much less readily apparent afterwards (Cazavan-Jeny et al., 2011 p. 153). There are some areas in accounting that are not fully regulated, these areas gives entities an opportunity to apply accounting principles and policies of their choice as there is no explicit principle regulating the specific area. For instance, there are quite few obligatory requirements in respect of accounting for stock options. There is limitation of accounting regulation in some countries and entities such as accounting for measurement and recognition of pension liabilities and certain aspects of accounting for financial instruments. This gives entities and accounting professionals an opportunity to apply accounting procedures and principles of their choice (Bens & Daniel, 2006 p. 292). Moreover, accounting gives an opportunity to entities to determine the authenticity of transactions. Entities can determine genuine transactions; they can be timed in order to provide the desired impression in the accounts. For instance, suppose an entity has an investment recorded at historical cost, the investment can easily be disposed at a higher sale price, being the current value. the managers of the entity has an opportunity to choose in the year they dispose the investment and hence increase profits in the entities accounts. In this case, accounting provides a framework in which the accounting professionals can make a choice (Reppenhagen, 2010 p. 137). Some accounting professionals may want to report increased profits while in actual reality the profits has reduced. As such, they may enter artificial transactions in to manipulative balance sheet amounts as well as move profits between accounting periods. They achieve this by entering in to two or more linked transactions with a helpful third party, in many cases a bank. For instance, suppose an entity make an arrangement to sell an asset to a bank and then it leases the asset back for the remaining useful life of the asset. In this case, the sale price under such sale and lease back can be pitched below or above the current value of the asset. This is because the difference can be compensated for by way of reducing or increasing rentals. This indicates how accounting provides a framework for predicting accounting choices (Kvaal, Erlend & Christopher, 2010 p. 179). Another reason that accounting provides a framework for predicting accounting choices is presentation and reclassification of financial numbers. The financial numbers are quite under explored in the works. However, entities may engage themselves in manipulation of balance sheet in order to reclassify liabilities so as to smooth reported leverage ratios and liquidity. This presentation of financial numbers is based on cognitive reference points. The idea behind this attitude is that employees may perceive profit of (say 300 million) as unusually larger than profit (say 290 million). Study indicates that some times entities massage figures so as to reach significant reference points (Cairns, David, et al., 2011 p. 19). Relevance in accounting information provides a framework for predicting accounting choices. Relevance is a major accounting principle. Relevant accounting information is can make a difference. This is by helping accounting users to form predictions about the results of the past, the present and the future events or to correct or confirm prior expectations. Information is very powerful; it can make a difference to decisions. This is by improving decision makers’ abilities to predict, it can make a difference by providing feedback on earlier expectations. Typically, information does both at once. This is because having knowledge about the outcomes of actions already taken will essentially improve decision makers’ capabilities to predict the outcomes of comparable future actions. Markedly, without the knowledge of the past, the basis for prediction will usually be lacking. Similarly, without an interest or concern in the future, having knowledge of the past is sterile. This indicates how accounting used to and provides the framework for predicting accounting choices, by providing relevant information capable of making difference in decision making (Broberg, Pernilla, et al., 2011 p. 52). The objective of accounting is to explain as well as to predict accounting practice. However, neither the explanation nor the prediction is preeminent. As such, the manner in which transactions and items are treated and presented in the financial reports affects the investor’s perception of the performance and position of an entity. While it is possible to develop individual accounting standards to deal with some specific issues, it is vehemently essential that there be a framework that gives a wider purpose that accounting is intended to achieve. This is significant as it ensures that accounting standards and principles are uniform and consistent, it ensures that they are not overly affected by self interest groups and political influence. The international accounting standards board (IASB) provides a framework for the presentation and preparation of financial statements. It provides the framework in the context of international financial reporting standards (IFRS). This gives an opportunity to entities to exercise choice in preparing and presenting financial statements (Wyatt & Anne, 2005 p. 983). The conceptual framework for financial reporting is an essential part of accounting. It guides accounting standard setters in setting standards. This gives a chance for the accounting professionals to apply the standards when preparing and presenting financial statements, they have a choice to apply one standard or the other as discussed above. All the accounting choices are permitted by the Australia accounting standards board (AASB) and the IASB. Firm managers are rational; their choice of accounting policies is based on the effect on the profits. As such, they choose accounting policies that maximise their own expected utility. Managers are very keep in their performance and the performance of the entities they manage. Their performance employment and performance is dependent on good performance and profitability of the entities. This is the reason why they don’t just choose any accounting policy, but they critically evaluate the effect that the policy with have on their own utilities. Thus the accounting choices by managers are not necessarily the ones that are best for maximising the shareholders wealth. They choose accounting policies purposely for their own benefits. This is dangerous as it comes at the expense of the firms shareholders and the lenders are said to behave opportunistically or in unethical manner. Although accounting provide a framework for predicting accounting choices, sometimes it’s not beneficial to an entity (Cazavan-Jeny et al., 2011 p. 153). Accounting choice comes at a cost to a firm; the framework is based on the major principle that provisions of financial information purposes at decreasing the cost of financing an entity's investments and projects. Supposedly, this reduction of cost is connected to the perception of an entity's risk by the investors and lenders. This makes entity managers to change the fundamental principles in accounting choice for investments and projects. This explains clearly how accounting provides a framework for predicting accounting choices. Eventually, the artificial reduction of investment costs by managers manipulates earnings. This is done purposely to achieve some preconceived notion of expected earnings. The investors have expected earnings from an entity's investments and projects, firm managers get concerned that the investments may not meet the expectations of the investors and thus they result in manipulating earnings. The motivation is to encourage the investors to purchase firm stocks and also to increase the value of the firm in the market (Brown & Alistair, 2006 p. 92). In conclusion, the essay provides sounding reasons of how accounting provides a framework for predicting accounting choices. Persons in authority in companies use the opportunity in the accounting choices to implement accounting policies and principles that favors their performance sometimes in expense of the firm’s shareholders. The report discusses the reasons for the accounting choices and the resulting benefit and costs to the firm. Some entities choose accounting policies such as affecting debt covenant issues to provide cost effectiveness. Such policies like this leaves firm managers with little choice for use of costs in their attempts to solve problems facing their firms. However, there are policies and principles that give managers a leeway to apply accounting policy of their choice without having implications. Essentially, accounting provides a framework for predicting accounting choices. References Bens, Daniel A. "Discussion of accounting discretion in fair value estimates: An examination of SFAS 142 goodwill impairments." Journal of Accounting Research 44.2 (2006): 289-296. Broberg, Pernilla, et al. "Why reduce profit? Accounting choice of impairments in Swedish listed corporations." International Journal of Accounting and Finance 3.1 (2011): 49-71. Brown, Alistair M. "The financial milieu of the IASB and AASB." Australian Accounting Review 16.38 (2006): 85-95. Cairns, David, et al. "IFRS fair value measurement and accounting policy choice in the United Kingdom and Australia." The British Accounting Review43.1 (2011): 1-21. Cazavan-Jeny, Anne, Thomas Jeanjean, and Peter Joos, "Accounting choice and future performance: The case of R&D accounting in France," Journal of accounting and public policy 30.2 (2011): 145-165. Guthrie, Katherine, James H. Irving, and Jan Sokolowsky, "Accounting choice and the fair value option," Accounting horizons 25.3 (2011): 487-510. Kvaal, Erlend, and Christopher Nobes, "International differences in IFRS policy choice: a research note." (2010): 173-187. Reppenhagen, David. Contagion vs. intrinsic factors of accounting policy choice, Diss. Emory University, (2010): 132-139. Wyatt, Anne. "Accounting recognition of intangible assets: theory and evidence on economic determinants." The accounting review 80.3 (2005): 967-1003. Read More