Decision-Usefulness and Stewardship Objectives for Financial Reporting - Coursework Example

Decision-usefulness and Stewardship objectives for Financial Reporting Name Institution Date The criterion around which the reporting of financial information and related academic research, for more than forty years, has been focusing on decision usefulness. In other words, when choosing among alternative ways to present data, policy makers have been required to select a reporting method whose information is most useful for decision-making in economic terms by particular designated users (Williams & Ravenscroft, 2014). Interestingly, the latest 2010 Conceptual Framework (CF) has incorporated only the objective of decision-usefulness and left out stewardship contrary to the previous 2001 and 2007 CF which had incorporated both objectives. This essay looks at the question of whether the Financial Reporting objective should be based only on decision-usefulness or whether to recognize stewardship as a separate objective. My assessment will be based on the possible merits and demerits of adopting stewardship against incorporating decision-usefulness as the only objective in trying to meet the needs of users of Financial Reporting. There are compelling reasons in support of identifying decision-usefulness objective in the CF. According to the proponents of decision-usefulness, the fact that resources are invested in reporting of financial information, if such resources were not useful, they would be wasted (Ball, 2008). In addition, financial reporting should influence decisions so to serve its purpose. Thus, the case for the objective of decision-usefulness is almost evident (Lennard, 2007). However, the main concern is decision-usefulness objective in and by itself offers adequate and relevant focus to allow financial reporting to develop in future. There is a range of qualifications attached to the decision-usefulness objective. The objective is mainly meant to provide information that can help user make decisions (Young, 2006). However, it does not mean decisions will simply flow mechanically from the financial statements’ information. Actually, users of financial reporting will require information beyond that existing in the financial reports (Lennard, 2007). Another argument is that financial reports in design are not intended to show value of the entity and that reference to both cash and cash flows can be read as other resources likely to be converted into cash or simply as cash (Williams, 2010). Decision-usefulness objective uses the term ‘resource allocation’ and proponents argue that it is not limited to decisions involving buying, selling, or holding securities of an entity or to lending money to the an entity. The objective recognizes also decisions on management appointment, voting on policies and remuneration (Barth, 2008). This clarification is essential for the assertion that the objective incorporates the useful information for assessing stewardship. These are some of the arguments that made the International Accounting Standard Board (IASB) to change the underlying objective of financial reporting in the 2010 CF. In deed, these qualifications are exclusively appropriate. However, there is still a chance for doubt with regard to fully correcting the impression of focusing on future cash flows. This implies that they might promote the development of accounting standards that mainly focus on decision-usefulness objective while neglecting other considerations in financial reporting, such as stewardship (Lennard, 2007). Thus, the rationale for IASB reconsidering the underlying objective of financial reporting again in 2015 is to come up with an improved CF that offers a strong foundation to help develop future accounting standards. The standards are expected to be based on principles and have internal consistence. In addition, they should lead to financial reporting that provides capital providers with information they require to make decisions in their fullest capacity. Unlike decision-usefulness objective, stewardship as an objective is not frequently characterized precisely. However, there are compelling reasons why is should be identified in the CF as an objective on its own. The existing IASB Framework recognizes stewardship as financial statement as well. A part from just providing information that helps in making economic decisions, it also show results of the accountability of management of available resources (Richardson, 2011). Users who are interested in assessing accountability of management make economic decisions that may include whether to reappoint the management or whether to hold or trade their investment in the entity. The current IASB Framework also argues that stewardship is implicit in the decision-usefulness objective. However, this explanation is adjacently included to the definition of objectives although they are treated differently. In addition, the current Framework appears to imply that the two concepts of stewardship and accountability are one and the same (Williams, 2010). Nonetheless, accountability refers to the fact that management have the responsibility to use the assets of the entity is a way that benefit shareholders. It also means that management has the overriding obligation to account to shareholders how these assets have been put in use (Richardson, 2011). However, the concept of stewardship in reflected differently within the decision-usefulness objective. It asserts that management is accountable for safekeeping and custody of assets entrusted to it and their profitable and efficient use (Lennard, 2007). It also mentions that management is accountable to protection of these assets from unfavourable effects of the economy, such as technological changes and inflation, including ensuring compliance with regulations, laws and contractual provisions. This view is opposed by the IASB who consider stewardship as directors, or management board of an entity being accountable to its owners. According to IASB stewardship is an essential aspect of the process of financial reporting in many jurisdictions and should be considered independently in the CF (IASB, 2010). It beliefs the two concepts are parallel objectives and do not necessary conflict, thus they have different emphases. The need for accounting in respect to business enterprise is normally rationalized with regard to agency theory. For instance, when a company is listed, the aspect of control and ownership are normally separated. Management is responsible for day-to-day control of the entity, but ownership remains with shareholders. Thus, both parties benefit from the arrangement but also there are risks. One of the common ways to reduce possible risks is requiring management to provide accounts to its shareholders on a regular basis (Lennard, 2007). Therefore, financial statements provide an essential condition for a modern company to exist. The objective of stewardship ensures that this role is in operation in financial reporting. The International Accounting Standard Board (IASB) is responsible for the issue of the CF for Financial Reporting. The objective of financial reporting forms the basis of the CF and these objectives benefit various users of accounting information, such as potential investors, lenders and other creditors whom general purpose financial reports are directed (Williams & Ravenscroft, 2014). The objective of financial reporting is to provide primary users group with the information they need. These users are the capital providers to the entity. Capital providers make decisions concerning allocation of their resources to an entity and how they can enhance their holdings (Nobes & Parker, 2008). Normally, when making these decisions, users of accounting information are interested in assessing the ability of the entity with regard to management’s stewardship and generation of net cash flows. A part from the primary users of financial statements, other users include employees, suppliers, customers, other trade creditors, government and their agencies, regulatory bodies and the public (FASB, 2010). Accounting information satisfies user’s different information needs. To start with, investors use the information to assess the effectiveness of managers in running the entity so to predict possible levels of return and risks in the future. Shareholders need information to assess the entity’s ability to pay them dividend. Accounting information helps lenders, such as banks to assess the ability of the entity to repay amount borrowed plus the interest and to meet its obligations (FASB, 2010). Creditors rely on information from financial statements to enable them assess whether amounts the entity owes them will be paid on time. Unlike lenders, trade creditors are interested in an entity for only a shorter period of time. Government and their agencies are also interested in accounting information of the entity (Nobes & Parker, 2008). Through such information, they are able to regulate entities’ activities, assess compliance with existing pricing policies and to determine taxation policies as well as use the information as the basis for both national statistics and income. Entities affect the public in different ways (FASB, 2010). Thus, accounting information helps members of the public assess the trends and current developments in the growth of the entity. Still, managers, competitors and investment analysts also require accounting information to help them make appropriate decisions. Changing the objectives of Financial Reporting has the potential to affect aspects of the accounting standards, including recognition and basis of measurement. Although all future cash flows are important in decision-making, financial statements have not tried to reflect on all such flows (Lennard, 2007). Contrary, financial reporting emphasizes the careful testing of the potential assets and liabilities in order to see if they adhere to tough recognition and definition criteria. Thus, focusing exclusively on decision-usefulness objective is likely to make this criteria more relaxed. For example, relationships with customers are considered a source of future cash flows and therefore treated as assets even when there is no contractual relationship. According to Lennard (2007) even when future cash flows have a relationship with more familiar assets, the decision-usefulness objective would be used to provide a basis of measurement that have a direct reflection on them. Where market values are available, they could be applicable based on the fact they reflect certainty and amount timing of all future cash flows. However, where they are not available the future cash flows could be discounted to produce a reasoned amount to reflect a market price (Williams & Ravenscroft, 2014). In deed, this is the essence of the introduction of fair value accounting. Reflecting on what we learnt on global financial crisis in 2008, the ultimate objective of financial reporting should be to disclose risks and uncertainties so to assist users of accounting information to better understand financial position, cash flows and financial performance of the entity to make better economic and investment decisions (FRC, 2009). For entities that are highly affected by the prevailing financial crisis, management should be expected to consider ways through which to address risks associated with such situations in their financial statements. Financial reporting should provide enough disclosures to help users know the events of the information presented in the financial statements (FRC, 2009). In particular, entities should disclose both the nature and extent of risks likely to occur from financial instruments the entities are exposed when reporting accounting information and how they manage the risks. Conclusively, based on the discussion, it is important that the stewardship objective should be clearly and precisely identified in the CF. It is true a multiplicity of objectives could be worrying, but only if these objectives contradicted each other. However, decision-usefulness and stewardship objectives do not conflict, but emphasize various elements of what financial reporting is meant to achieve. Identifying stewardship as a separate objective of financial reporting would eventually change the emphasis of the CF. Changes in aspects of accounting standards would make stewardship a more important tool for improving financial reporting. References Ball, R. (2008). What Is the Actual Economic Role of Financial Reporting. Accounting Horizons. 22(4): 427-432. Barth, M. (2008). Global financial reporting: Implications for U.S.Academics. The Accounting Review 83(5): 1159-1179. FASB (Financial Accounting Standards Board). (2010). Conceptual framework for financial reporting: Chapter 1, The Objective of General Purpose Financial Reporting, and Chapter 3, Qualitative Characteristics of Useful Financial Information. Statement of Financial Accounting Concepts No. 8. Norwalk, CT: FASB. FRC (Financial Reporting Council) (2009) Going concern and liquidity risk: guidance for directors of UK companies, October. IASB (International Accounting Standards Board) (2010). The Conceptual Framework for Financial Reporting 2010. London: IASB. Lennard, A. (2007). Stewardship and the Objectives of Financial Statements: A Comment on IASB's Preliminary Views on an Improved Conceptual Framework for Financial Reporting: The Objective of Financial Reporting and Qualitative Characteristics of Decision-Useful Financial Reporting Information 1. Accounting in Europe, 4(1), 51-66. Nobes, C. and Parker, R. (2008) Comparative International Accounting, 10th edn. Prentice Hall- Financial Times, Chapter 6. Richardson, A.J. (2011). Regulatory competition in accounting. A history of the Accounting Standards Authority of Canada. Accounting History Review, 21 (1), 95-114. Williams, P. F., & Ravenscroft, S. P. (2014). Rethinking decision usefulness. Contemporary Accounting Research. Williams, P.F. (2010). The Focus of Professional Ethics: Ethical Professionals or Ethical Profession? Research on Professional Responsibility and Ethics in Accounting, 14: 15-35. Young, J.J. (2006). Making up users. Accounting, Organizations and Society, 31(6), 579-600. Read More