The development and use of a Conceptual Framework instead of accounting standards will solve the problem of inconsistency in the application of accounting in practice.
When it comes to financial reporting, conceptual framework or accounting standards can be used. Conceptual framework refers to a statement of generally accepted theoretical concepts and principles that can be used to provide a frame of reference when it comes to accounting or financial reporting. Accounting standards are rules-based standards that are used in financial reporting. Accounting standards are set to provide a framework for reporting financial statements that are transparent, consistent, relevant, and reliable. Both conceptual frameworks and accounting standards have advantages and disadvantages. However, the use of conceptual framework is more likely to address the problem of inconsistencies in the application of accounting in practice.
Conceptual frameworks are statements that set forth the concepts that are used in financial accounting and reporting. The framework itself is a set of interrelated objectives and principles that set the basic theory of accounting and provide guidance for the development of accounting standards. Conceptual frameworks provide a basis for developing new accounting standards as well as provide a platform to evaluate the existing accounting standards. The main aim of the conceptual framework is to provide a set of concepts that can be used to define the subject, nature, purpose, and content of financial reporting. The key benefit of conceptual framework is promoting more consistent and logical financial reporting requirements. This is because the frameworks arise from a set of concepts that make the boards that set accounting standard’s more accountable.
Accounting standards comprise of sets of neutral principles that require the use of consistent, reliable, and relevant information in financial accounting and reporting. In the US, accounting standards are developed to be used by participants in the capital markets. Accounting standards are fixed principles that can be used to ensure the delivery of credible and understandable financial information. Accounting standards are more used than conceptual frameworks mainly because they provide precise answers when it comes to accounting and it also helps in legal situations. For example, when there are lawsuits alleging wrong accounting, accounting standards can be used to provide guidance. Despite these benefits, accounting standards have various shortcomings that lead to the problem of inconsistency in the application of accounting in practice. The rules used in accounting standards can also become useless at times or even dysfunctional when economic environments change or more innovative transactions are used. Accounting standards are therefore very rigid, and this could lead to inconsistencies in the application of accounting in practice.
According to SEC, accounting standards are rule-based can be used to address accounting objective that are characteristic of standards. However, misinterpretation of the standards could lead to inconsistencies, exceptions and bright-line tests in accounting practice. These shortcomings could lead to financial reporting that does not fully represent the underlying economic situation of transactions. The main advantage of conceptual framework is that it provides a consistent conceptual base that is used to avoid inconsistencies, contradictions, and other shortcomings in basic concepts of accounting, and so they produce standard accounting principles. Framework provides guidance to accounting standards to ensure that they have a consistent approach to problem solving.
Another way that conceptual framework and not accounting standards solve the problem of inconsistencies is that it addresses accounting issues that are not addressed by set standards. Framework is not a standard, but it provides guidance when it comes to preparing financial statements. Standards are rigid rules that require to be followed irrespective of the economic and financial situations that are not directly addressed by the standard. However, frameworks can provide the needed guidance to resolve accounting issues that are not covered by a standard. For example, while preparing financial statements, accountants or auditors could want to include some information, but there are no standards to provide guidance. However, frameworks can be used to provide guidance in such a situation.
Conceptual frameworks make use of economic arrangements in a way that does not omit any issue of relevance to investors, creditors, and other users. Frameworks also provide the principles and content that can specify and effectively deal with accounting for such economic arrangements. However, accounting standards do not consider economic arrangements, and this could lead to issues of relevance being omitted. In accounting standards, when accountants and auditors seek guidance about accounting for a transaction that is not defined by a standard, new standards are set. This can then provide an opportunity for opportunistic individuals to prepare financial statements that are misleading in order to adhere to the new rule.
According to Weil, when confronted, such individuals would say that such a thing is not prohibited by any standard. An example of such inconsistencies in accounting standards is Enron’s case, whereby the company misused the definition of a business to claim that the act of purchasing two different assets from one single seller was a business. The company did so that it could record and use negative goodwill. Enron could have said that the purchase of two assets from a single seller could fit the definition of a business because there was no standard or rule that said that it was not. Conceptual frameworks can address such a problem because it provides the appropriate principles to give the definition of the word business.
Accounting standards are set of rules that require financial reports to be prepared in a certain way. They also do not provide a clear understanding of financial reporting, and this could lead to inconsistencies. Accounting standards are more likely to be adhered to for purposes of compliance rather than for genuine communication. As a result, some accountants would use very little effort in preparing them, leading to inconsistencies. However, conceptual framework are incredibly important because they help users to understand the basis of financial reporting as well as the limitations.
Conceptual frameworks also provide a consistent statement of financial position. This means that the frameworks provide all the objectives and principles needed to provide the needed guidance in preparing financial statements. However, accounting standards are not consistent and are always subject to change by the boards that develop the standards. The development of accounting standards is also subject to political pressure. For instance, a particular economic or social situation that appears threatening to a standard will pressurize the board to change the standards in order to address the issue. This would therefore lead to more inconsistencies in accounting practice on the part of accounting standards.
Conceptual frameworks can provide a form of regulation of accounting standards and the boards that set these standards. While the boards can change or introduce new rules when the need arises, a conceptual framework is used to hold these boards accountable. Accounting standards that are constantly changed lack proper definitions, and this could lead to the preparation of misleading financial statements. In situations whereby accounting standards are not regulated by conceptual frameworks, problems arise. For example, in the US, when accounting standards were not regulated, some companies decided to include the projected value of intangibles as assets. Another example is when Enron used estimates rather than actual market prices to inflate its asset values. These inconsistencies would have been prevented by conceptual frameworks as they regulate the development and use of accounting standards.
Conceptual frameworks are made up of principles in different in very different levels that can be applied to numerous situations. However, accounting standards cannot be crafted in ways that exclude inconsistencies and contradictions among them. In such a situation, the hierarchy of the standards should be clear so as to show what rules are stronger than others. Even if the standard at the topmost level is considered in a situation, the standard cannot be implementable because it cannot address the issue clearly. This is because accounting standards are defined in details and deal with specific settings. However, conceptual frameworks provide a variety of methods that ensure that the results produced are consistent with the frameworks and standards.
In conclusion, the development and use of a Conceptual Framework instead of accounting standards will solve the problem of inconsistency in the application of accounting in practice. This is because as much as accounting standards provide a mass of detailed rules and guidance in financial reporting, the same rules are rigid and cannot be applied in different situations. Accounting standards also have various other inconsistencies as discussed in this paper. The use of conceptual framework can therefore be very important in solving the problem of inconsistency in the application of accounting in practice as it provides guidance to accounting standards and preparation of financial statements.