Question

1. The existing Conceptual Framework has several notable omissions. It does not include an explicit reference to substance over form nor does it define derecognition or when derecognition should occur. The International Accounting Standards Board has also removed prudence from its framework and has attracted criticism from the academic and practitioner communities for doing so. However, the Exposure Draft on the Conceptual Framework attempts to explain the roles of prudence and substance over form in financial reporting whilst putting forward proposals to clarify the aims of the accounting requirements for derecognition.

Required:

(i) Discuss the features of the concept of prudence and the arguments for and against its re-introduction into the Conceptual Framework.

(ii) Explain why it is important for there to be guidance in the Conceptual Framework on the role of substance over form, and the principles relating to derecognition set out in the Exposure Draft on the Conceptual Framework.

Answer 1

Concept of Prudence: -

Prudence which used as synonymous of discretion may vary from person to person. In the field of Accountancy, Auditing and Regulatory Matters it is used for assessment of Assets, Liabilities, Income and Expenses. It is required in these matters to present true & fair picture of financial position of an organization. Financial position can be shown differently for various different purposes such as when someone requires a loan from a financial institute it can overstated its Income & asset base and understated its expenses & liabilities. At the same time when it requires presenting the data to Tax Authorities it may be used in reverse mode. That why Prudence concept came into picture this concept state that Expenses & Liabilities should be booked at the initiation or on accrual, whereas Income & Assets should be booked at the time of certainty.

Arguments for Prudence

Prudence reduces risk of losing money of lenders, investors and owners as it shows Assets and Income on realization certainty but not on assumptions.

Arguments against Prudence

It does not provide space for things which can be sure such as other evidence may available for surety of appreciation of income and assets but due to realization basis some time it does not show proper picture.

Substance over Form

This concept is used in every transaction for recording and presentation of financial information. Without it many times auditors, accountants make erroneous decision. Meaning of this concept is simple that a transaction should be recorded and presented in its original form so that readers and users can use the information in correct manner. For example- Rent paid amount if wrongly booked as commission it will affect rules of Tax Deduction, wrong analysis of expenses but does not affect overall profit or loss position of organization. That is why this concept is so important.

De-recognition Principle

This principle states that when an asset should be derecognize from the books of accounts. This principle is set on certain factors such as ownership, possession, future economic benefit etc. But it is complex decision to decide Future economic decision is many cases it may various probability and many results. Due to uncertainties involved with this principle it should set out from exposure draft.