Question

Identify the main users of accounting referred to within the AASB/IASB conceptual framework. Does the identification of particular users within the conceptual framework have implications for the future of accounting measurement? In your response you will need to consider the implications of the identification of particular users on the use of fair values and historical cost accounting.

Answer 1

The IFRS Framework describes the basic concepts that underlie the preparation and presentation of financial statements for external users. The IFRS Framework serves as a guide to the Board in developing future IFRSs and as a guide to resolving accounting issues that are not addressed directly in an International Accounting Standard or International Financial Reporting Standard or Interpretation.

In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the IFRS Framework. This elevation of the importance of the [IFRS] Framework was added in the 2003 revisions to IAS 8.

Scope

The IFRS Framework addresses:

the objective of financial reporting

the qualitative characteristics of useful financial information

the reporting entity

the definition, recognition and measurement of the elements from which financial statements are constructed

concepts of capital and capital maintenance

Despite the almost universal adoption of International Financial Accounting Standards (IFRS) by
accounting regulatory committees in many countries, the FVA continues to foster an intense debate
about its impact on the recent global financial and economic crisis.
This debate is part of a broader one on the risks and opportunities that the financial and
economic crisis has for accounting. Between 2008 and 2012, much current research has attempted
to study how the recent crisis has affected theory and practice accounting.
The crisis even more shows the criticality of trade-off between relevance and
reliability of accounting information in markets that are above all imperfect and incomplete. Indeed,
one of the key lessons of the crisis is therefore the gap between market value and real value of
assets and liabilities appearing on the financial statement of firms.

Different contributions analysed highlight that fundamental argument against the
fair value measurement in financial reporting is that it leads to make accounting information that
does not indicate the real and useful ‘value’ of the items of the balance sheet for the firms.

The concept of ‘Accounting System’ is not very spread in Accounting Science debate of
nowadays. It comes essentially from the Italian doctrine, where, already in 1880, the famous scholar
Fabio Besta distinguished the simple ‘method’ of Double-Entry Accounting from a proper ‘system’
of Double-Entry Accounting; we can speak of a D.E. ‘system’ if, and only if, not only we find that
the sum of credits balances the sum of debits, but also we find that accounts are shared into two sets
or, namely, series: the first one (Assets and Liabilities), measures the original aspect of the entity’s
wealth, the second one (Net worth values and Income/Expenses) measures the derived or causal
aspect of the position and performance of business wealth (Besta, 1922).
This accounting system, in Italy known as the “Sistema patrimoniale classico” [Classical
Financial System], saw the only true values as the ones of Assets and Liabilities and corresponds,
roughly, to the classical American school of ‘Asset and Liabilities view’ (Sprague, 1912). Net
worth is only the difference between Assets and Liabilities and Income/Expenses are only the
differences between the previous and the actual Net worth. They have not a true value in
themselves. They are only derived values. This conception brings naturally to an additive
conception of business capital. Every item of assets and liabilities has its own value and we have
only to catch properly these separate values and after to sum up them together.
The emergence of the accounting system is very powerful for our goals, above all in a period of
crisis, because it finds a theoretical justification for an evaluation method that is the ancestor of
modern fair value. In fact Besta, the father of the aforesaid “Classical Financial System”, suggested
to value separately the items with one value that nowadays (with the lenses of IFRS 13) we will call
a ‘cost based’ fair value: in a world where the market values were rare and the income values too
uncertain to calculate, the FVA degenerated in a Substitution-Cost Accounting, that belongs,
however, to the main set of FVA.

In real economy, the concept of physical
maintenance of capital should prevail and, in it, the “original” series should be restricted to the
“numeraire” values (cash and cash substitutes). The other elements of financial reports should be considered as “derivative” value and then evaluated by means of the only reliable method, the
HCA. This would ensure stability to the values and an anti-cyclical role of accounting regulation.
Of course, in this case, the main emphasis is toward who look at the entity as a firm, as a business
able to product income over years and not toward who look at the entity as a volatile investment. In
financial economy, instead, should prevail the concept of financial maintenance of capital, and the
“original” series should enlarged to absorb potentially every asset or liability, everyone with its own
“fair value”, while in “derivative” series should remain only the ‘net worth’ values. Of course such
evaluations would be volatile and pro-cyclical, but, in this case, that would not be an undesirable
thing, because the capital market is effectively ruled by speculation.
A possible and interesting question is where to classify financial business like, e.g., banks. Are
they real or financial according our proposal? If retail banks and investment banks would still be
divided as they were until a recent past, then the difference between the two “accounting system”
might be assessed accordingly: retail banks concern real economy, even in a second level, while
investment banks concern financial economy, where they are the leading actors. But in the modern
western economy these two functions of banks are mixed, and then the generalized FVA is,
technically speaking, the best accounting solution for their financial reports. Probably, then, the
destabilization of real economies by financial actors, is not primarily caused by ‘accounting
regulation’, but by ‘business regulation’, too much unbalanced toward financial speculation against
the reasons of real economy.
But, for what concerns however the accounting law maker, the perspective of the aforesaid
“accounting system” could be very useful in any case for giving a more rational basis to the
financial reports.