Introduction.
The prudence concept has been an area of controversy, especially in accounting standards as there have been conflicting ideas on its relevancy and its desirability as a useful tool in the field of financial reporting. There has been a need to develop the prudence concept to suit financial reporting needs both in the contemporary context and in the future. A conceptual framework that incorporates the use of accounting practices that ensure consistency, coherence, acts as a guide to financial reporting and is easily understood by users is what is required for financial statement users.
Issue of prudence.
Over the years, there has been a need to develop the conceptual framework as it was considered to be deficient in the provision of the significance of caution, reliability and stewardship. Quality has been compromised when it relates to financial reporting and statement standards. Therefore, there is a critical need to improve the framework. Resource allocation has been negligent in the placement of stewardship and objectives should be clearly defined when dealing with the relevant parameters involving the targets that are set to be achieved (Irvine 2013). Concise efforts should be made to be more inclusive of financial statements while ensuring that coherence is achieved. The raging issues on prudence are important as it includes the key areas of conservatism and faithful representation in financial reporting.
Faithful representation and Conservatism within financial reporting.
Faithful representation is required within the accounting framework to provide a firm basis for which financial reporting can be undertaken. The qualitative characteristics of exercising the prudence concepts ensure the reliability of the application of financial standards of accounting (Irvine 2013). There is a need to include a degree of caution while undertaking the relevant accounting practices to maintain an accurate report. This is critical especially in areas where a degree of caution is expected to be exercised to avoid overstatements and understatements. The representation of prudence should be embedded in the standards of accounting while those who prepare financial statements should also exercise prudence.
Faithful representation entails the use of accounts that are wary of mismanagement and are conceptualized within the framework that caution is exercised primarily in estimations, and the structure should be consistent with the same. Prudence should be explicitly reflective in standards of practice and engrained in the conceptual framework of reporting. The uncertainty that may arise needs to be included in the measures of cash flows and changes must be recognized fully. For an adequate framework, prudence should be more considerate and transparent especially when it comes to assets and liabilities. Standards should provide a clear structure through which items based on the sheets should be recognized and carried out promptly.
Conservatism has mainly taken a normative approach in accounting and has played a key role in financial reporting. A conceptual structure will assist in upholding faithful representation that is neutral and complete as well as being error free. This improves reliability and verifiability of the accounting standards practiced. Conservatism has courted controversy in the past especially due to the ambiguity that stems from the different concepts and meanings. A detailed analysis of the consequences and determinants of conservative accounting should be maintained (Lawrence 2013). Conservatism, on the other hand, is divided into conditional and unconditional conservatism where some financial aspects are recognized while some are not. In conditional conservatism, this relates to the ease through which information good or bad on assets is reflected in financial statements. This is specific on the speed at which news may be reflective in the accounting system, if bad news is indicated faster than good news on financial statements, then it becomes conditionally conservative (IASB 2013).
Conservatism also has economic roles as it relates to the relevance’s that pertain to financial reporting. Financial reports are mostly employed in the review of stewardship agendas that is also inclusive of the valuation process. Conservatism is also essential for the creation of random decisions that pertain to financial information, therefore, reducing the effectiveness of contracting. The structure involved in prudence has generated focus on whether it meets the required user expectations and achieves the set performance standards that are expected from financial reports. Bias should be refrained from when it comes to prudence. Resource management is a crucial aspect of the directorate that requires constant assessment and checking of the desired qualitative characteristics that are as a result of stewardship from a managerial perspective.
The purpose of reporting should be maintained as the fundamental means through which information is provided by the reporting entities that assists investors, lenders and other financial users in making informed decisions. Therefore, there is a need for the application of all relevant and reliable sources that are used in the application of conservatism aspects as a means to create the specified and required structures that augur well with the conceptual framework where faithful representation and conservatism apply to significant effect.
Earnings management and accounting practices.
Accounting information is significantly affected by research and elucidates the importance of the principals of accounting. There is a discretionary tendency that exists as a result of accruals of accounting and other practices. Earnings management have been used extensively by managers and directors in the achievement of objectives that aid in attaining adequate earnings management. The choices that relate to earning management are based on the contracting, capital and motives from third parties. Accruals may be employed in the management and upward mobility in reporting of earnings attained. In the current context, it is important to note that it is quite significant in a conceptual framework as differences exist between conservatism and earnings management.
A theoretical structure that employs a moderation approach that is conditional is not consistent with ensuring that economic losses are smoothened out but rather is mainly focused on time recognition parameters that provide impairment of assets. Additionally, the conceptual system of a conservatism approach is not consistent with the support that is relative to the management practices that aid in the achievement of outcomes that are focused on earnings. As is in conformity with the IASB framework (SFAC 2) the prudence concept holds that assets should not be overstated, and expenses are not supposed to be understated. A credible conceptual system does not allow the deliberate understatement of the incomes and overstatement of liabilities as this will affect the earnings of the company through non-existent expenditure and unreliable incomes.
Such practices should be considered as opportunistic or idealistic methods through which earning management practices are carried out, and this is against investor confidence. For an accounting prudence concept, this may affect the incentives that emanate from earnings management. When earnings management is of significant concern, then there is a need to be considerate of the possible remedies that may arise from accounting prudence. Earnings management may face constraints in several areas for example when this relates to safeguards that may be brought about through prudence from the managerial policies and when in a conservatism context. A reliable framework allows for the ability of the current prudence framework that assists in the predictability of future earnings. The quality of earnings may, however, be affected by conservatism, therefore, impeding earnings management. Accounting practices should not allow for the manipulation and creation of earnings that are unsustainable through the use of faulty deductions in bad debts and charge overestimations by bad debts thus creating opportunities for lower earnings from which incomes are reported in the future.
The importance of the conceptual framework for developing financial standards.
A theoretical framework is necessary for financial reporting as it provides the objectives that are consistent with accounting practices and the tools involved in financial reporting. The theoretical structure can assist in the development of financial standards through the development of consistent standards that are applicable. The structure also provides and aids in the preparation of accounting policies that are consistent especially in areas where there is a lack of applicable standards in the variety of transactions that are involved. Additionally, this process provides an accounting policy that is dependable with the choice.
Conceptual systems also avail a composition that interprets and gives a clear understanding of the context involved. Qualitative characteristics of the theoretical makeup need to be maintained at all times that ensures that all areas of the structure are covered (Kamall 2012). The development of a system is also assisted through ensuring of harmonization of principles and standards that relate to accounting treatments. The structure also acts as a guide to professionals in the field that are inclusive of accountants, auditors thus enabling them to develop and better current financial standards. Contents of the makeup structure are important in the development of financial standards as they provide a basis through which financial measures are practiced.
Conclusion.
The evaluation of the importance of the prudence in accounting is proportionately broad with advances and changes made from history to the contemporary world. Areas that relate to conservatism and faithful representation are crucial especially in a financial reporting context. A conceptual composition is essential for the continuation and growth of financial standards of reporting while checking and dealing with concerns that are relative with the various stakeholders.
References
Julia Irvine (2013) Conceptual framework ED is fundamentally flawed. (2016). Economia. Retrieved 8 June 2016, from http://Conceptual framework ED is fundamentally flawed
Kamall, S. (2012) Accounting rules place box ticking above prudence. http://www.cityam.com/article/accounting-rules-place-box-ticking-above-prudence
International Accounting Standard Board (IASB). 2013. A Review of the Conceptual Framework for Financial Reporting. DP/2013/1 July. IASB, London.
Julia Irvine (2013) IASB reintroduces the concept of prudence. (2016). Economia. Retrieved 8 June 2016, from http://IASB reintroduces concept of prudence
Lawrence, A., Sloan, R. and Sun, Y. 2013. Non-discretionary conservatism: Evidence and implications. Journal of Accounting and Economics, 56 (2/3 sup 1), 112-133.
