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Philosophy of accounting

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The philosophy of accounting is the conceptual framework for the professional preparation and auditing of financial statements and accounts. The issues which arise include the difficulty of establishing a true and fair value of an enterprise and its assets; the moral basis of disclosure and discretion; the standards and laws required to satisfy the political needs of investors, employees and other stakeholders.

Introduction

The accounting profession regulates the manner in which enterprises report their financial results through standards issued by national accounting standards bodies. International Accounting Standards Board (IASB) establishes standards which define how transactions should be presented in financial statements. National accounting bodies have, with the exception of the Financial Accounting Standards Board (FASB) in the USA, have substantially harmonised their standards with the international standards.

IAS 1.5 defines the purpose of financial statements as follows:

Financial statements are a structured financial representation of the financial position of and the transactions undertaken by an enterprise. The objective of general purpose financial statements is to provide information about the financial position, performance and cash flows of an enterprise that is useful to a wide range of users in making economic decisions. Financial statements also show the results of management's stewardship of the resources entrusted to it.

IAS 1.10 defines how financial statements should be presented

Financial statements should present fairly the financial position, financial performance and cash flows of an enterprise. The appropriate application of International Accounting Standards, with additional disclosure when necessary, results, in virtually all circumstances, in financial statements that achieve a fair presentation.

Substance over Form

The distinction in financial reporting between substance and form raises important concerns in ontology and the philosophy of law[citation needed]. Accounting standards require the reporting of the substance of the matter, rather than merely the legal form of a transaction.[1] For example, finance Leases may be treated as sales rather than as lease expenses, in spite of their legal form.[2]

The real-world consequences of reporting form rather than substance can be severe. Baker and Hayes argue that failure to apply the concept of substance over form at Enron caused investors and creditors to have a unrealistic view of the company’s financial position.[3]

Truth

Concepts such as faithful representation, neutrality, prudence and completeness all contribute to the qualitative reliability of financial reports[4] This raises epistemological concerns.[citation needed]

The IASB does not present a definition of what it considers to be fair presentation but para, 46 of the Framework states:

Financial statements are frequenty described as showing a true and fair view of, or as presenting fairly, the financial position, performance and cash flows of an enterprise. Although the framework does not deal directly with such concepts, the application of the principal qualitative characteristics and of appropriate accounting standards normally results in financial statements that convey what is generally understood as a true and fair view of, or as presenting fairly such information.

Paragraph 24 of the Framework states that:

Qualitative characteristics are attributes that make the information provided in the financial statements useful to its users...."

The following qualitative characteristics are defined in the Framework:

  • Understandability: The information should by users, however, the framework (para 25) acknowledges that some users may not be able to understand the information.
  • Relevance: The information should be relevant to the decision making needs of its users - in terms of "evaluating past, present and future events"
  • Reliability: The information should be free of any material error or bias: it should present the substance of transactions with neurality, prudence and completeness.
  • Comparability: Users should be able to compare results over time or compare the results of different enterprises and evaluate their relative positions with confidence.

In the absence of accounting standards that specify how these characteristics should be applied, these concepts have wise scope for interpretation.

References

  1. ^ IASB Framework, para. 35
  2. ^ Basic Leasing Terminology, Business Owner's Toolkit
  3. ^ Baker,C.R & Hayes, R, "Reflecting Form Over Substance: The Case of Enron Corp.", Critical Perspectives on Accounting, Volume 15, Issues 6-7, August-October 2004, Pages 767-785
  4. ^ IASB Framework, para 31--38
  • Isaac Cheifetz (July 18, 2005). ""The Philosophy of Accounting"". Minneapolis Star Tribune.
  • "What is conservative accounting philosophy?". Wikianswers. Retrieved 4/4/2009. {{cite news}}: Check date values in: |accessdate= (help)
  • Glenn Cheney (Feb. 7, 2005). "FASB returns again to the philosophy of accounting". WebCPA. {{cite web}}: Check date values in: |date= (help)

See Also

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