Accounting information can be used to assist both financial and managerial oriented decisions. In order to come to effective financial or managerial decisions, many factors other than accounting should be duly considered.
Accounting information is extremely vital in/and for all enterprises though it does have certain limitations.
Accounting is only one source of information and primarily provides information based on financial terms: Although this information is vital, decisions cannot be based solely on a monetary basis. Various decisions depend upon a diverse range of issues being considered. A unique combination of Quantitative as well as Qualitative factors should be considered to ensure an effective decision making process.
The historical perspective of financial accounting: In order to obtain a recent estimate of an entity’s financial performance, the corporate managers carefully scrutinize financial accounting information. In retrospect, this information is based on past performance. The information does provide clarity on the monetary issues but does not provide a definite insight into the strategic future; as the future holds various changes in terms of technology, economic situations as well as political scenarios etc. Such factors in relation to accounting are unpredictable. Therefore, a careful balance between historical accounting as well as the future forecasted outlook is required.
Historical cost accounting vs. underlying value in use: Some items loose their monetary value over a period of time, but under the financial accounting rules need to be included in financial reports. Though mentioned year after year in the books as monetary figures, the information may be unreliable due to the historical assumptions made on the item’s measurability criterion. For example, a machine in a textile factory is considered to have a useful life which extends over a period of ten years in monetary terms; however, after the period of ten years, the machine may still have the same value as prior years and contribute significantly to the overall operability of the factory.
Inability to reflect the true value of strategic management: Various factors such as goodwill and natural circumstances influence the operations of an enterprise; however, these elements are difficult to measure thus, leading to their unavoidable exclusion from financial reports. For example companies depend upon their shareholders, who in turn depend on the performance of the Chief Executive Officers. Although the CEOs may have been hired by the company based upon prior performance, their future performances are not reliably measurable as they may continually vary. In the initial stages, it may be impossible to measure whether the CEO’s presence will deter or appeal to the shareholders, which in turn will influence the profitability of the enterprise.
Measuring Volatility of external factors: Financial accounting information does not take into consideration volatile and ever increasing changes in the natural and commercial environment. Although scarcely measurable in monetary terms, their unstable nature may have adverse effects if included within the financial reports and have a volatile and cosmetic impact upon the earnings of the firm. For example, tariffs on trade, duties and other environmental issues can have significant short-term volatile effects on the organisation.
The effect of non-stable monetary unit: Based from region to region, accounting information is generated at all enterprises based on the assumption that the monetary unit is stable over a period of time. In the real world scenario, the unit fluctuates on a daily basis. Enterprises usually decide on a flat rate to calculate their financing and investing needs. However, this can have adverse impacts which cannot be communicated to shareholders, if the unit has high fluctuations. For example: Indonesia 1995 US$ 1 = RP 6000, 1997 US$ 1 = RP 12000, 1999 US$ 1 = RP 9000.
From the answer above, it is evident that certain limitations of accounting information have to be taken into consideration before enterprises use merely financial information to aid their decision making process.
Ethics is defined as that branch of philosophy concerned with the moral life and consisting of consideration of one’s ordinary actions, judgments and justification as a means of discovering what one ought to do and of determining what actions are morally good, acceptable, or right and what actions are unacceptable or wrong.
A manager within an organisation always faces a conflict of interest between short term profitability and long term sustainability of the entity. If the manager chooses to implement decisions that are beneficial to the entity in the long term, his behaviour is primarily considered to be ethical. However, the goal of achieving short-term profit maximization has been duly compromised. According to self-interest theory an individual seeks to maximize his/her personal utility whereby short-term profit maximization motives could be thought dominate managerial incentives.
Ethicists have developed two frameworks relevant to businesses. They are the Utilitarian and Deontology frameworks. Utilitarianism is defined as the moral correctness of an action based entirely on its consequences whereas Deontology defines moral correctness of an action through the underlying nature of its correctness. Deontology can be divided into two parts where one part considers that action itself is measured thus lying is always unacceptable, on the other hand, the other part considers the cumulative nature of action as well as the consequences and thereby deems that lying could be acceptable under certain circumstances.
Ethics within the scenario of businesses are largely determined by the frameworks outlined above. Business ethics have a large impact upon the global society as fraud and embezzlement can impose large dead-weight losses within the world economy. In Australia, business ethics are primarily defined by the Corporations Law and Accounting Professional Codes Of Conduct such as the ICAA which govern the professional behaviour of the relevant professional members.
Ethical rules for accountants are subtly more stringent than for normal business professionals. Under the assumption, that the ethical behaviour of accountants mirrors the behaviour of the company auditors, I seek to explain the underlying dilemma. The Chief Financial Officer works under the supervision of the Chief Executive Officer of the organisation. His/her primary responsibility is to ensure that the financial reports prepared under his supervision mirrors the true and fair view about the financial. operating and investing decisions of the entity. He is directly accountable to the shareholders for his actions. However, his actions are determined by the leadership of the CEO. If the CEO demands the CFO to incorrectly manipulate the financial reports of the organisation, the individual faces a dilemma. He has a dual sense of responsibility and an ethical situation arises whereby, he/she can either pursue his own self-interests (financial security) or disobey the commands of the CEO and report fairly to the share-holders. Thereby, following the correct spirit of ethical behaviour, his role entails reporting fairly to the shareholders and whistle blowing against the CEO.
The plan states that managers who have a short-term time horizon with an enterprise and have their bonuses based upon the short-term profitability of the enterprise will be motivated to pursue their personal agendas (wealth) rather than enhance the long-term sustainability of the enterprise. In deontology terms, there is a significant conflict of interest in terms of the ethical behaviour of the manager which could be compromised by the self-interests of the manager who might manipulate the true underlying profitability of the going-concern.
Accounting policies affect the reported figures which appear in the financial statements which affect the wealth of managers.
There are three economic consequences of accounting policy choice:
I. Compensations Plans: In this case the organisational bonus scheme is used to bring the interests of both the managers and the shareholders together. However an economic consequence of the bonus scheme is that managers may also be motivated to cosmetically increase reported profit by the appropriate selection of income-increasing accounting policies which might not mirror the true underlying increase in the reported profits of the entity.
II. Debt contracts: If an entity is approaching the limits of a clause in a debt contract, there are incentives for managers to select appropriate accounting policies which allow the company to avoid being in violation of the debt contract, by income-increasing accounting policies.
III. Political costs: refer to the costs imposed on a company via regulatory bodies. Political costs are hypothesized to be a function of size measured in terms of net profit, total assets or total sales. Political costs create incentives for managers of large organizations to select income-decreasing accounting policies in order to reduce political visibility.
Discuss what information you believe would be useful to the following group of report users:
I. Employees: The most essential information required by the employees is the information relating to the survival of the enterprise they work for as they earn their wages from the going-concern. Financial reports provide an insight for the employees to understand whether the enterprise is currently making profits or losses which in accordance can lead to fairer wage negotiations etc. Most importantly, it provides employees with an opportunity to assess their level of security with the enterprise.
II. Investors: Most importantly, financial reports provide investors with insight relating to the profitability and sustainability of the underlying entity. It also offers the investors a chance to compare itself to other enterprises in terms of monetary performance and divulge where certain changes can be made in order to gain competitive advantage. Investors may also base their decisions on selling or retaining their shares based on the past history of financial reports.
III. Regulators: Considering the regulator to be the government in this case, the most essential benefit to the government from financial reports is the levying of taxes for the enterprises. Apart from this, the government can also use the financial information to include in producing industry statistics. The information also assists the government in assessing the level of fair competition within the realm of a particular industry.
IV. Suppliers of goods and services: The financial reports assist the suppliers in determining whether the enterprise is going to remain in business. In some cases, suppliers have an outstanding debt from the enterprises and the reports provide insight as to whether the enterprises will be able to meet their debts. Based on the reports, suppliers can also decide the credit limits and time they are willing to offer to the enterprises etc.
V. Customers: Customers over a period of time become attached to certain products, which in turn leads them to keep up with the enterprises performance in monetary terms; whether the company is going to survive and be able to consistently supply their goods or services. These reports also provide the customers with an opportunity to assess the substitute goods/services in monetary terms, whereby the customer can assess the ultimate value for money good/service.
What are the main arguments of the article on “Financial Reporting of Cultural, Heritage, Scientific and Community Collections”?
Article Summary: This article attempts to inform the readers about the existing CHSCCs debate between the academics and the regulatory accounting bodies, namely the AASB and the FASB. It describes the nature of cultural, heritage as well as scientific collections and discusses the feasibility of recognizing these items as assets on the statements of financial positions for public sector entities.
The main arguments reported within the article are based primarily on the definition of assets as well as the perceived usefulness of financial information generated after the recognition of CHSCCs as assets, In order to outline the arguments, it is crucial to define assets as future “economic benefits controlled by the entity as a result of past transaction or other past events”.
Future economic benefits: The common characteristics possessed by all assets (economic resources) is service potential or future economic benefit, the scarce capacity to provide services or benefits to the entities that utilize them. CSHCCs although generally held for long periods of time and seldom sold, are assets that continue to provide economic benefits or service potential through their use. In a not-for-profit organization that service potential is used to provide desired goods or services to beneficiaries. Thereby, Carnegie and Wolnizer view that CHSCCs cannot be defined as assets because they do not embody financially quantifiable service potential as they do not generate net cash inflows either through regular activities of the entities in which they are held or by commercial exchange, does not hold true. This argument highlights the apparent misconception in Carnegie and Wolnizer’s argument that the existence of assets is not defined nearly by the unreliability of its measurement rather by the achievement of its objectives. The ASB and the PSASB in Australia strengthen this view by stating that the mere ability to generate net cash inflow is not critical in determining whether these CHSCCs embody future economic benefits and linking future economic benefits with net cash inflows, as Carnegie and Wolnizer do, would mean that most items held by not for profit entities would not qualify as assets.
Control: A museum, art gallery or library may choose to either impose charges or allow the free viewing of its collections; these choices do not affect the control of the CHSCCs by the entity. These choices do not affect the control of CHSCCs as such entities do not encompass full cost recovery and the entities inability to impose charges for the publics use of these assets does not compromise their control over CHSCCs. Thereby, Carnegie and Wolnizer’s arguments that museums, art galleries and libraries do not control their CHSCCs because of the restrictions on their use and disposal does not stand true. The inability to sell CHSCCs does not compromise the utility of the entity as their objectives are significantly different.
Past transactions and other past events: This argument is accepted by academics and regulators alike whereby this essential characteristic of an asset is satisfied by the CHSCCs.
Value-in use and value-in exchange: Exchangeability is not an essential characteristic of an asset because future economic benefits are not precluded by their inability to sever an asset from the entity, nor are they necessarily related to the existence of present disposal value (SAC 4). The disclosure of the value-in-use and value-in-exchange in terms of CHSCCs within the statement of financial position has a broader purpose than merely reporting to the external parties, solely on the solvency position of an entity. Therefore, Carnegie and Wolnizer’s argument that value in exchange is a collection of no consequence and thereby, the statement of financial position is a poor predictor of the solvency of an entity is negated.
Recognition criteria for assets: An important criterion for the recognition of assets on the statement of financial positions is the reliable determination of the cost. Carnegie and Wolnizer believe that CHSCCs fail this critical requirement and state that the historical costs and current costs of CHSCCs are irrelevant because historical or market values cannot be reliably determined for CHSCCs. However, this assertion that recognizing assets at such amounts is irrelevant, is an argument about the most relevant basis of measurement, not about the recognition. It is argued that this information is certainly better than no disclosure about these assets.
Usefulness of information: Information about CHSCCs controlled by public sector entities is necessary to make informed assessments about the allocation of scarce public funds, and any changes in the allocation of funds from period to period. The public has a definite beneficial interest in the recognition of CHSCCs because it is the public itself that provides the funds required by these entities to acquire assets and to fund operations. Thereby, Carnegie and Wolnizer’s argument that the reporting of CHSCCs is not economically useful can be carefully scrutinized.
Cost benefit considerations: The authors argue that Carnegie and Wolnizer’s estimate of the cost of valuing CHSCCs for the state library and national gallery is probably unjustified ($23.5 million). The authors estimate the cost to be closer to $450000 and state that the benefits are more difficult to identify and measure. CHSCCs benefits are hypothesized as generally outweighing the cost of the exercise which is in direct opposition of Carnegie and Wolnizer’s argument that the cost of requiring CHSCCs to be valued is prohibitive.
Recognition not generally accepted or practiced: The authors argue that current practice should not influence best practice for the future and thereby the survey results obtained by Carnegie and Wolnizer in support of their view that CHSCCs should not be recognised as assets is unjustified. Although, the recognition and measurement of CHSCCs is not generally accepted or practiced in Australia or the United States, survey results aside, this should not nearly lead to the acceptance of the argument that CHSCCs should not be recognised as it would be deemed as accepting the status quo.
Other arguments: Finally, the article outlines other reasons for the resistance to recognizing and measuring CHSCCs. These arguments include that the managers of an art museum might be able to effectively manage the collection to enhance their own personal status by pursuing the recognition of CHSCCs.
“As a general rule, public sector accounting should be totally different to private sector accounting.” Discuss.
Accounting information is determined primarily by the underlying financial structure of an entity. It can be assumed that the objectives of private entities and public entities are significantly different. The overall objective of private entities is the maximization of profits whereas the objective of most public entities is to fulfill the needs of its beneficiaries.
Furthermore, as public sector entities are non profit organizations, managers are not motivated to manipulate the true financial performance of the entities, to enhance their personal status for income benefits. On the other hand, the managers of private sector entities can be assumed to be motivated by self-interest theory, thereby, leading to the possible manipulation of the true financial performance of the entity. As the nature of these entities and the motivations for accounting policy choices are significantly different, I argue that the governing rules and regulations should be adjusted accordingly, to suit the differing objectives of the organizations.