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What are the Objectives of Accounting A two part view Introduction I was asked to help with answering the

question by student Mark Ready: "What are the objectives of accounting?" This page has been significantly updated since I first posted it on 17 January 2002. Since 17 January, I have had further correspondence with Mark and another student. I have specifically added materials on two American enquiries into accounting and its objectives: the Trueblood Report and the Wheat Committee. I have added a potted history of accounting and have added a few other snippets of my own. I'll begin by taking a very simple view of the need for accounting statements: do we need them at all? when did the need for them first arise and why? what would we do if we didn't have accounting statements? This page address the first of these two questions: when did the need for accounting statements arise and why. In the first section we look very briefly at the history of accounting and then we will see who might use accounting information and why. The second section of the page looks at two ways in which accounting has developed: the Anglo Saxon way and the Continental European way. Thirdly, I will include a little bit of commentary on the Trueblood Report and the Wheat Committee and their roles in the development of a conceptual framework of accounting. Finally, a very brief look at some of what might happen if we didn't have any accounting systems and standard to work with. A Brief Review of Accounting History There are many books, journals and web sites devoted to accounting history, so I won't go into any great detail here about the history of accounting. Nevertheless, it is fairly widely known that accounting records, or proxies for them, have been found from as long ago as the time of the Ancient Egyptians: notches on sticks if nothing else! The most famous accounting event in history, though, was the publication of the work by Father Luca Pacioli, friend and teacher of Leonardo da Vinci. Pacioli is considered by many, rightly or wrongly, to be the father of modern accounting. If he's the father of anything, it's probably most fair to say that he is the father of book keeping.

Still, medieval Europe was a time of great mercantilist expansion and the Venetians are most notable for developing accounting for stewardship: looking after the capital and accounts of Merchants and their business interests. This is the start of modern interest in book keeping and accounting. With the growth of trade and industry throughout the sixteenth to the nineteenth centuries came the growth and increase in complexity of business and commerce; and that, in turn, led to the need to develop book keeping and accounting laws and systems. Company and Partnership Law From a UK point of view, the first great modern Statute governing accounting statements came the Companies Act of 1844. The mid nineteenth century saw the arrival in the UK of limited companies and the need to regulate the presentation of accounting reports: the Trading Account, the Profit and Loss account and the Balance Sheet. Company law was a relatively stable affair since there was no new legislation directly aimed at accounting reporting for another century: there was a great consolidating act in 1948 and then nothing more until 1967. The 1980s and 1990s saw a flurry of legislation in this area, however, and the UK now has a very comprehensive set of Company Law on the statute books: incomplete no doubt, but comprehensive. 1890 saw the first Partnership Act in the UK and this Act has remained largely in force for the best part of a century. This Act brought with it the General Partnership and the Limited Partnership and the various reporting requirements that went with them. Accounting Standards The accounting profession came to realise that the major changes to business and commerce that came along with the later third of the twentieth century led to the need to upgrade book keeping, accounting and accounting reporting requirements. Consequently, we now have the accounting profession itself, an accounting standard setting body and the International Accounting Standards Board. At the same time, the Inland Revenue is a major player and point of influence in the accounting world as it sets standards of its own as they relate to the taxation of businesses. Accounting Systems and Software Modern book keeping and accounting systems range from pencil and paper to complex computer based systems. Along the way we have pre ruled ledgers and books of account, we have free form papers that trained book keepers and accountants can simply fill in as they go along.

The latter quarter of the twentieth century saw the development of sophisticated computer based book keeping and accounting systems that can be used for virtually any business, commercial or even personal set up: large or small, complex or simple, one currency or more. By way of providing an indicator of the growth of the computer based accounting system, the Sage Accounting Software company has grown from sales of around 50 million in the mid 1980s to sales of 2.5 billion by the end of 2001. why. and information accounting uses who about little a investigate now specific more be Who Uses Accounting Information and Why? This section is taken from Foster and firstly lists the major users of accounting information and then outlines some of the information they need and says a little bit about why they need it. Shareholders, investors and security analysts Managers Employees Lenders and other suppliers Customers Government/Regulatory agencies

Shareholders, investors and security analysts have at least two focus points: Investment focus with the emphasis on choosing a portfolio of securities that is consistent with the preferences of the investor for risk, return, dividend yield, liquidity and so on. Stewardship focus in which the concern of shareholders is with monitoring the behaviour of management and attempting to affect its behaviour in a way deemed appropriate. Managers Managers look for a variety of information, including information relating to their own incentive contracts. Managers also use financial statement information in many of their financing, investment and operating decisions. Employees Employees are interested in financial statement information that helps to inform them about the continued and profitable operation of their employer. Particularly pertinent at the moment, following the Enron scandal of November/December 2001, is the realisation that employees look to financial statements to monitor the viability of their pension plans. Lenders and Other Suppliers

Many bank loans include bond covenants that can result in the bank restructuring the existing loan agreement: again, the Enron case is directly relevant here. One effect of incorporating such covenants into the loan agreement is to create a demand by the bank for successive financial statements of the business. Customers Customers, and here we mean industrial and commercial customers rather than domestic or high street customers, have an interest in monitoring the financial health of an organisation: a long time customer says it already has reduced its orders sharply so that it doesn't depend on the company as the single source for any products is the reaction that Foster records vis a vis a business in trouble and its customers' reaction to that event. Government/Regulatory Agencies Revenue raising: income tax, sales, tax, VAT Government contracting: paying suppliers on a cost plus basis, monitoring government suppliers and their potential for earning excess profitability Rate determination: rates of return that a utility can earn Regulatory intervention: whether a government back loan guarantee to a financial distressed organisation needs support Two Overall Development Pathways for Accounting This section is taken verbatim from Walton et al and simply compares the two development pathways: Anglo Saxon v Continental European. Walton et al point out that the development of accounting has gone down two pathways: the Anglo Saxon pathway and the Continental European pathway. Figure 1.2 from Walton et al's book is reproduced in full below.
Continental European Accounting Systems Social Economic Environment Capital Markets Culture Legal System Capital is mainly provided by the banking sector State focused Dominated by codified law: law provides detailed accounting rules Financial accounting and taxation are closely connected Capital is mainly raised through stock markets Individualistic Dominated by case law: accounting rules developed by private standard setting bodies Tax rules do not influence financial accounting practice Notably investors Anglo Saxon Accounting Systems

Fiscal System

Decision useful information primary users Creditors, tax authorities, investors

of financial statements The dominance of the prudence principle and the influence of taxation Fair presentation, true and accounting on financial accounting harms the fair view principles decision usefulness of financial statements Tendency towards lower extent of Tendency towards higher scope of disclosure extent of disclosure disclosure considerable amount of recognition and Almost no recognition and scope of measurement options accounting policy measurement options Calculation of Income calculation is part distributable Prudent calculation of income of decision usefulness income fair presentation, true principle of conservatism and fair view dominance of the limitation of income distribution accrual principle tendency towards higher hidden no limitation of income reserves distribution tendency to lower hidden reserves No mutual influence of Mutual influence of taxation and Tax base taxation and financial financial accounting accounting Example countries Belgium Germany France Greece Italy Japan Portugal Switzerland Australia UK Ireland Canada New Zealand Netherlands Singapore USA

The Trueblood Report The American Institute of Certified Public Accountants (AICPA) commissioned the Trueblood Report in 1973: the Trueblood committee study group was asked to report on the Objectives of Financial Statements. Trueblood discussed twelve objectives of financial reporting: 1 Decision Making 2 Financial Statement 3 Cash Flows 4 Earnings 5 Management Ability 6 Disclosure

7 Statement of Financial Position 8 Uncompleted Transactions 9 Expected Information 10 Forecasts 11 Governmental 12 Social Concerns Let's look at all twelve in a little bit of detail 1 Decision Making The basic objective of Financial Statements is to provide information useful for making economic decisions 2 Financial Statement An objective of financial statements is to serve primarily those users who have limited authority, ability or resources to obtain information and who rely on financial statements as their principle source of information about an enterprises economic activities. 3 Cash Flows An Objective of Financial statements is to provide users with information useful to investors and creditors for predicting, comparing and evaluating potential cash flows to them in terms of the amount, timing and related uncertainty. 4 Earnings An objective of financial statements is to provide users with information for predicting, comparing and evaluating enterprise earning power. 5 Management Ability An objective of Financial Statements is to supply information useful in judging management's ability to utilize enterprise resources effectively in achieving the primary enterprise goal. 6 Disclosure An objective of financial statements is to provide factual interpretive information about transaction and other events which is useful for predicting, comparing and evaluating enterprise earning power. Basic underlying assumptions with respect to matters subject to interpretation evaluation prediction or estimation should be disclosed 7 Statement of Financial Position An objective is to provide a statement of financial position useful for useful for predicting, comparing and evaluating enterprise earning power. This statement should provide information concerning enterprise transactions and other events that are part of incomplete earning cycles. Current values should also be reported when they differ significantly from historical costs. Assets and liabilities should be grouped and segregated by relative uncertainty of amount and timing of prospective realization or liquidation. 8 Uncompleted Transactions An objectives to provide a statement of periodic earnings useful for predicting, comparing and evaluating enterprise earning power. The net result of completed earnings cycles and enterprise activities resulting in recognizable progress toward completion of incomplete cycles should be reported. Changes in values reflected in successive statements in financial position should be reported, but not separately since they differ in terms of their certainty of realization. 9 Expected Information Another objective is to provide a statement of financial activities useful for predicting, comparing and evaluating enterprise earning power. This statement should report mainly on factual aspects of enterprise transactions having or expected to have significant cash consequences. This statement should report data that require minimal judgement and interpretation by the preparer. 10 Forecasts An objective of financial statements is to provide information useful for the

predictive process. Financial forecast should be provided when they will enhance the reliability of users predictions. 11 Governmental An objective of financial statements for governmental and not-forprofit organizations is to provide information useful for evaluating the effectiveness of the management of resources in achieving the organization goals. Performance measures should be quantified in terms of identified goals. 12 Social Concerns An objective of financial statements is to report on those activities of enterprises that affect society which can be determined and described or measured and which are important to the role of the enterprise in its social events. To a greater or lesser extent, we can see evidence from modern Annual reports and Accounts in the UK that the recommendations we see here have found favour in the accounting profession. Take a look at any AR&A from any company you like and see the extent to which European and American accountants have adopted the kind of sentiments spelled out by Trueblood (and others). The Wheat Committee of the USA The Wheat Committee was headed by Francis M Wheat, a corporate lwayer. The committee had the job of examining The American Accounting Principles Board's "organization and operations to determine how to get better results faster." The committee also considered whether the government or the private sector should formulate accounting principles. As a matter of interest, in developing countries, this latter point is one that often overrides the development of all aspects of accounting. The reason being that there are so many vested interests in the development of the infrastructure of accounting, that people simply don't want to let go of what they have. An excellent example is the former Soviet Union where al legislative and executive power was highly concentrated. Now, over ten years after the collapse of the FU, there are still many former Soviet Republics in which reform of the accounting profession has stopped. These Republics may have passed laws on accounting and adopted International Accounting Standards but the change from Soviet ot International practices has really yet to take place. The Committee reported in 1972 and proposed the replacement of the part time, unpaid APB with a new organization-the Financial Accounting Standards Board-of paid, full time members the members of the FASB would maintain standard setting as a function of the private sector The committee stressed the importance of ensuring the board's independence of private interests that might interfere with its primary objective of serving the public interest. The committee therefore recommended that trustees of a newly created, independent organization-the Financial Accounting Foundation-appoint the board, which would

consist of four CPA practitioners and three other members with considerable financial reporting experience. In May 1972, the AICPA council adopted the recommendations in the Wheat report and immediately began to implement them, which culminated in the establishment of the FASB in 1973. The Conceptual Framework of Accounting What is the Conceptual Framework? The conceptual framework is a body of interrelated objectives and fundamentals. The objectives identify the goals and purposes of financial reporting and the fundamentals are the underlying concepts that help achieve those objectives. Those concepts provide guidance in selecting the transactions, events and circumstances to be accounted for, how they should be recognized and measured and how they should be summarized and reported. To date, the FASB has issued seven Concepts Statements1 (Concepts Statement No. 6, Elements of Financial Statements) covering the following subjects: Objectives of financial reporting by business enterprises and nonprofit organizations Qualitative characteristics of useful accounting information Elements of financial statements (that is, the definitions of assets, liabilities, revenues and so forth) Criteria for recognizing and measuring those elements Use of cash flow and present value information in accounting measurements. Source: FASB August 2001 Why Is a Framework Needed 1 Components of and need for a Conceptual Framework Corporate status captures both the legal entity and the limit of liability principles. were established by the Victorian laws and case law. 2 Advantages/Disadvantages of a Conceptual Framework A conceptual framework would provide accountants and the users of accounting inforamtion with a standard set oif rules, principles and procedures that would work in the way that a recipe for Yorkshire Pudding works or in the way that a procedure in an engineering workshop works. For example, the conceptual framework of accounting would provide the following features: there would be less of a patchwork quilt feel to accounting information issues can be ranked

there would be scope for less political interference e.g. British Aerospace and SSAP12 we would be able to see the overall picture of accounting and accounting information maybe we would be able to satisfy the needs of all user groups? there might be a need for multiple conceptual frameworks? whilst a conceptual framework might not make accounting standard setting and implementation easier, it would add a set of guidelines and procedures that would make those processes more certain Source: From the web site of the University of Exeter School of Business and Economics Who Benefits from a Conceptual Framework? The Accounting Standards setters would be the most direct beneficiary of a conceptual framework. The framework provides standards setters with both a foundation for setting standards and concepts to use as tools for resolving accounting and reporting questions. The framework provides a basic reasoning on which to consider the merits of alternatives. Although it does not provide all the answers, the framework narrows the range of alternatives to be considered by eliminating some that are inconsistent with it. It thereby contributes to greater efficiency in the standard setting process by avoiding the necessity of having to redebate fundamental issues such as "what is an asset?" time and time again. In addition, the framework contributes to greater efficiency in communications, both internal and external. By providing a common terminology and frame of reference, it greatly facilitates any debate about specific technical issues. It also greatly facilitates communications between the standards setters and their constituents. A framework should also reduce political pressures in making accounting judgements. The framework is used to guide the development of accounting standards that are intended to facilitate the provision of evenhanded, or neutral, financial and related information. Neutral information enables users of that information to make informed investment and credit decisions. Consequently, neutral information serves the public interest by helping to promote the efficient allocation of scarce resources in the economy and society. The framework helps the capital markets and other markets to function more efficiently in the same way. The use of an agreed upon framework reduces the influence of personal biases on standard setting decisions. Without the guidance provided by an agreed upon conceptual framework, standard setting would be quite different, as it necessarily would have to be based on the personal frameworks of individual members of the Board. As Charles Horngren, former APB member, former FASAC member and former FAF trustee, once noted,

"As our professional careers unfold, each of us develops a technical conceptual framework. Some individual frameworks are sharply defined and firmly held; others are vague and weakly held; still others are vague and firmly held." He added that: "At one time or another, most of us have felt the discomfort of listening to somebody attempting to buttress a preconceived conclusion by building a convoluted chain of shaky reasoning. Indeed, perhaps on occasion we have voiced such thinking ourselves My experience as a member of the APB taught me many lessons. A major one was that most of us have a natural tendency and an incredible talent for processing new facts in such a way that our prior conclusions remain intact." In an environment in which standard setting is based on the personal conceptual frameworks of individual standard setters, agreement on specific standard setting issues will only occur when a sufficient number of those personal frameworks intersect. However, even those agreements may prove to be transitory because, as the membership of the body changes over time, the mix of individual conceptual frameworks will change as well. As a result, that standard setting body may reach significantly different conclusions about similar, or even identical, issues than it did earlier, resulting in standards not being consistent with one another and past decisions not being indicative of future ones. Standard setting therefore becomes more or less ad hoc. Moreover, without a framework, rational debate cannot occur because positions about the appropriate accounting treatment for a given transaction can neither be defended nor refuted, the appropriate treatment is simply "in the eye of the beholder." The credibility of financial reporting is enhanced when objectives and concepts are used to provide direction and structure to financial accounting and reporting. The framework helps by leading to the development of standards that are not only internally consistent but also consistent with each other. As a result, both preparers and users of financial statements benefit from financial statements that are based on a body of standards that is more internally consistent and less ad hoc. The framework further helps users of financial reporting information to better understand that information and its limitations. It also provides a frame of reference for understanding the resulting standards. That frame of reference is useful to preparers who apply those standards and to auditors who examine the resulting reports, as well as to students who study accounting and the faculty who teach it. Source: FASB August 2001, as amended What Would we do if we Didn't Have Accounting Statements?

Suppose there were no Companies Acts, no National accounting standards, no International Accounting Standards? What kind of information would we have and what kind of information would we need? Firstly, book keeping and accounting exist because there is virtually a natural existence for them to do so. We keep accounting records as private individuals because we need to monitor our bank account, our credit card account, our utility bills and so on. If we didn't pay any attention to such details, we could end up in a pickle. Even people who claim not to keep financial records at home, but who know their bank balance, their payments schedules and so on ARE keeping account: but they aren't writing it down. Secondly, there is really no business on earth that doesn't need book keeping and accounting records, systems and outputs. Not only is there the book keeping need to keep everything in order and so on; but there is the managerial need to control, to plan and to manage. Without book keeping and accounting records and systems, management could not do its job properly.