Concept of Prudence and its Re Inclusion in the Conceptual Framework

Question: Discuss about the Concept of Prudence and its Re Inclusion in the Conceptual Framework of Accounting. Answer: Introduction Conceptual framework of accounting is the structure which describes the aim and the purpose of maintaining the financial statements and defines the concepts for making general purpose financial statements. It majorly deals with how the assets and liabilities of the company will be measured in correct and fair manner and simultaneously prescribes the norms and principles for recognizing the expenses and incomes and the presentation thereof. The conceptual framework further details that the company following the framework has to comply with the requirements of the accounting standards, auditing and assurance standards and other provisions of the laws applicable for the time being in force. The major objective of the report is to lay down the importance of conceptual framework of accounting and in what ways the same has been considered useful by nit only the users of the financial statements but also the persons concerned with accounting of the company and also with the personnel engaged with those charged with Governance. The second major aim is to provide the meaning and definition of the concept of prudence. The historical background of the concept of prudence has been explained and it has been detailed as to why the concept of prudence has been again included in the conceptual framework of accounting. In order to complete the study in the useful and complete manner for the users of the financial statements the company of Australia has been chosen namely Wesfarmers Limited. The company is registered in Australia and is listed in Australia Stock Exchange and is regarded as the one of top 25 of companies listed in the Australia Stock Exchange. The annual report of the company for the year ending June two thousand and sixteen has been analyzed in detail in regard to the defined parameters like remuneration report, property plant and equipment, etc and checked whether the company has complied with the conceptual framework as laid down or not. At the end the report has been concluded and the proper recommendation is made for the users. Conceptual Framework To start any kind of work, the plan or lay out is required so that all the efforts can be allocated and directed to one goal which will be the successful completion of the work. If no framework or structure is defined then the workers involved in completion of the work will end up with so many confusions and resulting thereby zero results or it may be done in haphazard way which will never provide the useful information to the users of the work so done. Similarly in case of accounting framework is required before proceeding for any accounting work. This framework has been commonly known as the conceptual framework of accounting. The conceptual framework of accounting envisages that the accounting so made and the financial statements so prepared out of it shall reflect three characteristics which are as follows (Anastasia, 2015 and Capital Markets Advisory Committee Meeting, 2013): The financial statements so prepared shall be represented to the users of the financial statements in the faithful manner which signifies that the financial statements shall be free from any type of error and also shall be unbiased and without service the interest of any person. The financial statements so prepared shall provide all the information that will be helpful for the users of the financial statements to understand and make maximum use of it and thus the financial statements shall be relevant to the users of the financial statements The financial statements so prepared shall be provide the information in such a manner that which encompasses the reliability of the financial statements and information thereon and on which the users can take the more effective and efficient decision (IASB, 2010 and Weiss, 2014) In this way the conceptual framework of accounting entails that the financial statements so prepared shall represent the status of affairs of the company and financial performance in the faithful manner, shall be relevant for users and reliable enough to support their decisions. It provides the objectives and ways as to how the assets and liabilities will measured and how the income and expenses will be recognized in the financial statements of the company. Inclusion of Prudence in Conceptual Farmework Prudence in the common parlance means the act of being caution. The concept of prudence has gained the importance since its inception. It was first included in the year of nineteen hundred and eighty nine in the regulatory framework of accounting. In this framework it is defined as the level of caution that has been exercised in making the reliable estimates under the conditions of uncertainty in the manner which leads to the understatement of assets and income. The said definition the concept of prudence has been criticized in the very well manner. Critiques argued that the concept has referred only for the understatement of assets and incomes and have not talked for the liabilities and expenses. In the year of two thousand and ten, the concept of prudence has been expelled from the framework by stating that the prudence concept is not in compliance with the International accounting standards framework and thus will not be able to provide the good quality financial statements to the users of the financial statements. It has been argued that if the financial statements are imprudent then it will defeat the purpose of conceptual framework of accounting of having the financial statements in the neutral manner. In the year of two thousand and fifteen the concept of prudence in again included and is referred to as the re inclusion of the concept of prudence in the conceptual framework of accounting (Cooper, 2015). In this conceptual framework it is laid down that the prudence means to ensure that there is no overstatement of asset or income and understatement of liabilities or expenses. In other words it states that the amount shall be booked in anticipation for losses and expenses but no amount shall be set for profits or gains and incomes. Thus, now the definition facilitates the providing of good quality financial statements to user of the financial statements and thats why the same has been re included in the conceptual framework. Annual Report Analysis In order to facilitate the analysis of the conceptual framework of accounting coupled with prudence, company of Australia has been chosen namely Wesfarmers Limited. It is registered and listed in the Australia Stock Exchange. The company is engaged in the business of selling all the products that are required in daily routine life and thus have the chain of departmental stores in Australia and across other countries including New Zealand. The analyses have been made with annual report of the company for the year ending 2016: Report of Remuneration: The Company has introduced the framework for remuneration of the executives in the way which focuses on having the performance culture in an organization and very importantly link the payment made to the executives on the basis of the achievement of the organizational goals and objectives. The company has divided the remuneration in three parts fixed annual remuneration, short term incentive and long term incentive. For group managing directors fixed annual remuneration is 34%, short term incentive is 33% and long term incentive is 33% of the total remuneration (Annual Report, 2016). It reveals that the major part of the remuneration is based on the risk which is associated with the achievement of the companys objectives and the goals. The committee has also laid down the four guiding principles of the same. This risk based remuneration can lead to adoption of the manipulated practices which can show that the goals have been achieved and hence remuneration may be paid with higher rates. Inventories The inventory have been stated at the lower of the cost or net realizable value at the year end and have been bifurcated the inventory in three parts raw material, work in progress and finished goods. Thus, the amount of inventories is not more than their cost or net realizable value. Accounts Receivables The account receivables includes trade receivables, advances and all loans advanced during the course of business. These accounts receivable are recognized on the basis of fair value and subsequently valued at amortized cost using the effective interest rate method and more importantly these receivables are checked for impairment at the end of every year and are impaired and shown at carrying cost. It implies that the accounts receivables neither more understated nor overstated. Property, Plant and Equipment The property plant and equipment have been measured at cost of asset loess the amount set aside for depreciation and amount pertaining to the impairment loss. Depreciation has been calculated using the straight line method and that too in accordance with the estimated useful life of an asset. At the end of every year the company revises the useful life of an asset and there are the chances that the depreciation expense may be taken at lower value and thus affecting the profit. Intangible Assets Initially they are recognized at the cost or the excess amount paid on business combination in case of goodwill and subsequently recognized at cost after amortization and impairment. The assets with definite lives like software have been amortized at straight line method depending on the useful lives of that asset. It reveals that the intangible assets including the goodwill have not been overstated. Conclusion The report has served with the understanding of the conceptual framework of accounting and the reason has been explained why the concept of prudence have an important role in the framework and why the same have been included in the conceptual framework. With the analysis of the annual report of Wesfarmers Limited, more insights have been given where the chances of hurting the conceptual framework and prudence may arise. It is concluded that in order to have high remuneration the KMP may get involve him in mal practices. Thus, to conclude, in the conceptual framework of accounting prudence is very essential. It is to recommend that the prudence shall be the part of the conceptual framework of accounting otherwise the financial statements will not reflect neutrality References Anastasia, (2015), Financial Statement Analysis : An Introduction available on https://www.cleverism.com/financial-statement-analysis-introduction/ accessed on 30-04-2017. Capital Markets Advisory Committee Meeting, (2013), Conceptual Framework available on https://www.ifrs.org/Meetings/MeetingDocs/Other%20Meeting/2013/March/AP%203%20conceptual%20framework.pdf accessed on 30-04-2017. Cooper S, (2015), A Tale of Prudence, available on https://www.ifrs.org/Investor-resources/Investor-perspectives-2/Documents/Prudence_Investor-Perspective_Conceptual-FW.PDF accessed on 30-04-2017. International Accounting Standards Board, (2010), Conceptual Framework for Financial Reporting 2010 , pages 16-21 Wesfarmers Limited Official Website, Annual Report 2016 available on https://www.wesfarmers.com.au/ accessed on 30-04-2017. Weiss D, (2014), Faithful Representation available on https://bschool.huji.ac.il/.upload/Seminars/Faithful%20Representation%20October%202014.pdf accessed on 30-04-2017..