Resolving Expectations Gaps in Financial Reporting: Issues for International Financial Reporting Standards

ABSTRACT

Financial statements have continued to play relevant roles to investors and in decision making despite limitations as a result of identifiable expectations gaps. Thestudy examines unresolved financial reporting gaps and how they affect public investors’ confidence in financial statements in decision making. The importantrole of the International Accounting Standards Board for International Financial Accounting Standards (IFRS) cannot be over-emphasized. This is critical in theemerging accounting knowledge base and globalization dispensation.

Key Words :: Financial Reporting Expectations Gap, Recognition, Measurement of Financial Information.

INTRODUCTION

The custodianship and stewardship functions required of earlier financial accounting statements formed the process of development of the subject. Thesefunctions constitute the basis of corporate responsibility in modern business. It is in fulfilment of these essential requirements that financial accountingstatements were expected to provide two basic functions as to measurement and communication of information. Focusing on the above functions,financial accounting statements as measurement tools assert period performance outcome and financial position. Financial accounting statements also ascommunicating tools are reporting statements which are communicated to end-users.

These statements further serve as data and information for decisionmaking by users and management to initiate further actions as the statements serve as persuader statements. Statutory audit certified financial reports are regarded as credible and reliable, although events such as Enron, Parmalat, AP, and Xerox among others have castdoubts and non-credibility on statutory audit and financial reporting. Financial Statements’ credibility and other audit issues have further triggered issues offinancial statements’ gaps. (Benston,2006). While focus on audit issues have been the trend, not so much attention has been focused on expectations gaps infinancial accounting reporting and related issues and the resolving of the issues.

In financial accounting statements, underlying conventions of measuringeconomic transactions are largely historical based and at best revalued on occasions. The bases for preparing accounting information have come underincreasing criticisms in recent times.

THE ISSUES ::

Although audit practice is an assurance practice, an extension of the subject is financial reporting which is highly judgmental. Financial Reporting principles andpractice encompass multitude of assumptions and judgments. Hence, it is possible for audit report on an entity to have been clean and unqualified and yet thecompany collapses soon after such reports. The issues become those of credibility which either hinge on management representations in financial reports or theunderstanding of financial reporting in their own contexts. This study is a lens focus on the multitude of assumptions and judgments in the context of financialreporting. The study attempts at resolving of these issues.

EXTANT LITERATURE REVIEW ::

Unresolved issues of financial statements expectations gaps are varied. Higson (2005) observed conceptual framework of the Financial Accounting StandardsBoard (FASB) and the International Accounting Standards Board (IASB) which were expected to be addressed. Notable issues of financial statementsexpectations gaps among others are: issues of recognition and measurement, the communication theory cause of financial statements expectations gap, users’decision perspective and lack of comprehension of some fundamental aspects of accounting.

EXPECTATIONS GAP OF RECOGNITION AND MEASUREMENT IN FINANCIAL REPORTING ::

In an Australian study (ASCPA and ICAA, 1994), the recognition and measurement expectation gap has drawn great concern. It is considered vital to ‘clear anymisconceptions to ensure both preparers and users of financial reports fully understand the reporting and auditing process.’ It is considered that issue ofexpectations gap should be used to describe the difference between the expectations of users of financial reports and the perceived quality of financialreporting and auditing services (Higson, 2005). Differences in financial data and information are considered unreasonable; also, expectations gap about theinadequate performance in accounting practice.

In September 2006, the FASB issued FASB No. 157, Fair Value Measurements (SFAS No. 157). This provides guidance for using fair value to measure assets andliabilities. In February 2007, the FASB issued FASB No. 159, the Fair Value Option of Financial Assets and Financial liabilities. These provisions permit entities tochoose to measure eligible financial assets and liabilities at fair value.Applying fair value for financial instruments is a means of reducing recognition and measurement inconsistencies that occur under the current mixed attributereporting regime. In CFA Institute (2008), findings of CFA Institute 2007 Financial Reporting and Measurement survey showed that 58% of respondents preferfair value as the single measurement basis for financial assets and liabilities with amortized cost information provided as a note disclosure item, 72% ofrespondents indicated that companies should not have recognition and measurement options for similar items. This is predicated on the belief that a singlemeasurement basis can allow greater comparability between reporting entities and within items reported by the entity. Another survey (CFA Institute, 2008)conducted by the European Federation of Financial Analysts Society (EFFAS) corroborates the findings as it showed that 61% of their respondents were generallysupportive of fair value as the single measurement basis.The need for reducing recognition and measurement inconsistencies cannot be overemphasized. While that objective is paramount in financial reporting,balances must be struck among nations’ diversity challenge and accounting practices. The critical need for accounting comparability within industry, nations andglobal contests cannot be overemphasized. The IFRS has the responsibility to facilitate this objective thereby, assisting to close the expectation gap.

THE COMMUNICATION THEORY CAUSE OF FINANCIAL STATEMENTS EXPECTATIONS GAP ::

Accounting terminologies and financial statements may truly be technical jargons as far as the layman and majority of the general public accounting informationusers are concerned. Those with basic accounting knowledge may not even understand as much as the professionals and the accounting preparers. It is wellknown in communication theory that effective communication is achieved only when the object of a message is successfully passed across to the receiver. Whenthere is a misunderstanding or a distortion in the facts being received, then communication is not achieved. This communication cause could therefore be saidto contribute to financial statements expectations gap. There is conscious effort by financial statement preparers to express these statements in narrations andin graphical forms as understandable as possible.

Modern Accounting Information Systems also serve as aid to effectively communicating accountinginformation.This expectations gap is prevalent. Skilled accounting practices require continuous update not only of emerging accounting issues at local levels, but also atglobal levels. Besides, emerging accounting issues and gaps are critically challenging as to the exactness and comprehension of the issues concerned. The resultof emerging accounting issues and challenges are the issuance of accounting standards, pronouncements on statutory audits and from the Security ExchangeCommissions (SEC).

Accounting standards evolve and debated over a timeframe before adoption. They are also not static as they are amended, and withdrawnand replaced as the case may be. While the complexities experienced in standards setting and their comprehension exist on one hand, being conversant withthese standards and evolving standards also exist on the other hand. These are extant challenges in professional accounting practices. The other challenge isthe understandability of accounting information by the layman. Astute financial analysts will continue to be relevant for good communication of the informationconveyed through financial statements.

EXPECTATIONS GAP OF USERS’ DECISION PERSPECTIVE OF FINANCIAL STATEMENTS ::

The basic objective of financial statements is to provide information useful for making economic decisions (Trueblood Reports in AICPA, 1973). This assertion hasbeen controversial as several authorities such as Armstrong (1977), Drury (2000), and Edmonds, Edmonds and Tsay (2003) have queried the conceptualframework which admits that Annual Financial Statements are to provide useful information to users for economic decision making. Essentially from relevantcost accounting perspective, financial accounting costs which are historical costs (past costs information) are classified as sunk costs and these cannot beexpected to serve as basis for decision making.

Costs and management accounting reporting will normally emphasise costs and benefits in decision making.Backward-looking financial statements cannot directly provide the future estimates which decision making processes require. Besides, financial accountingstatements may have been published ‘too late’ to be of relevant use to shareholders’ decision making.Financial accounting statements were originally meant to serve stewardship accounting purpose and to acknowledge managements’ performance. Even whenpast financial accounting information may be relevant for one purpose, it is not true that one set of accounting information will be useful for all decisionpurposes.

It is noted that if the objective of financial statements is for stewardship, then the whole conceptual framework for wholesome users’ decision makingwould have been unwarranted. It is observed by Laughlin and Puxty (1981) that this assumed object of financial statements for decision making, thoughunspoken, is questionable.

ACCOUNTING CONCEPTS ::

Accounting concepts and generally accepted accounting principles (GAAP) requirements notwithstanding, accounting practices in nations differ one fromanother since accounting in individual countries have been a product of several factors. Notable environmental factors that shape accounting development inspecific countries are:

1. Each country’s legal requirement, tax and Security Exchange Commission requirement. Accounting principles and practice have therefore, beendesigned to meet each country’s need;
2. Adherence to particular financial accounting model. Most former colonies of developed countries had their accounting system by choice andhistorical antecedent, patterned after their colonial masters;
3. Process for setting national financial accounting standards. Most developing countries thereafter established nation’s accounting standards board;such as the Indian Accounting Standards Board , as well as other nations’ accounting setting standards bodies; and
4. Conservatism relative to uncertainties, which businesses have to cope with and there are diversities from one set of national GAAP to another. Thishas developed alongside national demands and pace of development of accounting standards.