3 - Decision Usefulness and Conceptual Framework for...

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Unformatted text preview: Decision Usefulness and Conceptual Framework for Financial Reporting A. Focus on decision-making There are two distinct ways to look at financial reporting and standard setting. The first is from the perspective of preparers of financial reports. From this perspective, accounting rules would be guided by what accountants think is the theoretically correct way of determining accounting numbers (for example, net income) and the way they think that information should be reported. This perspective was dominant until the late 1960s. As an indication of that approach, accountants hotly debated what the correct income number should be. In hindsight, this was a fruitless. As we learned from the previous lesson, markets are imperfect and incomplete. When markets are imperfect and incomplete, information asymmetry plays a key role. That means in the real world, we cannot find the market value of all assets. Without such values, and changes in these values, we cannot derive a definitive income number. In other words, depending who you are and what information you have, you will come up with a different income number, even if you tried your hardest to be truthful and unbiased. Furthermore, as we will discuss in later chapters, each person potentially has different incentives in the reporting process. Instead of a focus on preparers, the present accounting framework has taken the opposite focus a focus on decision usefulness to users . Accounting rules are guided by what information readers would find useful in making decisions. Such decisions include, for examples, whether to invest in equity investments or to participate in debt financing. Considerable attention is paid to the benefits of supplying the information. Due to the importance of this idea, the relevant paragraphs relating to the objective of financial reporting are displayed below in Table 1. However, that is not to say that the decision usefulness approach ignores costs of information production. Costs and benefits should be weighed: The benefits derived from information should exceed the cost of providing it. [IFRS Framework 44] 3-1 You can think of the decision usefulness approach in terms of a marketing plan. In very broad terms, focus on the needs of the customers (users) in your market and supply what they demand, as long as the sales revenues (benefits) exceed the cost of providing the product. Below we look at this marketing plan for financial reporting, known to accountants as the Conceptual Framework. B. Users and their needs The first issue to tackle in a marketing plan is the target market. In financial reporting, we need to identify the consumers/users of the information. As seen above, the conceptual framework of the IASB and CICA explicitly identify investors and creditors as key users of financial statement information (among other constituents). After identifying the target market, we need to think about the needs of customers in this market. What kinds of decisions do these users need to...
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3 - Decision Usefulness and Conceptual Framework for...

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