Approaches to financial reporting and criticisms of financial reporting

23 March 2020,
Kathmandu, Nepal

Conceptual Framework provides a principles-based approach to financial reporting. Whereas, GAAP is rules-based approach. So, what's the difference? Some of you might assume its just same. But, there is significant difference i.e. in principles-based approach you can comply with the provisions or explain why you didn't do as per Standards whereas incase of rules-based approach you must apply or you will face criminal sentence.

Looking at it from simple perspective, you might think that in principles-based approach there could be room for manipulation. In case of rules based approach the person should only follow the whats written within the rules so they find loopholes they justify as 'its permissible under the law'. But, in principles-based approach there are principles which will is complied with based on these principles the rules are prepared. So, principles-based approach is the effective tool to align appropriate human behaviour.

Nowadays, users have become more critical of the non-financial reporting as there isn't any specific standards. Other criticisms of finacial reporting are:

• Historical Information
  
  The statement of profit or loss shows the performance of an entity over the past reporting period whereas investors are intrested in future cash flows. Usually the audited statements are published much later but by that time the information might be useless.
  
• Clutter
  
  Financial reports are becoming cluttered due to extensive disclosure requirement. And, the information disclosed is generic so it doesn't provide useful information to users.
  
• Financial/non-financial information
  
  Financial information such as current and past performance isn't indicative of future value creation. It dependant upon different variables such as governance, risk exposure, management of resource and sustainable practices. Since, no IFRS Standards require disclosures of non-financial information so there is a information gap and those who do need to trade-off information between usefulness and presentation.
  
• Unrecognised assets and liabilities
  
  Under IAS 37, assets are not recognised but liability is when they are probable. Internally generated goodwill are not recognised which means that that even though the company's brand and other intangibles which play a crucial role in sucess are not recognised.
  
• Estimates
  
  Financial reporitng uses alot of estimates where there is subjectivity and room for manipulation in order to maximise profits. This also limits comparability between entities within the same industry.
  
• Historical cost
  
  In case of PPE as per IAS 16 Property, Plant and Equipment, it is permitted to measure it at historical cost. This value could have changed significiantly along with time. But, this is not presented in SOPL.
  
• Policy Choices
  
  The choice of accounting policy in standards, such as IAS 40 Investment Property and  IAS 16 Property, Plant and Equipment, allows entites to choose between cost and fair value models. This imits comparability between entities within the same industry.
  
  Thanks!
  
  References:
  BPP
  IFRS Foundation
  Kaplan Publishing