Accounting standard-setters have an expectation that the readers of general purpose financial reports have a ‘reasonable knowledge’ of accounting. Specifically, the IASB Framework states that ‘users are expected to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence’. Hence, there is an expectation that financial statements are not tailored to meet the needs of people who have not, in some way, studied financial accounting. Students should be encouraged to consider whether this expectation is in itself ‘reasonable’.
As Chapter 2 states, there is an expectation held by accounting standard-setters that users of financial statements have a reasonably sound knowledge of financial accounting. For example, within the IASB Framework (which is also the Australian Accounting Standards Board (AASB) Framework) reference is made to users who ‘are expected to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence’. Within the United States Conceptual Framework Project, reference is made to the ‘informed reader’.
Hence, a view has been adopted by the regulators that users of financial statements should have a certain level of knowledge, and when accounting standards are being developed, this level of knowledge is assumed. In defence of this position, we could probably argue that if such an assumption was not made then the development of accounting standards would be much more difficult and time consuming given that the standard-setters would need to consider how uninformed users might react to the particular standards. The position adopted is also consistent with other professions which also typically assume a certain level of expertise when developing guidance for their professions’ members (however, we need to be careful with justifications like this—just because others do a certain thing does not mean it is the ‘right’ thing).
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If users find it necessary, there are many experts who would be available to provide advice on how particular numbers were derived. Of course, such advice will generally be at a cost which does raise the issue that it can be costly for some individuals to gain an understanding about the operations of organisations that perhaps have an impact on their ongoing existence. Hence, while there is arguably a ‘right-to-know’, for people without an accounting knowledge this right can only be exercised at some cost.
In making this judgement, students should consider the various articles that frequently appear in newspapers, and various discussions that occur on television and radio in relation to an organisation’s profits. Rarely is any mention made of the accounting methods used, even though the profits ultimately reported are directly a product of the many decisions that would have been made regarding how particular items should be accounted for (if possible, direct reference should be made to a number of articles which discuss organisations’ reported profits). Hence, it does appear as if profits are often held out as some form of ‘hard’, objective measure of organisational performance.
In considering why the media might behave in this manner, one possibility is that those responsible for writing the stories are ignorant that financial accounting relies upon a great deal of professional judgement and they might believe that every decision made by accountants is clearly mapped out by a comprehensive system of rules. Alternatively, the writers might consider that people simply do not want to be ‘bogged down’ in the fine detail. As another possibility the accounting profession, through such vehicles as conceptual frameworks, may have successfully cultivated an impression (with the people in the media, and others) that the practice of accounting is objective, and the output of the accounting system is highly comparable between different entities—meaning that one organisation’s profits can appropriately be compared to another.
The implications of this approach to reporting profits in the media is that one entity’s performance as represented by its profit might simply be compared to another, and that the entity with the higher reported profit might be considered to be more successful, and therefore to represent a better investment. Its management might also be considered in a more favourable light than the management of the entity with the lower reported profits. Implications such as this, however, assume that readers and media listeners do not appreciate that profits are directly related to the various accounting choices made.
Advocates of an efficient market perspective, however, might argue that as long as the information about accounting method selection is made public somewhere, such as in the annual report, then the market (for example, the capital market), on average, will be able to understand how the adoption of particular accounting methods affected reported profits, and hence the market will not simply fixate on the final numbers reported. There are differences in opinion about the efficiency of markets, such as the capital market.
A further point that could be raised in relation to this question is that accounting ‘profits’ are not a comprehensive measure of organisational performance given that accounting profits typically disregard many of the social and environmental implications of a reporting entity.
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