The critical evaluation of an emerging issue in Accounting and Finance

Introduction

A financial statement is a document encompassing a summary of the financial information and position of a company (Atrill & Mclaney 2015). The financial statement serves as an essential document that provides relevant financial and accounting information about the company to the various stakeholders. However, there has been a growing concern regarding whether the financial statements have lost relevance to the users (Francis & Schipper, 1999). It can be argued that the usefulness of financial information has always been a major issue of interest in accounting and finance research. Accordingly, two main groups are benefited by the financial statements that include preparers that may consist of the users within the company and the external users that may consist of investors, shareholders, and creditors, among others. There is a general belief that the financial statement should aid the users for decisions judgment (Setyaningrum et al., 2020).

Nonetheless, there is a long-standing question of whether the financial statements are beneficial to the users and help them decide. To address this issue, several improvements have been made to the accounting standards, yet this issue remains to be unsolved even today (Camfferman & Zeff, 2018). In this regard, it is often claimed that “finding the solution to this problem is not the responsibility of the accounting profession as it has done all it can reasonably do.” Correspondingly, this essay attempts to draw critical arguments regarding whether the accounting profession has the responsibility to identify solutions to this problem or whether the responsibility of finding solutions lies to different individuals or entities.

Critical Evaluation and Discussion

The current accounting standards are an outcome of the continuous evolution. Accordingly, over the decades, the accounting standards-setters, particularly the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), have laid concerted effort to improve the usefulness as well as the credibility of the accounting and financial reporting to users (Alali & Cao, 2010; Paz & Griffin, 2009). Simultaneously, FASB & IASB have identified the framework for the usefulness of the financial statement that includes relevance, reliability, comparability, and understandability (Cheung et al., 2010). As per the relevance criterion, it has been argued that the financial statement information needs to be relevant to the users and affect their economic decisions (Kadous et al., 2011). Similarly, it has been argued that financial statement information needs to be reliable to be useful to the users. This implies that the financial information needs to be free from material error and bias.

On the other hand, the comparability criterion suggests that the users of the financial statement should be able to compare the financial information so that they can predict the financial performance and position of the firm, while the factor of understandability suggests that the financial statement information should be readily understandable by users (De Franco et al., 2011; Cheung et al., 2010). Nonetheless, these four elements, which are argued to guide the quality and usefulness of the financial statement, are contentious. This is because if the financial statements prepared by the firms are consistent with the relevance, reliability, comparability, and understandability, why there have been so many collapses of the firms (Cheung et al., 2010).

Also, it has been argued that there lacks any empirical evidence supporting the improvement in accounting and financial reporting to users. It has been argued that more complex new accounting and reporting rules have come up over the last decades, deteriorating the usefulness of the financial statement to users (Dyer et al., 2017). Similarly, Bradburya & Scott (2020) argued that although several pieces of evidence are suggesting the benefits of accounting standards such as the International Financial Reporting Standards (IFRS), there is also substantial empirical evidence arguing IFRS is more complicated. The complexity has emerged as a significant concern for the users of the financial statements, including investors, regulators, standard setters, and accounting professionals.

As a result, there is widespread dissatisfaction among the users of the financial statements about their relevance and usefulness. The blow is verified in several empirical types of research that have consistently documented the declining use of financial information in predicting future performance as well as reflecting the performance of the company. It has been contended that in the current context, the financial statements have ‘degenerated’ to become more-burdensome and are nothing but a mere ‘compliance exercise’ that has limited usefulness to the stakeholders. It has been argued that the financial statement provides only 5% of the relevant information that is used by the users. At the same time, it has been contended that the financial statements prepared by the firms are devoid of the actionable information needed by the users making their decisions. This is disappointing given the cost and efforts spent complying with the accounting rules and standards (Lev, 2018).

Clearly, the above arguments illustrate the deteriorating usefulness of financial statement information. Correspondingly, the question that arises here is whether finding the solution to this problem or increasing the financial statement information usefulness and effectiveness predominantly lies with the accounting profession or had it has done all it can reasonably do, and thus the responsibility lies somewhere else. To answer this question, it would be ideal to evaluate the causes or the key factors that have led to the deteriorating usefulness of financial statement information to determine whether the reasons are under the control of the accounting profession or not. Addressing this question would further help understand “Who may be the agents of change? Will it be the accounting profession, or will it be others?”

It is argued that quality accounting standards are critical for ensuring the usefulness of the financial statement to the users. Still, it has been further contended that the quality accounting standards alone do not provide sufficient conduction to induce acceptable accounting practices essential for promoting the financial statement's usefulness and effectiveness. In this regard, it has been argued that differences in the accounting and financial reporting system may contribute to non-comparable accounting figures even if similar accounting standards are followed (Ball et al., 2003; Chen et al., 2002).

In a similar context, Chen & Zhang (2010) argued that the institutional differences in terms of culture, legal requirements, political and socio-economic systems also could influence the reliability, relevance, and comparability of the financial statement information. In this regard, it has been argued that emerging economies usually lack accountants, auditors, and regulators to support the Western accounting standards and practices, which is claimed to limit the usefulness of the financial statement (Albu et al., 2020). Accordingly, it has been argued that accounting standards such as IFRS are mainly designed from the developed economies that have highly developed capital markets. Correspondingly, it is questionable whether these standards are suitable for transitional economies, which usually lacks infrastructure for monitoring managers’ financial reporting decisions (Chen & Zhang, 2010). Albu et al. (2020) argued that when the local norms and practices are not aligned with the Western frameworks, it can reduce the usefulness and effectiveness of the financial statement.

It is argued that regulatory enforcement is one of the most critical aspects of the financial statement infrastructure that influences the usefulness of the information to the users. Notably, an active monitoring system is claimed to contribute to high accounting practices essential for ensuring the reliability of the financial statement (Chen & Zhang, 2010). However, weak regulation and enforcement mechanisms in the country are claimed to limit the reliability and relevance of the financial statements and thus create challenges for the users of the financial statement to use the financial statement information for making effective economic decisions (Brown, 2011; Merkl-Davies, 2004).

The role of national culture is also argued to play an important role in accounting and financial enforcement. Accordingly, countries that rank high in terms of uncertainty avoidance dimension of Hofstede’s measurement of national culture are argued to have less strict accounting regulations. In contrast, the countries that rank low in terms of uncertainty avoidance dimension claim to have stronger accounting regulations as people are more likely to accept regulatory changes (Kleinman et al., 2019). Also, the political influence exerted by the public authorities and other interest groups has been argued to affect the implementation of the accounting standards as well as accounting practices, undermining the quality of the financial statement and thus limiting the usefulness of the financial information to the users (Alali & Cao, 2010).

The deficiencies’ in the financial statement are apparent and can be argued to be increasing. However, it has been identified from the arguments drawn above that not all the factors contributing to the deficiencies’ in the financial statement are under the control of the accounting profession. For example, it has been noted that the quality of financial information is influenced by the differences in terms of culture, legal requirements, political and socio-economic systems. Notably, these factors are unlikely to be affected by the accounting profession. However, there are certainly key factors in which the accounting profession can play an essential role in introducing improvements and changes. For example, the current reporting systems that include a balance sheet and income statement are argued to be centuries old, unaffected by the radical changes in information and communication technologies. Simultaneously, there are certain ill-defined elements under the accounting standards that are rarely terminated (Lev, 2018). Thus, based on the above-illustrated arguments, it can be argued that it would be unfair to consider the accounting profession solely responsible for finding the solution to problems associated with the usefulness of the financial statement to the users. Instead, it can be argued that finding the answer to this problem requires a collaborative effort and synergy among the executives, managers, public authorities, enforcement agencies, standard setters, and the accounting profession.

Conclusion

To conclude, the deteriorating usefulness of financial statement information has emerged as a matter of concern for the users. Correspondingly, there is a greater need to find the solution to this issue. This essay critically evaluated whether the responsibility of finding the answer to this problem rests solely on the accounting profession or had it done all it can reasonably do. Correspondingly, based on the critical evaluation and the arguments drawn in this essay, it has been argued that various factors have contributed to the deteriorating usefulness of financial statement information, such as culture, legal requirements, accounting infrastructure, political and socio-economic systems. Besides, the obsolete current reporting system and lack of significant changes to some elements of the accounting standards are also identified to be the leading causes of the deteriorating usefulness of financial statement information to users. Hence, it can be argued that it would be unfair to state the responsibility of finding the solution to the problem only on the accounting profession. Still, at the same time, the role of the accounting profession in bringing changes in the accounting and financial system cannot be ignored. In other words, there is a greater need for a collaborative effort and synergy among the executives, managers, public authorities, enforcement agencies, standard setters, and accounting profession for finding the solution to this issue. Additionally, academicians such as accounting researchers can also play an essential role in finding the answer to the problem by researching the issues affecting the usefulness of financial statement information rather than laying considerable attention on studying more ‘glamorous’ issues like corporate governance and corporate governance.

References

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