For a financial reporting system to be effective, it must be coherent, meaning that all its pieces must fit together based on an underlying logic. There are however certain barriers to creating such a framework and which limit the overall effectiveness of financial reporting systems.
The characteristics of a coherent financial reporting framework include the following:
- Transparency: Users of a company’s financial statements should be able to observe the underlying economics of the company clearly reflected. Full disclosure and fair presentation will help to create this transparency.
- Comprehensiveness: The framework should encompass all transactions that have financial consequences; those that are presently occurring as well as new types of transactions as they are developed.
- Consistency: Similar transactions should be measured and presented in a similar manner across companies and time periods regardless of industry, company size, or any other characteristics.
Barriers to Creating a Coherent Financial Reporting Framework
Barriers to creating a coherent financial reporting framework include the following:
- Valuation: Historical cost valuation requires minimal judgment; however other valuation approaches require a considerable amount of judgment but can provide more relevant information.
- Standard-Setting Approach: Financial reporting standards may be established based on either a principles-based approach, rules-based approach, or a combination of the two approaches. A principles-based approach requires considerable judgment in financial reporting and does not give specific guidance on how to report a particular element or transaction. A rules-based approach, on the other hand, establishes specific rules for reporting each element or transaction. An objectives-oriented approach combines the principles-based and rules-based approaches and includes a framework of principles and appropriate levels of implementation guidance.
- Measurement: Financial reporting standards may be established by adopting either an “asset/liability” approach, which gives preference to proper valuation of the balance sheet, or a “revenue/expense” approach, which focuses more on the income statement. This disparity can result in one financial statement being reported in a theoretically sound manner, while the other statement reflects less relevant information.
Which of the following is not considered a characteristic of a coherent financial reporting framework?
The correct answer is A.
Verifiability is not regarded as a characteristic of a coherent financial reporting framework, but consistency and transparency are.
Reading 22 LOS 22g:
Identify characteristics of a coherent financial reporting framework and the barriers to creating such a framework