The Limitations Of Accounting Standards

Limitations Of Accounting Standards

As the world progresses ever so slowly towards having uniform global accounting standards many points of view have emerged on both the virtues and limitations of accounting standards. While there are valid arguments on both sides of the debate, accounting standards will be with us and are continuing to move towards harmonisation and ultimately, global accounting standards.

What Are Accounting Standards?

An accounting standard is a common set of principles, standards and procedures that define the basis of financial accounting policies and practices. Accounting standards improve the transparency of financial reporting in all countries. Most countries use International Financial Reporting Standards (IFRSs) and older International Accounting Standards (IASs) created and issued by the International Accounting Standards Board (IASB). There are currently 16 active IFRS and 29 active IAS standards. These standards guide on the treatment of various accounting transactions and relationships. They provide the framework upon which the rules that we see in everyday accounting statements are built. From this understanding of what accounting standards are we can start to draw some direction on what the limitations of accounting standards are and how they affect those charged with creating financial statements.

 

Inflexibility And Rigidity

When you choose one alternative you simultaneously exclude all other alternatives. Similarly when an accounting standard chooses a particular method of treating a transaction or relationship all other methods of treating it are excluded. This doesn’t immediately mean that other methods are inaccurate or inappropriate it simply means that the chosen path is the only one available to those in accountancy. This limitation of accounting standards results in an inflexible and rigid system of accounting. The problem emanates from situations where the accounting standard chooses a method or methods of treating a transaction that are not the most appropriate method for doing so. Even when the accounting community becomes aware of the fact that there is a more appropriate method the process of creating or changing an accounting standard is cumbersome and lengthy. It involves white papers and open discussion before a standard is accepted and this may take up to 2 years. All while an inappropriate method is being used. Binding preparers of financial statements to methods that may be inappropriate through inflexibility is the first limitation of accounting standards.

 

High Cost

There are two ways of looking at this limitation of accounting standards. Firstly, as we have just discussed, changing accounting standards where necessary is a process that involves many moving parts. There are great costs involved in the process of creating accounting standards. The International Financial Reporting Standards program started in 2001 with the first standard, IFRS 1 being released in 2003. To date, 16 standards have been released as IFRS in 19 years. It is also worth noting that IFRS 1 was restructured in 2008 to reflect findings that required adjustment after its initial release. The process is costly in terms of time. Secondly, the cost limitation of financial statements is also evident in the cost associated with compliance. In some cases, accounting standards place a large amount of work at the feet of those who prepare financial statements. As accounting standards become more and more detailed in an attempt to keep information reliable they also place a greater burden on accountants. Take the example of International Accounting Standard 37 which requires extractive industry players like mining companies to include the projected cost of returning the claim site to a usable condition in the initial cost disclosed to investors and other stakeholders. This is despite the timing of this activity being unknown. The expenditure on getting estimates of these costs is considerable because it requires experts.

 

Difficult To Choose Among Alternatives

Many accounting standards offer choices between methods for accountants to use. While this goes some way towards mitigating the limitation of accounting standards that is inflexibility it introduces another limitation of accounting standards this the difficulty of choosing between available methods. Whether you are valuing inventory, investment assets, inflation accounting and many other variables there are options on methods to use. The problem that this limitation of accounting standards presents is that more often than not the different methods provide different values for the same thing. This creates a moral dilemma that may encourage accounting practitioners to cherry-pick methods from various standards. For instance picking methods that overstate assets or income in one standard while choosing methods that understate expenses or liabilities in another standard. The overall effect would be an overstatement of the profit and value of the business. This limitation of financial statements also hinders the comparability of financial information as two businesses may choose to use two different approaches to value financial statement items.

 

Scope Is Restricted

Another limitation of accounting standards is their restricted scope. The International Accounting Standard Boards try as they might, cannot include all information in accounting standards. They do their best to include all issues they are aware of, however, they cannot include issues they are not aware of in their considerations. As a result accounting standards may fail to address emerging issues in the world of financial reporting. While the world has moved in leaps and bounds through technology and new information over the last 20 years many accounting standards have not changed in the same period. When new ways of arranging transactions or business relationships emerge, accountants are unable to represent the true form of these relations because accounting standards have not yet caught up with the new methods. This limitation of accounting standards binds accountants in the scope that accounting standards have to capture information and present it accurately. As discussed before changing accounting standards is a process that takes a lot of time.

 

The notable limitations of accounting standards are their inflexibility, time-consuming process to create them, the difficulty of choosing between alternative treatments and their restricted scope.

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