Question

“Faithful Representation was one of the key qualitative characteristics”.

Write an essay with which include the following details:

a) Explain the importance of this characteristic.
b) List the elements that make up Faithful Representation and explain their relevance to today’s accounting environment within a business’ operations.
c) Explain how it relates to the overall objective of the Conceptual framework for financial reporting
d) With respect to the Enron fraud, give one example where this characteristic was violated.

Answer 1

(a): The characteristic of ‘Faithful Representation’ is important as it allows information in the financial statements to faithfully represent the transactions and events that occur during the reporting period. In other words this characteristic requires that all transactions and events should be accounted for in a manner so that the true economic substance is represented and the representation is beyond just the legal form. Thus this characteristic is important as it emphasizes on substance and economic reality.

(b): The elements that make up Faithful Representation are complete, error free and unbiased. The first element i.e. the element of complete requires that financial statements must include all information that users need so as to be able to form a clear picture of results as well as financial position of the business. Thus no information can be omitted which might have led the users to have a different opinion of the business. The second element is error free and requires that financial statements should have no errors and the information contained in them should present a fair view of the company. The last element is the unbiased element and this element requires that the results should not be amplified in an unnecessary manner or should not be made to look worse than they really are. These elements are highly relevant to today’s accounting environment within a business’ operations. This is because in today’s accounting environment the need to present a true and fair view is all the more essential with increased power of regulatory frameworks and acts like Sarbanes Oxley in place.

(c ): The principle of Faithful Representation directly relates to the overall objective of the Conceptual framework for financial reporting. It should be noted that the primary objective of the Conceptual Framework is that financial reporting should provide information that is useful to present and that users (like potential investors, creditors, and other users) are able to make rational decisions on the basis of the financial statements. Thus the principle of Faithful Representation is aligned to the above mentioned objective and this is how it directly relates to the overall objective of the Conceptual framework for financial reporting.

(d): With respect to Enron the characteristic that was violated was the element of ‘unbiased’. Enron’s audited financial statements of the year 2000 had overstated the notes receivables assets and shareholder’s equity by $172 million. The company’s 2001 unaudited financial statements overstated them by $828 million. An overly optimistic view was created wrongly.