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On the conceptual foundations of financial reporting

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  • Ilia D. Dichev

Abstract

Standard setters advocate a balance sheet approach to financial reporting, which views assets and liabilities as primary, and income as just the derivative change in net assets. This paper argues that income is conceptually and practically better described as ‘adjusted net cash flows,’ where the adjustments are the accounting accruals. One proof of that is seen in the existence of whole accounting systems like tax accounting and national income accounting, which emphasize the determination of income but have no balance sheets. The paper also argues that an income-based approach to financial reporting is by nature better suited to reflect the success of advancing cash to earn more cash, which defines what for-profit entities do. There are two main features of the income-based approach. One is attention on the cash flows as the natural foundation for financial reporting because they are precisely determined, and provide a clear link to firm valuation. The other is attention on the accounting accruals, which serve to adjust the raw cash flows to better show the current success of investing cash to ultimately earn more cash. Specifically, the paper argues for revenue recognition which is close to current practice, and for expense recognition which is aligned with the matching principle.

Suggested Citation

  • Ilia D. Dichev, 2017. "On the conceptual foundations of financial reporting," Accounting and Business Research, Taylor & Francis Journals, vol. 47(6), pages 617-632, September.
    • Handle: RePEc:taf:acctbr:v:47:y:2017:i:6:p:617-632
    DOI: 10.1080/00014788.2017.1299620
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    Citations

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    Cited by:

    1. Rong Huang & Carol Marquardt & Bo Zhang, 2023. "Revenue-expense matching and performance measure choice," Review of Accounting Studies, Springer, vol. 28(3), pages 1690-1720, September.
    2. Carien van Mourik & Yuko Katsuo Asami, 2018. "Articulation, Profit or Loss and OCI in the IASB Conceptual Framework: Different Shades of Clean (or Dirty) Surplus," Accounting in Europe, Taylor & Francis Journals, vol. 15(2), pages 167-192, May.
    3. Gulraze Wakil, 2020. "Firm size proxies and the value relevance of predictive stock return models," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 44(3), pages 434-457, July.
    4. Yuta Shibasaki & Chikara Toyokura, 2020. "The Disclosure of Non-GAAP Performance Measures and the Adoption of IFRS: Evidence from Japanese Firms' Experience," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 38, pages 19-54, November.
    5. Yuta Shibasaki & Chikara Toyokura, 2019. "The Disclosure of Non-GAAP Performance Measures and the Adoption of IFRS: Evidence from Japanese Firms' Experience," IMES Discussion Paper Series 19-E-20, Institute for Monetary and Economic Studies, Bank of Japan.
    6. Kim, Robert & Kim, Sangwan, 2021. "Does revenue-expense matching play a differential role in analysts’ earnings and revenue forecasts?," The British Accounting Review, Elsevier, vol. 53(5).
    7. Baruch Lev, 2018. "The deteriorating usefulness of financial report information and how to reverse it," Accounting and Business Research, Taylor & Francis Journals, vol. 48(5), pages 465-493, July.
    8. Jiang, John (Xuefeng) & Wang, Isabel Yanyan & Wangerin, Daniel D., 2018. "How does the FASB make decisions? A descriptive study of agenda-setting and the role of individual board members," Accounting, Organizations and Society, Elsevier, vol. 71(C), pages 30-46.

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