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Chapter 10

Concepts – Evolution of a Global Conceptual Framework

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Objectives

By the end of the chapter, you should be able to:

discuss how financial accounting standards have evolved

discuss the accounting principles set out in the International Framework the UK Statement of Principles FASB Statements of Financial Accounting Concepts

comment critically on rule-based and principles-based approaches.

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Development of standards Numerous accounting standards produced by: International – IASB European – EU Directives National standard setters – FASB in USA; ASB in UK.

Early standards aimed at consistency to protect the auditors Aim to achieve consistency in the treatment of major items eg. IAS 2 Inventories), and were seen as a mechanism to avoid conflicting rules and practices. Developed in answer to existing problemsLater standards aimed at transparency for investors Emphasis on provision of information useful for making economic decisions Reliability of information only apparent if management changes.

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Conceptual framework

The framework does not create standards. It aims to assist:• standard setters to develop standards on a rational basis • preparers with a principles basis for decisions where there

are no standards• auditors who can refer to the Framework principles, and • stakeholders when interpreting the financial statements.

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Framework content

Objectives of General Purpose Financial Reports (GPFRs)

Qualitative characteristics of informationAssumptions underlying preparation of

financial statementsInfluences on preparation of statementsDefinition, recognition and measurement

of accounting elements

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Concepts of Accounting

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FASB concepts statements

The FASB series of Concepts Statements include:Statement No. 1 : Objectives of Financial Reporting by Business Enterprises

Statement No. 2 : Qualitative Characteristics of Accounting Information

Statement No. 6 : Elements of Financial Statements

Statement No. 5 : Recognition and Measurement in Financial Statements of Business Enterprises.

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IASB framework for presentation and preparation of financial statements

The objective:

is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions

The qualitative characteristics: are the attributes that make the information in financial

statements useful to investors, creditors, and others. The Framework identifies four principal qualitative characteristics:

Understandability Relevance Reliability Comparability

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Qualitative Characteristics

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Qualitative characteristics

Relevance timely - users have the information when it is needed

and useful Feedback - on the way in which past events have

affected the entity during the period being reported on, and the outcome of earlier predictions on which the entity’s management based its decisions

predictive - allow users to either make their own prediction about the economic viability of the entity or assess predictions and assurances given by management as to the future success or otherwise of the entity

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Qualitative characteristics Understandability

presented in such a way that it can be recognised for what it is and be understood by users who have a reasonable knowledge of business and economic activities and accounting, and a willingness to study the information with reasonable diligence.

Reliability representationally faithful, verifiable, unbiased

Comparability between accounting periods and entities in similar businesses

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Influences on Qualities

Need to balance between characteristics Relevance – timely Reliable – verifiable an accurate

Benefits must exceed costs Materiality is subjective judgement call

IAS 1 says this is relevant to all financial reporting Prudence

Caution with estimates Not overly conservative No secret reserves

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Assumptions in Preparation

Accrual basis accounting transactions accounted for in the period in which they

occur, not necessarily when cash is exchanged. Going concern basis

that the business will continue operating as normal for the foreseeable future (at least the next accounting year)

discontinued activities reported separately Period reporting

Common time periods (normally a year) Allows for performance comparison Interim financial reports

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IASB framework for presentation and preparation of financial statements

Definition of elements: Assets - resources controlled by the enterprise as a

result of past events and from which future economic benefits are expected to flow to the enterprise

Liabilities - present obligations of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits

Equity - the residual interest in the assets of the enterprise after deducting all its liabilities

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IASB framework for presentation and preparation of financial statements

Income - increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants

Expenses - decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants

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IASB framework for presentation and preparation of financial statements

Recognition and Measurement: Elements are recognised in the financial statements when

the following criteria are satisfied: It is probable that any future economic benefit associated with

the item will flow to or from the enterprise; and The item's cost or value can be measured with reliability.

Measurement involves assigning monetary amounts at which the elements are to be recognised and reported.

A variety of measurement bases are used today to different degrees and in varying combinations, including: Historical cost Current cost Net realisable (settlement) value Present value (discounted)

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Conceptual framework – convergence project

Framework to be developed over eight phases• Phase A: Objective and qualitative characteristics (Final

chapter published)• Phase B: Elements and recognition• Phase C: Measurement • Phase D: Reporting entity (ED Q2 2010)• Phase E: Presentation and disclosure• Phase F: Purpose and status of framework • Phase G: Applicability to not-for-profit entities • Phase H: Other issues, if necessary.

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Phase A – the objective of financial reporting

The fundamental objective is to provide financial information that is useful to present and potential equity investors when making investment decisions and assessing stewardship. Stewardship not specifically mentioned.

BUT reviewing past performance has an implication for assessing future cash flows. Presumption that general purpose financial statements will satisfy the information needs of other stakeholders.

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Phase A – qualitative characteristics

Two fundamental qualitative characteristics Relevance and faithful representation

Other characteristics that may make the information more useful are: Comparability Consistency, verifiability Timeliness and understandability.

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Do you agree or disagree with the following statements: Accountability and decision-usefulness are not compatible The present balance sheet almost defies comprehension.

Discussion points

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Do you agree or disagree with the following statements: Insufficient attention is paid to an enterprise’s cash or liquidity position Current values may be more relevant than HCA, but may be too unreliable.

Discussion points (Continued)

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2. R. MacVe in A Conceptual Framework for Financial Accounting and Reporting: The Possibilities for an Agreed Structure suggested that the search for a conceptual framework was a political process. Discuss the effect that this thinking has had and will have on standard setting.

Review questions

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Review questions (Continued)

4. ‘The replacement of accrual accounting with cash flow accounting would avoid the need for a conceptual framework.’ Discuss.

9. Key qualitative characteristics in the IASB Framework are relevance and reliability. Preparers of financial statements may face a dilemma in satisfying both criteria at once. Discuss.

10 An asset is defined in the IASB Framework as a resource which an entity controls as a result of past events and from which future economic benefits are expected to flow to the entity. Discuss whether property, plant and equipment automatically qualify as assets.