THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

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CHAPTER 2

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WHAT IS THE CONCEPTUAL FRAMEWORK?

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… a coherent (comprehensible) system of interrelated objectives and fundamentals

that is expected to lead to consistent standards and that prescribes (recommends) the nature, function and limits of financial

accounting and reporting. (FASB)

… a coherent (comprehensible) system of interrelated objectives and fundamentals

that is expected to lead to consistent standards and that prescribes (recommends) the nature, function and limits of financial

accounting and reporting. (FASB)

Coherent (comprehensible) system & consistent indicated that Standard Setter advocates a theoretical & non arbitrary framework, & the words prescribes support normative approach

A conceptual framework can be descriptive, prescriptive (regulatory) or a mixture of both:a descriptive framework attempts to develop a

set of interrelated concepts, which serves to codify and explain existing financial reporting practices

a prescriptive framework attempts to develop a conceptual basis for what financial accounting practices should be 3

Accounting academics & standard setters alike have attempted to develop a CF that provide a definitive statement of the nature & purpose of financial accounting & reporting which provide guidance for all accounting practice.

Since 1980s standard setters & professional accounting bodies have strong interest in the development of CF to guide the preparation & presentation of general purpose financial reports in the public & private sector. 4

1989 IASB started CF, but the progress has been slow, with disagreement about their content & applicability.

Encounters difficulty to addresses fundamental issues relating to measurement.

Later 1990s, political intervention.

2002, IASB/FASB convergence project rekindled (renewed) interest in CF.

The JV: from harmonization to convergence. 5

To develop single, complete & internally consistent CF.

however the project face many of difficulties encountered in previous attempt to develop CF.

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WHY HAVE A CONCEPTUAL FRAMEWORK? Problems

lack of a general theory Some accountants needs for CF. They argue

unnecessary to develop theory of accounting through CF, the past not doing it.

The profession has survive so for without a formal constructed theory.

Therefore problems arise...because lack of CF, bad practice at times triumph over good practice (Gellein, former APB and FASB member )

Therefore some recommendations of authoritative bodies can be viewed only of somewhat random solutions to pressing problems of the moment. 7

Permissiveness of accounting practice it permits alternative accounting practice to be applied to

similar circumstances 'the more practical alternative would be to leave the every

organization free to choose it's own method within broad limits to which reference has been made '

Inconsistency of practices Regulators have tried to establish order by issuing numerous

resolutions & accounting standards. Some of the early regulations were a distillation of practice,

supported by arbitrary arguments rather than a set of consistent principles.

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defense against political interference

APB, 1970. '....they become generally accepted by agreement (often tacit agreement ) rather than by formal derivation from set of postulate or basis concepts.... '

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Therefore; Solomons sees CF as a defense against political

interference in neutrality of accounting reports. He note that accounting policy can be implemented only by making a value judgment, but there is no way of proving that the value judgments of any individual or group are better for society than those of others. Thus the provision of “coherent theoretical base” for which standard are derived provide a conceptual defense;

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'if a standard setting body cannot show that its standards will lead to the production of information having the qualities & characteristics necessary to attain a defined accounting objective , it will have no defense against sectional interest that

sees a standard as injurious to its welfare, for if a standard is not derived from a conceptual

framework, how can it be shown that one standard is better than any other?’

WHY HAVE A CONCEPTUAL FRAMEWORK?

Benefits: consistent, logical reporting requirements greater compliance enhanced accountability fewer specific standards enhanced understandability of reporting

requirements

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OBJECTIVES OF THE CONCEPTUAL FRAMEWORK

Information for decision making

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…the objective of general purpose financial reporting is to provide

information to users that is useful in making and evaluating decisions about

the allocation of scarce resources.

…the objective of general purpose financial reporting is to provide

information to users that is useful in making and evaluating decisions about

the allocation of scarce resources.

1. The particular objective of Financial Statement are to present fairly & in conformity with GAAP, financial position, result of operations & other changes in financial position.

2. The general objective of financial statement are as follows;

a) To provide reliable information about economic resources & obligation of business enterprise in order to;

i. Evaluate its strength of weakness;ii. Show its financing & investment;iii. Evaluate its ability to meets its commitments;iv. Show its resource base for growth.

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b) To provide reliable information about changes in net resources resulting from a business enterprise’s profit-directed activities in order to;

I. Show expected dividend return to investorsII. Demonstrate the operations ability to pay…..III. Provide management information for planning &

controlIV. Show its long term profitability

c) To provide financial information that can be used to estimate earning potential of the business

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d. To provide another need of information about changes in economic resources & obligation.

e. To disclose other information relevant to statement user, needs.

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3. THE QUALITATIVE OBJECTIVES

i. Relevance: selecting the information most likely to aid users in their economic decision

ii. Understandability: which implies not only that selected information must be intelligible, but user can understand it.

iii. Verifiability: accounting result may be corroborated (confirm) by independent measures, using the same measurement method

iv. Neutrality: Accounting information directed towards the common needs of users, rather than particular needs of specific user.

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V. Timeliness; which implies an early communication of information, to avoid delay in economic decision-making

VI. Comparability; which implies that differences should not be the result of different accounting treatment

VII. Completeness; which implies that all information that reasonably fulfills the requirements of the other qualitative objectives should be reported.

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SUMMARY

The conceptual framework is intended to provide a coherent and prescriptive guide to accounting practice

If effective it should result in the communication of more useful financial information to users

Developing a conceptual framework has been a long and complicated process

Criticisms of conceptual framework projects exist Others debate the importance of these criticisms

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OBJECTIVES OF CONCEPTUAL FRAMEWORKS – IN PICTORIAL

CONCLUSION

WHAT IS CF? WHY CF? ELEMENTS IN CF?

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CRITIQUE OF CONCEPTUAL FRAMEWORK PROJECTS

A CRITIQUE OF CONCEPTUAL FRAMEWORK PROJECTS

Help in explaining reasons for the slow development of the CF & highlights issues relevant to achieving progress in the current IASB/FASB project.

Two approaches; scientific & professional approach.

Scientific approach; method used in scientific inquiry & must justify their validity by recourse (option) to logic & empiricism (practicality) or both.

Professional approach; best course of action by recourse to ‘professional values’, similar to constitutional approach to rule setting.

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• Crucial issues of recognition & measurement, which basically a description of the elements of accounting reports based on observations of current practice.

Board approach totally descriptive The aims & philosophy of the CF had been

lost by time. The philosophy, sees concepts as being the

residual (left over) of the standard setting process, is in direct contradiction to the purpose of CF.

Similar criticism of IASB CF; Assets & liabilities are defined in very similar

terms. The recognition criteria are couched (hidden), in

term of probability – subjective concept. In addition recognition criteria fails to offer any

guidance on the measurement problem, which is fundamental to accounting

As, it is important, as it is in science, the prior agreement is reached of the precise definitions of the elements of accounting?

Definition & prior agreement on the meanings of terms are important to the development of a consistent , interrelated & meaningful system.

CF is a common understanding of definitions is crucial to consistent preparation & interpretation of financial statements.

ONTOLOGICAL AND EPISTEMOLOGICAL ASSUMPTIONS Throughout the CF projects, the focus;

Freedom from bias, or neutrality Information quality that avoids leading users to conclusions that secure the

particular needs, desires or preconceptions (biases) of the preparers

Solomon's explains freedom from bias as ‘financial mapmaking’

Accounting is financial mapmaking: the better the map, the more it represents the complex phenomena that are being map.

We judge the map by how it represents the facts. (its about realism).

The philosophy of realism from the assumptions that we can observe, measure & communicate an objective of economic reality.

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CIRCULARITY (COMPLEXITY) OF REASONING

Objective of a conceptual frameworkis to guide the everyday practice of accountants

However, the qualities, in turn depend on other non-operationalized information quality e.g. the discussion on neutralities relies on

relevance, reliability & representational faithfulness, but the necessary & sufficient conditions for obtaining these qualities are not stated.

FASB statement 3 paragraph 20 ‘recognition’... professional judgement

Its provides no specific guidance as to how this should be achieved.

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AN UNSCIENTIFIC DISCIPLINE Is accounting a science? CF may have attempted

to adopt the deductive (scientific) approach, but this approach is questionable if accounting does not qualify as a science to begin with.

Stamp Report (1981) Until we are sure in our minds about the nature of

accounting, it is fruitless for the profession to invest large resources in developing a conceptual framework to support accounting standards

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Stamps consider accounting is more closely aligned to law than to the physical science. Accounting & legal profession deal with conflicts

between different user groups within varying interests & objectives.

Law as normative discipline which is prescriptive in nature & full of value-laden concepts (is wording that attempts to influence the listener or reader by appealing to emotion) contrast (to an appeal to logic and reason)

Accounting faces imperfect market & involves subjectivity based, human decisions-making process;

(in contrast) physical science are considered to be positive discipline, descriptive in nature & characterized (considered) by value-free concepts.

Positive accounting theory is still in embryonic stage.

This does not necessarily indicate the lack of scientific approach,

However, Provide the theoretician is rigorous in applying

ontological, epistemological & methodological rules relating to the field of study, the scientific methodology may be said to be applied.

POSITIVE RESEARCH

Basic focus on CF projects – ignores the empirical findings of positive accounting research in conflict with each other

Both ignore mounting evidence that capital markets that are not completely efficient

The response from the market does not means that individual process the information efficiently or that individuals or groups cannot make incorrect investment, lending, supply & purchase decision.

If the CF could ensure useful information …would serve useful purpose

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PROFESSIONAL VALUESthe conceptual framework as a policy documentGeneralised body of knowledge, the

CF fail a number of ‘scientific’ testsControversies among accounting

theorists centre mainly on how accounting practices should be carried out

The distinction between theories and policies is important

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PROFESSIONAL VALUES

Tutticci, Dunstan and Holmes argue that;Conceptual framework point of

reference when debating issuesRole of international harmonisation

Developing accounting standardsUsing conceptual framework approach

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PROFESSIONAL VALUES ANDSELF-PRESERVATION ‘Self-preservation’

Implies the pursuit of self-interest ‘Professional values’

Suggests idealism and altruism (unselfishness) Greenwood

Group interests and aims-provides to the community worth of service with strong sense of responsibility.

Gerboth Sense of personal responsibility – the essence of

professionalism- is what makes the accountant’s decisions objective

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SUMMARY OF CRITIQUE ON CF PROJECT The CF is intended to provide a coherent and

prescriptive guideto practice

If effective it should result in the communication of more useful information to users

Several criticisms of the CF exist; Scientific Professionals values

Others debate the importance of these criticisms Ensure people received useful information

Policy documents based on professional values and self-interest

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THE MALAYSIAN CONCEPTUAL FRAMEWORK:

• Brief history of the accounting profession in Malaysia– MACPA has been actively involved in providing

its members with technical guidance and training as well as setting the professional examinations.

– dominant force behind the MACPA is the chartered accountants (CAs) from the UK and Australia.

– The Big Six[1] supported the MACPA– ACCA, ASA & Big Six

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• The Accountancy Act 1967 provided for the registration of accountants and the establishment of the MIA.

• The MIA recognised ten professional bodies for admission purposes.

• MAS 6• 1997, the Financial Reporting Act 1997 was passed

and the• Malaysian Accounting Standards Board (MASB) was

formed to issue legally binding accounting standards. • Apparently, standard setting activity was taken out of

the hands of the profession. Subsequently, the Companies Act 1965 was amended to require compliance with approved accounting standards.

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STANDARD SETTING

Began with formation IASC in London in 1973. Committee comprised representative professional

accounting bodies in 9 countries The aims to develop accounting standard for private

sector for the used of countries throughout the world. They were adopted & used for the development of

accounting standards National accounting standard reflected the orientation

arising from code law legal framework & tax based accounting systems.

Companies used IAS to provide additional information for capital market participants in a more transparent & comparable manner.

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Early IASC standard often allowed a choice of accounting policy to include preference of various member nations.

Late 1980s IASC began work on the improvement project , to improve the quality of IAS & removed many optional treatment.

ACCOUNTING REGULATION IN AN INTERNATIONAL CONTEXT

– IOSCO (International Organization of Securities Commissions) – 1974

– In 2005, the European Commission to adopt IASB standards

– international harmonization

– Convergence (IASB + FASB)• Overhaul & eliminating optional treatments.• Reduce differences between FRSs & US GAAP

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THEORIES OF REGULATION

Three views of regulatory activity public interest theory – overview

Application to accounting standard setting protect user interests

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regulatory capture theory

Application to accounting standard setting

redistribution of wealth private-interest theory

Application to accounting standard setting

the power to coerce (persuade)

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SO WHY IS ACCOUNTING REGULATED?

Three theory frameworks Public-interest theorists Capture theorists Private-interest theorists

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STANDARD SETTING APPROACHES

Free or regulated market?

should accounting standards be formulated by authoritative bodiesor left to the free market?

should accounting standards be formulated in the public or private sector?

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STANDARD SETTING APPROACHES

Free-market approach

demand & supply of accounting information

Regulatory approach

market mechanisms will not be able to achieve a socially optimal equilibrium price for accounting information

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SUMMARY

1960s criticisms of the accounting profession have attracted increasing public attention.

Legitimizing procedure of standard-setting process

Political environment Alternative interest groups

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THE ROLE OF A CONCEPTUAL FRAMEWORK

States the scope and objective of financial reporting

Identifies and defines qualitative characteristics of financial information and the basic elements of accounting

Deals with principles and rules of recognition and measurement, and report disclosures

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THE ROLE OF A CONCEPTUAL FRAMEWORK

Issues: Do we need a general theory of accounting? Is current accounting too permissive? Are current accounting practices too

inconsistent? Is there too much political interference in the

neutrality of accounting reports?

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DEVELOPING A CONCEPTUAL FRAMEWORK

The development of conceptual frameworks is influenced by two key issues: Principles (based on GAAP and CF) versus rules-

based (not depend on CF) approaches to standard setting

information for decision making and the decision-theory approach

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A REVIEW OF THE CONCEPTUAL FRAMEWORKFOR FINANCIAL REPORTINGDiscussion Paper DP/2013/1

Comments to be received by 14 January 2014

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