deegan fat4e ppt_ch06

6-1Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd PPTs to accompany Deegan, Financial Accounting Theory 4e

FINANCIAL ACCOUNTING THEORYCraig Deegan

Slides written by Craig Deegan

CHAPTER 6Normative theories of accounting: the case of conceptual framework projects


Learning objectives6.1 Understand the role that a conceptual framework can play in

the practice of financial reporting.

6.2 Be aware of the history of the development of the various past conceptual framework projects.

6.3 Be able to identify, explain and critically evaluate the various building blocks that have been developed within various conceptual framework projects.

6.4 Be able to identify some of the perceived advantages and disadvantages that arise from the establishment and development of a conceptual framework.

6.5 Be aware of recent initiatives being undertaken by the International Accounting Standards Board to develop an improved conceptual framework for financial reporting.


Learning objectives (cont.)

6.6 Be able to identify some factors, including political factors, that might help or hinder the development of a conceptual framework project.

6.7 Be able to explain which groups within society are likely to benefit from the establishment and development of a conceptual framework of accounting.

6.8 Understand the meaning of ‘accountability’ and the relationship between accountability and accounting.


What is a conceptual framework?• A coherent system of interrelated objectives and

fundamentals that is expected to lead to consistent standards and that prescribes the nature, function and limits of financial accounting and financial statements (Statement of Financial Accounting Concepts No. 1: Objectives of Financial Reporting by Business Enterprises 1978)

• It attempts to provide a structured ‘theory’ of accounting


Conceptual frameworks as normative theories

• Conceptual frameworks provide prescription so they can be considered as normative theories of accounting


A revised conceptual framework

• In recent years the FASB and IASB had been jointly working towards the development of an improved conceptual framework

• This stalled in 2010, and was later reactivated in 2012

• The IASB took over the project from 2012 as the FASB decided it would concentrate on other priority areas at this time.


Rationale for conceptual frameworks• To develop the practice of financial reporting logically

and consistently we need to address and agree upon such issues as:

– what we mean by 'financial reporting' and what should be its scope;

– which organisational characteristics indicate that an entity should produce financial reports;

– the 'objective' of financial reporting;

– qualitative characteristics financial information should possess for it to be ‘useful’;

– what are the elements of financial reporting; and

– what measurement rule(s) should be employed. continued


Rationale for conceptual frameworks (cont.)

• Proponents argue that without agreement on these issues accounting standards will be developed in an ad hoc manner

• There will be limited consistency between accounting standards in the absence of a conceptual framework


The 'building blocks' of the conceptual framework• The framework must be developed in a particular

order

– some issues (or assumptions) need to be resolved before moving on to subsequent 'building blocks'

– One obvious issue that needs early agreement would be what is meant by 'financial reporting‘, and in particular ‘general purpose financial reporting’.

– Other issues that would also need agreement early in the process would be:

Definition of a reporting entity

Definition of the users of financial statements (and assumptions of their accounting knowledge)

The objective of financial reporting continued


The 'building blocks' of the conceptual framework (cont.)

• Because the rest of the framework flows from key assumptions about the 'objective‘ of general purpose financial reporting, if we reject these assumptions, then we personally might be prepared to reject the prescriptions provided by the framework

• Refer to Figure 6.1 (p.217) on the next slide for an overview of the potential building blocks of a conceptual framework of financial reporting


Components of a conceptual framework of accounting


History of the development of CFs

• CFs were developed in a number of jurisdictions including

– US, UK, Canada, Australia, New Zealand, International Accounting Standards Committee

• In recent years many countries have adopted the IASB Conceptual Framework given that they have decided to adopt the accounting standards released by the IASB

• No standard-setters had developed a complete CF; measurement issues typically remained unaddressed

• Since 2012 the IASB increased its work towards completing a revised conceptual framework


Development of frameworks of accounting in the US• 1961 and 1962: Moonitz, and Moonitz and Sprouse

prescribed that accounting practice should be based on current values

• 1965: Grady developed theory based on description of existing practice

– led to the release of Accounting Principles Board (APB) Statement No. 4

– however, accounting profession under criticism for lack of any real framework

continued


Development of frameworks of accounting in the US (cont.)

• Led to formation of Trueblood Committee in 1971 which produced the Trueblood Report

– report outlined 12 objectives of accounting and seven qualitative characteristics which financial information should possess

– objective 1: focused on information needs of financial statement users

– objective 2: need to serve users with limited ability to demand financial information

continued


Development of frameworks of accounting in the US (cont.)• 1974: APB replaced by FASB which then embarked

on its CF project

• Six Statements of Financial Accounting Concepts (SFACs) released from 1978 to 1985

• Initial SFACs normative in nature, but SFAC No. 5 relating to recognition and measurement largely descriptive of current practice

– received much criticism

– since 2005 FASB and IASB had been jointly working towards the development of a revised conceptual framework that would be used by both boards—referred to as the 'convergence project'


Development of a CF in the UK• Early moves towards guidance relating to objectives

and identification of users provided by The Corporate Report (1976)

– concerned with addressing the rights of the community in terms of their access to financial information (broader than notion of users adopted in other frameworks)

– ultimately contents generally not accepted by the accounting profession

• 1991: ASB adopted the International Accounting Standards Committee’s (IASC's) CF

• IASC framework was generally consistent with the US and Australian frameworks—subsequently became known as the IASB Framework


Development of a CF in Australia• Degree of progression was slow

• Only four Statements of Accounting Concepts (SACs) were released

– SAC 1: Definition of the Reporting Entity

– SAC 2: Objectives of General Purpose Financial Reporting

– SAC 3: Qualitative Characteristics of Financial Information

– SAC 4: Definition and Recognition of the Elements of Financial Statements

continued


Development of a CF in Australia (cont.)

• Fifth SAC relating to measurement was never released

• Had a number of similarities to the US CF project

• 2005: Australia adopted the IASB Conceptual Framework as a result of the decision by the Financial Reporting Council that Australia would adopt IAS/IFRS by 2005


Current efforts of the IASB and the FASB• From 2005 the IASB and the FASB had been jointly

working towards the development of a revised conceptual framework

• The need for this revised framework arose because of the 'convergence project' in which the IASB and the FASB are working together to converge their two sets of accounting standards

• Will take several years to complete and will continually evolve

continued


Current efforts of the IASB and the FASB (cont.)• The IASB and FASB were undertaking the work on the

conceptual framework in eight phases, these being:

– objectives and qualitative characteristics

– definitions of elements

– recognition and de-recognition

– measurement

– reporting entity concept

– boundaries of financial reporting, and presentation and disclosure

– purpose and status of the framework

– application of the framework to not-for-profit entities

– remaining issues, if any

The first phase above was completed in 2010 before further work was temporarily suspended


IASB initiatives since 2010

• The IASB restarted the Conceptual Framework Project in 2012

• FASB withdrew its involvement at that time

• The IASB discontinued the ‘phased approach’ and decided to develop a complete set of proposals

• Released a Discussion Paper entitled A Review of the Conceptual Framework for Financial Reporting in July 2013

• Optimistically expected to finalise the revised framework by late 2015


Building blocks of the CF• Building blocks of the various CFs have addressed

– definition of the reporting entity

A reporting entity produces general purpose financial statements which therefore requires us to also define ‘general purpose financial statements’

– objectives of general purpose financial reporting (GPFR)

– perceived users of GPFRs

– qualitative characteristics that financial information should possess for it to be ‘useful’

– elements of financial statements

– possible approaches to measuring the elements


General purpose financial statements

• The Conceptual Framework provides guidance for general purpose financial statements and not special purpose financial statements

• GPFSs are financial statements

– intended to meet the information needs common to users who are unable to command the preparation of reports tailored so as to satisfy, specifically, all of their information needs

• By contrast, special purpose financial statements are provided to meet the information demands of a particular user, or group of users

• GPFSs are financial statements that comply with accounting standards and other generally accepted accounting practices (GAAPs)


Who is required to prepare GPFSs?

But which entities are expected to prepare general purpose financial statements?

The answer is …….

Reporting entities are required to produce general purpose financial statements

Okay, but what is a ‘reporting entity’?


Definition of the reporting entity• In 2010 the IASB released an exposure draft entitled

Conceptual Framework for Financial Reporting: The Reporting Entity in which it defined a reporting entity as:

a circumscribed area of economic activities whose financial information has the potential to be useful to existing and potential equity investors, lenders and other creditors who cannot directly obtain the information they need in making decisions about providing resources to the entity and in assessing whether management and the governing board of that entity have made efficient and effective use of the resources provided.


Factors which can be indicative that an organisation is a reporting entity

• Separation of management from those with an economic interest in the entity

• The economic or political importance/influence of the entity to/on other parties

• The financial characteristics of the entity


Determining whether an entity is a reporting entity and therefore required to produce general purpose financial statements


Users of general purpose financial statements (GPFSs)

• Once we have determined what a general purpose financial statement is and which entities are required to prepare them (reporting entities) the next issue to consider is who are expected to be the users of the general purpose financial statements

• In this regard, paragraph OB 5 of the IASB Conceptual Framework states:

Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide information directly to them and must rely on general purpose financial reports for much of the financial information they need. Consequently, they are the primary users to whom general purpose financial reports are directed

continued


Users of GPFSs (cont.)

• The definition of users provided in 2010 by the IASB can be contrasted with the definition provided in the former IASB Framework for the Preparation and Presentation of Financial Statements (1989). It had formerly defined users as encompassing investors, employees, lenders, suppliers, customers, government and their agencies, and the public.

• This former definition is therefore much broader than the definition now used by the IASB.

• Do we think that the definition of users is too restrictive? Why or why not?


Alternative perspective on the ‘users’ of GPFSs

• UK: The Corporate Report

– all groups impacted by an organisation's operations have rights to information about the reporting entity, not necessarily related to resource allocation decisions

– The above definition is much broader than the definition currently in use


Level of expertise expected of financial report readers• Once we have determined who are the users, we

then need to consider their level of accounting expertise

• Generally accepted that readers are expected to have some proficiency in financial accounting

• IASB Conceptual Framework (para. QC 32)

Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently. At times, even well-informed and diligent users may need to seek the aid of an adviser to understand information about complex economic phenomena.


Objectives of GPFR• Once we have considered issues such as:

– What is a general purpose financial statement?

– Which entities are required to produce GPFSs?

– Who are the perceived users of GPFSs ?

then the next issue to consider might be to determine what the objective of the GPFSs is

• Traditional objective was to enable outsiders to assess the stewardship of management

• Recent commonly accepted goal of financial reporting is to assist report users in their economic decision making

– less emphasis placed on the stewardship function

– more emphasis on decision usefulness


Objective embraced within the IASB Conceptual Framework

• According to the IASB Conceptual Framework released in September 2010: (paragraph OB2):

The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.

• Objective of decision usefulness can call into question the usefulness of historical cost information

continued


Objective embraced within the IASB Conceptual Framework (cont.)

• As we know from previous lectures, before we are prepared to accept the prescriptions provided by a normative theory (or the predictions or explanations provided by a positive theory) we must be satisfied with the underlying assumptions made within the model or theory

• Hence, if we reject the assumptions about the objective of general purpose financial reporting then we would be inclined to reject the prescriptions made despite how logical the balance of the framework may appear

• Is the objective (previous slide) too restrictive?


Qualitative characteristics of financial information

• To ensure financial information is useful for economic decision making, we need to consider the attributes or qualities that financial information should have

• The IASB Conceptual Framework identifies:– Fundamental qualitative characteristics

relevance faithful representation

– Enhancing qualitative characteristics comparability verifiability timeliness understandability


Fundamental qualitative characteristic: relevance

• Something is relevant if it influences decisions on the allocation of scarce resources

– if it is capable of making a difference in a decision

• For information to be relevant it should have:

– predictive value, and

– feedback (or confirmatory) value


Materiality• A limiting factor on the disclosure of relevant and

representationally faithful information is the notion of materiality

• An item is material if (IASB Conceptual Framework, para. QC 11)

omitting it or misstating it could influence decisions that users make on the basis of financial information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the information relates in the context of an individual entity’s financial report. Consequently, the Board cannot specify a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation.


Fundamental qualitative characteristic: faithful representation• The previous Conceptual Framework referred to

reliability rather than faithful representation

• According to paragraph QC12:

To be a perfectly faithful representation, a depiction would have three characteristics. It would be complete, neutral and free from error. Of course, perfection is seldom, if ever, achievable. The Board’s objective is to maximise those qualities to the extent possible.


Representational faithfulness —implications for traditional accounting

• Traditionally, the doctrine of conservatism and the acceptance of 'prudence' has been adopted

– bias towards understating asset values and overstating liabilities

• This doctrine is not consistent with notions of representational faithfulness


Which fundamental qualitative characteristic should be considered first?

• Paragraph QC 18 of the IASB CF states:

The most efficient and effective process for applying the fundamental qualitative characteristics would usually be as follows (subject to the effects of enhancing characteristics and the cost constraint, which are not considered in this example).

First, identify an economic phenomenon that has the potential to be useful to users of the reporting entity’s financial information.

Second, identify the type of information about that phenomenon that would be most relevant if it is available and can be faithfully represented.

Third, determine whether that information is available and can be faithfully represented. If so, the process of satisfying the fundamental qualitative characteristics ends at that point. If not, the process is repeated with the next most relevant type of information.


Balancing relevance and representational faithfulness

• Paragraph QC17 of the IASB Conceptual Framework states:

Information must be both relevant and faithfully represented if it is to be useful. Neither a faithful representation of an irrelevant phenomenon nor an unfaithful representation of a relevant phenomenon helps users make good decisions.


Costs versus benefits

• We also need to consider whether the cost of providing certain information exceeds the benefits to be derived from its provision

– costs include collection, storage, retrieval, presentation, analysis and interpretation

– benefits come from sound economic decision making by users

• Measuring potential costs and benefits involves a great deal of professional judgement


Enhancing qualitative characteristics• At the next level below the fundamental qualitative

characteristics are the ‘enhancing qualitative characteristics’

• There are four enhancing qualitative characteristics that useful financial information should possess:

• Comparability– implies there are advantages in restricting the number of accounting

methods that can be used

– but when promoting the virtues of ‘comparability’ we should consider issues associated with reducing the efficiency with which management can report results and financial position – the ‘efficiency perspective’

– particular accounting methods might be relevant when applied in some situations. Forcing ‘comparability’ will restrict the ability of management to use methods that might be relevant in a limited number of situations

continued


Enhancing qualitative characteristics (cont.)

• Verifiability

– refers to the ability, through consensus among measurers, to ensure that information represents what it purports to represent, or that the chosen method of measurement has been used without error or bias

continued


Enhancing qualitative characteristics (cont)

• Timeliness

– means having information available to decision-makers in time to be capable of influencing their decisions. Generally, the older the information is the less useful it is. However, some information may continue to be timely long after the end of a reporting period because, for example, some users may need to identify and assess trends

continued


Enhancing qualitative characteristics (cont.)

• Understandability

– In the IASB Conceptual Framework, information is considered to be ‘understandable’ if it is likely to be understood by users with some business and accounting knowledge

– this qualitative characteristic is perhaps best seen as a requirement (or challenge) for standard-setters to ensure that the accounting standards they develop for dealing with complex areas produce accounting disclosures that are understandable (irrespective of the complexity of the underlying transactions or events)

– Based on your knowledge of accounting practice, how successful do you think accounting standard-setters have been at meeting this challenge?


Weighting the relative importance of the four enhancing qualitative characteristics

• We now know that there are four enhancing qualitative characteristics that financial information should ideally possess

• The IASB Conceptual Framework notes that these characteristics can be weighted differently in different circumstances and for different transactions or events

• But without clear guidance there will obviously be a deal of subjectivity involved in seeking to provide useful financial information


Can GPFRs provide unbiased accounts of performance?

• The practice of accounting is heavily reliant on professional judgement

• Prior to accounting standards being released, standard-setters attempt to determine the economic consequences that might result following the implementation of the standards

– if they consider economic consequences, can accounting standards really be considered objective or neutral?

– does it matter?

continued


Can GPFRs provide unbiased accounts of performance? (cont.)

• If we accept the notion that preparers will be driven by self-interest (from PAT) notions of objectivity or neutrality are unrealistic

• Political nature of standard setting process also affects neutrality and objectivity

– the IASB considers various submissions from many (potentially ‘self-interested’) parties before finalising any accounting standard

• In communicating reality accountants construct reality (Hines 1988)

– that is, if accountants identify something and start to place a monetary value on it then it gains importance – it becomes visible (and 'real')

– conversely, if accountants ignore it – such as many externalities caused by business entities – then for many people the 'issue' does not exist


The elements of financial reporting

• The next building block of a conceptual framework would consider the definition and recognition criteria of the elements of financial reporting

• Definition criteria—what attributes are required before an item can be considered as belonging to a particular class of element

• Recognition criteria—employed to determine whether the item can be included in the financial statements


Five elements of financial reporting in the IASB Framework

• assets

• liabilities

• equity

• expenses

• income

– in the IASB Conceptual Framework, income is further subdivided into revenues and gains

– ten elements formerly identified in the US by FASB


Definition of assets

• Currently defined as

– '… a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity' (IASB Conceptual Framework, paragraph 4.4)

• Three key characteristics

– must be an expected future economic benefit

– the reporting entity must control the future economic benefit

– the transaction or other past event giving rise to the reporting entity's control must have occurred

continued


Definition of assets (cont.)

• The definition refers to the benefit and not its source

– in the absence of future economic benefits, the object or right will not qualify as an asset

• The benefits can result from ongoing use, not necessarily a value in exchange


The characteristic of control

• Control relates to the capacity to benefit from the asset and to deny or regulate others' access to the benefit

• Legal enforceability is not a prerequisite for establishing the existence of control

– control (and not legal ownership) is required, although controlled assets are frequently owned


Recognition of assets

• An asset—and all the other elements of accounting—shall be recognised when

– it is probable that any future economic benefit associated with the item will flow to or from the entity, and

– the item has a cost or value that can be measured with reliability (IASB Framework, para.83)

• Probable is generally considered to mean 'more likely rather than less likely'


'Current thinking' of the IASB in relation to assets• Within the 2013 discussion paper A Review of the

Conceptual Framework for Financial Reporting, released July 2013 it was noted that there were shortcomings with the existing asset definition. They stated:

– Some users misinterpret the terms 'expected' (IASB definition) to mean that there must be a high likelihood of future economic benefits for the definition to be met; this excludes asset items with a low likelihood of future economic benefits.

– The definitions place too much emphasis on identifying the future flow of economic benefits, instead of focusing on the item that presently exists, an economic resource.

continued


Current thinking about assets (cont.)

– Some users misinterpret the term 'control' and use it in the same sense as that used for purposes of consolidation accounting. The term should focus on whether the entity has some rights or privileged access to the economic resource

– The definitions place undue emphasis on identifying the past transactions or events that gave rise to the asset, instead of focusing on whether the entity had access to the economic resource at the balance sheet date

continued


Current thinking about assets (cont.)

• In its July 2013 discussion paper the IASB proposed the following definition for assets:

– …a present economic resource controlled by the entity as a result of past events

• An ‘economic resource’ is defined in the discussion paper as:

– A right, or other source of value, that is capable of producing economic benefits

• These definitions also seems to have limitations

• Some of the above terms seem rather ambiguous


Definition of liabilities

• A liability is presently defined as

– '… a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits' (IASB Conceptual Framework, para.4.4)

– present obligations not only refers to legally enforceable obligations but also those imposed by notions of equity and fairness, or by custom or other business practices


Recognition of liabilities

• Recognition criteria consistent with those of assets and the other elements of accounting

• A liability shall be recognised when:

– it is probable that the sacrifice of economic benefits will be required, and

– the amount of the liability can be measured reliably

• Has implications for disclosure of various provisions


Present thinking of the IASB and FASB in relation to liabilities• The IASB believes that the existing liability definition has

limitations:

– some users misinterpret the terms to mean that there must be a high likelihood of future outflow of economic benefits for the definition to be met; this excludes liability items with a low likelihood of a future outflow of economic benefits

– the definitions place too much emphasis on identifying the future outflow of economic benefits, instead of focusing on the item that presently exists, an economic obligation

– the definitions place undue emphasis on identifying the past transactions or events that gave rise to the liability, instead of focusing on whether the entity has an economic obligation at the reporting date

continued


Present thinking of the IASB and FASB in relation to liabilities (cont.)• In the 2013 discussion paper the IASB proposed the

following definition of a liability:

– A liability is a present economic obligation of the entity to transfer an economic resource as a result of past events.

• As with the proposed definition of assets, the suggested change in the liability definition could potentially have significant implications for financial reporting. For example:

– the above definition could act to exclude constructive or equitable obligations that are not enforceable against the entity. This would be a major departure from existing practice

– Would this be a good change?


Approaches to determining profit • In principle, there could be two broad approaches to

determining profits, these being the:

– ‘asset/liability approach’ which links profits to changes in assets and liabilities

– ‘revenue/expense approach’ which relies on concepts such as the matching principle

• The definition of expenses and revenues in the IASB Conceptual Framework is based on the asset/liability perspective


Definition of 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' (IASB Conceptual Framework, para. 4.25)


Recognition of expenses

• An expense shall be recognised when

– it is probable that the consumption or loss of future economic benefits resulting in a reduction in assets and/or an increase in liabilities has occurred, and

– the consumption or loss of economic benefits can be measured reliably


Definition of 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' (para. 4.25)

continued


Definition of income (cont.)

• Income can be recognised from normal trading relations, as well as from non-reciprocal transfers such as grants, donations, bequests or where liabilities are forgiven

• IASB Conceptual Framework further subdivides income into revenues and gains

– revenue arises in the course of the ordinary activities of an entity

– gains represent other items that meet the definition of income and may, or may not, arise in the ordinary activities of an enterprise

– not clear why there is a need to break income into two components


Recognition of income

• As with the other elements of accounting, income is recognised when:

– it is probable that the inflow or other enhancement or saving in outflows of future economic benefits has occurred; and

– the inflow or other enhancement or saving in outflows of future economic benefits can be measured reliably


Definition of equity

• Equity is defined as 'the residual interest in the assets of the entity after deducting all of its liabilities' (IASB Conceptual Framework, para.4.4)

• As a residual interest it ranks after liabilities in terms of claims against the assets

• Definition is a direct function of the definitions of assets and liabilities


Measurement principles• A VERY important issue

• According to IASB (2013) ‘measurement’ is the process of determining the amounts to be included in the financial statements.

• Until recently, conceptual frameworks of accounting have tended to provide very limited prescription in relation to measurement issues

• How we measure assets and liabilities has direct implication for income and expense recognition, and therefore for ‘profits’

• We currently have a mixed (or ‘eclectic’) approach to measurement

• Ideally, should we have one method of measurement or a variety of valuation approaches?


Latest IASB thinking on ‘measurement’• According to the IASB (2013):

– measuring all assets and liabilities on the same basis would result in all amounts in the financial statements having the same meaning, which would make totals and subtotals more understandable than those in financial statements prepared under existing requirements

• However, there are problems with this approach:

(a) measuring all assets and liabilities on a cost basis may not provide relevant information to users of financial statements. For example, a cost-based measurement is unlikely to provide relevant information about a financial asset that is a derivative

(b) for some assets and liabilities, some users of financial statements may consider information about current market prices to be less relevant than information about margins generated by past transactions. Measuring all assets and liabilities at a current market price may not provide users of financial statements with sufficient benefits to justify the costs of determining (or estimating) those prices continued


Latest IASB thinking on ‘measurement’ (cont.)

• The IASB’s preliminary view is that the Conceptual Framework should not recommend measuring all assets and liabilities on the same basis

• The IASB was of the view that using the one basis of measurement might not provide relevant information in relation to all assets

continued


Latest IASB thinking on ‘measurement’ (cont.)The IASB’s preliminary views in relation to assets are that:

(a) if assets contribute indirectly to future cash flows through use or are used in combination with other assets to generate cash flows, cost-based measurements normally provide information that is more relevant and understandable than current market prices

(b) if assets contribute directly to future cash flows by being sold, a current exit price is likely to be relevant

(c) if financial assets have insignificant variability in contractual cash flows, and are held for collection, a cost-based measurement is likely to provide relevant information

(d) if an entity charges for the use of assets, the relevance of a particular measure of those assets will depend on the significance of the individual asset to the entity

continued


Latest IASB thinking on ‘measurement’ (cont)

In relation to liability measurement, the IASB’s (2013) preliminary views are:

(a) cash-flow-based measurements are likely to be the only viable measurement for liabilities without stated terms.

(b) a cost-based measurement will normally provide the most relevant information about:

(i) liabilities that will be settled according to their terms; and

(ii) contractual obligations for services (performance obligations).

(c) current market prices are likely to provide the most relevant information about liabilities that will be transferred.

continued


Latest IASB thinking on ‘measurement’ (cont)IASB (2013) also made a number of other interesting recommendations in relation to measurement, for example:

•the number of different measurements used should be the smallest number necessary to provide relevant information. Unnecessary measurement changes should be avoided and necessary measurement changes should be explained; and

•the benefits of a particular measurement to users of financial statements need to be sufficient to justify the cost

After reflecting upon our discussion of ‘measurement’ we should now understand that there are many issues for the IASB to consider before it finalises the component of the Conceptual Framework that relates to measurement. It does appear that the prescription of one method of valuation (such as fair value) is very unlikely


Benefits associated with conceptual frameworks Developing a conceptual framework for financial reporting is a time-consuming and costly exercise – so why bother? Some justifications would include:

•Accounting standards should be more consistent and logical

•Increased international compatibility of accounting standards

•Standard-setters should be more accountable for their decisions

•Communication between standard-setters and their constituents should be enhanced

continued


Benefits associated with CFs (cont.)

• The development of accounting standards should be more economical

• Where conceptual frameworks cover a particular issue, there might be a reduced need for additional standards

• Emphasise the 'decision usefulness' role of financial reports rather than restricting concern to stewardship


Disadvantages of conceptual frameworks• Smaller organisations may feel overburdened by

reporting requirements

• Typically economic in focus, so ignore transactions that have not involved market transactions or exchange of property rights

– further reinforces the importance of economic performance relative to social performance

• Represent a codification of existing practice


CFs as a means of legitimising standard-setting bodies

• Some (e.g. Hines and Solomons) have suggested that CFs have been used as devices to help ensure the ongoing existence of the accounting profession

• Increase the ability of the profession to self-regulate, thus counteracting government intervention


Thoughts on ‘accountability’ as embraced by the IASB Conceptual Framework

• As we have noted the IASB appears to favour a decision usefulness perspective in which the decision making needs of existing and potential investors, lenders and other creditors are given priority over the information needs of other stakeholders

• This is a fairly restrictive perspective of accountability

• We can summarise the IASB’s apparent ‘accountability’ judgments by way of the diagram on the following slide

• So, to conclude this lecture, consider this diagram and think whether you agree with the apparent positions/decisions taken by the IASB and FASB


Accountability judgements made by the IASB and FASB

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