GODFREY HODGSON HOLMES TARCA CHAPTER 4 A CONCEPTUAL FRAMEWORK

The role of a conceptual framework A structured theory of accounting 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

The role of 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 reporting. FASB

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?

The role of a conceptual framework Benefits: consistent, logical reporting requirements greater compliance enhanced accountability fewer specific standards enhanced understanding of reporting requirements more economical standard setting

Objectives of conceptual frameworks Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit and similar decisions. FASB

Objectives of conceptual frameworks Information should be useful in making economic decisions useful in assessing cash flow prospects about enterprise resources, claims to those resources and changes in them

Objectives of conceptual frameworks

Developing a conceptual framework The development of conceptual frameworks is influenced by two key issues: principles versus rules-based approaches to standard setting information for decision making and the decision-theory approach

Principles-based and rule-based standard setting IASB mostly produces consistent, coherent principles-based standards Rule-based standards may increase comparability and verifiability and may reduce earnings management

Principles-based and rule-based standard setting The standards of the FASB have traditionally been rule-based Emphasis now being given to principles Timely given the IASB/FASB convergence program

Information for decision making and the decision-theory approach Accounting data are required for decision making or accountability purposes stewardship decision making users

Information for decision making and the decision-theory approach The decision-theory approach maps the process by which the outputs of the accounting system provide inputs to the decision model of a user

Information for decision making and the decision-theory approach Decision-theory process Overall theory of accounting Individual accounting system Prediction model of user Decision

International developments: the IASB and FASB Conceptual Framework In 2004 the FASB and IASB agree to undertake a joint project to: develop an improved, common conceptual framework goal of developing standards that are principles-based, internally consistent and internationally converged an Exposure Draft was produced - June 2009 deferred consideration of not-for-profit sector issues

International developments: the IASB and FASB Conceptual Framework ED has several contentious areas: entity vs proprietorship perspective primary user group decision usefulness and stewardship qualitative characteristics

International developments: the IASB and FASB Conceptual Framework Australia follows an approach whereby issues for both the not-for-profit and for-profit sectors are considered together Standards are intended to apply to both sectors IFAC’s International Public Sector Accounting Standards Board has begun a project to develop a public sector CF

A critique of conceptual framework projects Approaches to developing a CF: scientific recourse to logic and empiricism or both professional prescribes the best course of action by recourse to professional values

A critique of conceptual framework projects Scientific criticisms: prescriptive unspecified rules and conventions do not resolve contemporary disclosure issues vague definitions do not address measurement issues risk of mechanical decision making framework may become an end in itself overreliance on definitions

Ontological and epistemological assumptions Freedom from bias (neutrality) an information quality that avoids leading users to conclusions that secure the particular needs, desires or preconceptions of the preparers Solomons: freedom from bias as ‘financial mapmaking’ Feyerabend: scientific truth is not absolute Hines claims mainstream accounting is ‘taken-for-granted’

Circularity of reasoning Objective of a conceptual framework: guide the everyday practice of accountants A superficial view deducing principles from generalised theory Existing frameworks typified by internal circularity: e.g. FASB Statement No. 2 qualitative characteristics are often stated in terms of other qualities which are non-operationalised

An unscientific discipline Is accounting a science? prescriptive by nature and value laden Stamp 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.

Positive research Conceptual framework projects ignore the empirical findings of positive accounting research in conflict with each other Mounting evidence that capital markets are not efficient If the conceptual framework could ensure users receive useful information this would serve a useful purpose

The conceptual framework as a policy document As a generalised body of knowledge, conceptual frameworks fail a number of ‘scientific’ tests The distinction between theories and policies is important CFs not produced in a political vacuum CFs may just be a reflection of the dominant group’s will

Professional values and self-preservation implies the pursuit of self-interest ‘Professional values’ suggests idealism and altruism Gerboth sense of personal responsibility Hines professional legitimacy

Conceptual framework for auditing standards Auditing is a discipline based in logic The traditional verification role has evolved into business risk auditing

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 In auditing there has been a shift away from substantive testing toward the role of client business risk

Key terms and concepts Conceptual frameworks for accounting and auditing Statement of accounting concepts FASB and IASB Principles-based and rule-based standards Decision making and decision-theory Professional values and self-preservation Business risk auditing