Concepts – Evolution of a Global Conceptual Framework Chapter 10 Concepts – Evolution of a Global Conceptual Framework

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.

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 problems Later standards aimed at transparency for investors Emphasis on provision of information useful for making economic decisions Reliability of information only apparent if management changes.

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.

Framework content Objectives of General Purpose Financial Reports (GPFRs) Qualitative characteristics of information Assumptions underlying preparation of financial statements Influences on preparation of statements Definition, recognition and measurement of accounting elements

Concepts of Accounting

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.

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

Qualitative Characteristics

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

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

Influences on Qualities Need to balance between characteristics Relevance – timely Reliable – verifiable and 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

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

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

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

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 using monetary amounts at which the elements are to be recognised and reported. A number of measurement bases can be used including: Historical cost Current cost Net realisable (settlement) value Present value (discounted)

Conceptual framework – IASB-FASB 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.

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.

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.

Discussion points 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 (Continued) 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.

Review questions ‘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.