Corporate Financial Reporting I Lecture 4 The IASB Conceptual Framework

Aims and Outcomes Aims: This lectures aims to introduce you to the conceptual framework of financial reporting adopted by the IASB and the ASB. Learning outcomes: After the lecture and recommended reading students should be able to: State and explain the contents of the IASB Framework and compare and contrast it with the ASB Statement of Principles Discuss the usefulness and validity of a number of criticisms of these frameworks

What is a conceptual framework? ‘.. a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function and limits of financial accounting and financial statements’ (FASB, 1967)

How has such a framework developed in the UK? The Corporate Report (1975) ICAS (1988) ‘Making Corporate Reports Valuable’ Solomons (1989) ‘Guidelines for Financial Reporting Standards’ ASB (1999) ‘Statement of Principles for Financial Reporting’ From 2005 UK financial reporting will be influenced by IASC (1989) Framework for the Presentation and Preparation of Financial Statements Similar developments have also taken place in the USA, Australia, Canada and New Zealand.

Advantages/Disadvantages of a Conceptual Framework A conceptual framework of accounting would provide the following features: There would be less of a patchwork quilt feel to accounting information Issues can be ranked There would be scope for less political interference e.g. British Aerospace and SSAP12 We would be able to see the overall picture of accounting and accounting information Maybe we would be able to satisfy the needs of all user groups? There might be a need for multiple conceptual frameworks? Whilst a conceptual framework might not make accounting standard setting and implementation easier, it would add a set of guidelines and procedures that would make those processes more certain

The Pro Lobby Without a framework, rational debate cannot occur because positions about the appropriate accounting treatment for a given transaction can neither be defended nor refuted, the appropriate treatment is simply "in the eye of the beholder." The credibility of financial reporting is enhanced when objectives and concepts are used to provide direction and structure to financial accounting and reporting. The framework helps by leading to the development of standards that are not only internally consistent but also consistent with each other. As a result, both preparers and users of financial statements benefit from financial statements that are based on a body of standards that is more internally consistent and less ad hoc. (Charles Horngren)

The objectives of financial statements The Statement of Principles defines the objective of financial statements as: “to provide information about the reporting entity’s financial performance and financial position that is useful to a wide range of users for assessing the stewardship of management and for making economic decisions.” This definition provides the basis for developing all the subsequent principles within the Statement. Fundamentally, the Statement assumes that it can achieve this objective by focusing on the information needs of present and potential investors. This is because they need information about the organisations financial performance and financial position that is useful to them in evaluating its ability to generate cash, and in assessing its financial adaptability

Anthony Hopwood’s view The UK was very late in following the fashion of having a conceptual framework Questioned to what extent the ASB was simply acquiring part of the trappings of Anglo-Saxon standard setting long after such a tool had ceased to be thought relevant other than for symbolic purposes.

More against lobbyists `It is hard for people to get to grips with documents like the Statement of Principles, because it's very abstract, but in the last two years the ASB has proposed several standards that apply the concepts in it, and they give some funny answers in practice Ron Paterson, Head of Ernst & Young's Technical Services Department (5/98)

The users of financial statements IAS 1(1974) Disclosure of Accounting Policies Shareholders, financial analysts Creditors and suppliers Employees, trades unions Customers Statisticians, economists and taxing and regulatory authorities Framework for the Preparation and Presentation of Financial Statements Investors and their advisors Lenders, suppliers and other trade creditors Employees and their representative groups Governments and their agencies The public

IASB Framework for the Preparation and Presentation of Financial Statements (and the ASB Statement of Principles) Amendments The Objective of Financial Statements The objective of financial statements is to provide information about financial performance and position that is useful to a wide range of users for assessing the stewardship of management, and making economic decisions Gives priority to the investor group Their needs are to be met by general purpose financial statements financial performance financial position generation and use of cash financial adaptability

Amendments The Reporting Entity Financial statements report on all activities and resources under the control of the entity The Qualitative Characteristics of Financial Information Financial information is useful if it is: Relevant Reliable Comparable Understandable Material (threshold)

Amendments The elements of financial statements Reflecting transactions and events involves classification and aggregation into the various elements of financial statements. These are : Assets Liabilities Ownership interest Gains Losses Contributions from Owners Distributions to Owners

Amendments Recognition in Financial Statements Recognition – depicting in words and monetary amounts the effects that transactions and events have on the elements. Assets/liabilities recognition requires: sufficient evidence of existence measurement at a monetary amount with sufficient reliability There are three stages to recognition: initial recognition subsequent remeasurement derecognition When deciding on initial recognition there are two categories of uncertainty: element uncertainty measurement uncertainty

Amendments Measurement in Financial Statements Measurement - assigning a monetary carrying amount Selecting a measurement basis historic cost current value Determining the monetary amount under that basis on initial recognition this will be the same under both bases Revising monetary amounts where appropriate under historic cost to the lower of depreciated historical cost and recoverable amount under current value revision should follow ‘value to the business’ rules The Statement envisages the adoption of a mixed measurement system

Amendments Presentation of financial information Discusses the aggregation and classification of information and gives details of good presentation practices Accounting for interests in Other Entities Discusses how interests in other entities should be fully reflected in the financial statements, particularly with respect to differences between single entity statements and consolidated statements

Some possible issues Context issues: Status of the Statement/Framework Relationship with the law Content issues: Objectives - may conflict Principles - may conflict Elements and Recognition – the balance sheet emphasis Measurement – the role of current value Presentation - performance statements What would the standard setters’ response be?

A model for considering the several regulatory frameworks of financial reporting (Alexander 1999) The regulatory framework for financial reporting suggests that there are several levels of concept. These could be summarised as: Type A: The ultimate purpose of accounting e.g. true and fair view or present fairly Type B: A series of derivative concepts and conventions e.g. those related to relevance and reliability etc. in the SoP/Framework, or the 5 principles contained within the Companies Act Type C: Detailed technical rules of how to recognise, measure and present assets, liabilities, equity, revenues, expenses, cash flows and various related disclosures as found in various IASs/IFRS, SSAPs/FRSs and in the Companies Act Alexander (1999) argues for the pre-eminence of Type A concepts, because Type B concepts are inconsistent and such inconsistencies would then be reflected in Type C rules resulting in inconsistent financial reporting. Given international differences in accounting is this sensible?

Type A pre-eminence A Type A concept would be used: to guide standard setters when making Type C rules to guide preparers of financial statements and auditors in interpreting Type B concepts and Type C rules to guide preparers of financial statements and auditors in the absence of Type C rules to require preparers of financial statements to sometimes make extra disclosures in order to achieve the Type A concept in exceptional circumstances to require preparers of financial statements to depart from Type C rules in order to achieve the Type A concept The latter ‘override’ makes sense – allowing an override of detailed rules in order to meet an overall objective – but it does raise the possibility of allowing preparers of financial statements to evade the rules that they do not like. Should we therefore restrict the override only to the preparers of the Type C rules (the standards setters) rather than to the preparers of financial statements (company directors)?