1. Financial Accounting Theory Craig Deegan
Chapter 6
Normative theories of accounting—the case of conceptual framework projects
Slides written by Craig Deegan
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-1

2. Learning objectives In this chapter you will be introduced to:
the role that conceptual frameworks (CFs) can play in the practice of financial reporting
the history of the development of the various existing conceptual framework projects
the various building blocks that have been developed within various conceptual framework projects
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-2

3. Learning objectives (cont.)
perceived advantages and disadvantages that arise from the establishment and development of conceptual frameworks
recent initiatives being undertaken by the IASB and the FASB to develop an improved conceptual framework
factors, including political factors, that might help or hinder the development of conceptual framework projects
groups within society which are likely to benefit from the establishment and development of conceptual framework projects
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-3

4. What is a conceptual framework?
'A coherent system of interrelated objectives and fundamentals that is expected to lead to consistent standards' (Statement of Financial Accounting Concepts No. 1: Objectives of Financial Reporting by Business Enterprises 1978)
Attempts to provide a structured theory of accounting
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-4

5. Conceptual frameworks as normative theories
Conceptual frameworks provide prescription so they are considered normative theories of accounting
'Prescribes the nature, function and limits of financial accounting and reporting' (Statement of Financial Accounting Concepts No. 1: Objectives of Financial Reporting by Business Enterprises, 1978)
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-5

6. A revised conceptual framework
In recent years the FASB and IASB have been jointly working towards the development of an improved conceptual framework
In 2008 they released a document entitled: Exposure Draft of an improved Conceptual Framework for Financial Reporting
This phase of the project specifically addressed the objective of financial reporting and the qualitative characteristics and constraints of decision-useful financial reporting information.
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-6

7. Rationale for conceptual frameworks
To develop the practice of financial reporting logically and consistently we need to address 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;
what are the elements of financial reporting; and
what measurement rule should be employed.
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-7

8. Rationale for conceptual frameworks (cont.)
Proponents argue that without agreement on these issues accounting standards will be developed in an ad hoc manner
Limited consistency between accounting standards in the absence of a conceptual framework
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-8

9. The 'building blocks' of the conceptual framework
The framework must be developed in a particular order
some issues (or assumptions) need to be resolved or made before moving on to subsequent 'building blocks'
One obvious issue that needs early agreement would be what is meant by '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
The objective of financial reporting
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-9

10. The 'building blocks' of the conceptual framework (cont.)
Because the rest of the framework flows from assumptions about the 'objective', if we reject the assumption, then we personally might be prepared to reject the prescriptions provided by the framework
Refer to Figure 6.1 (p.213) in the text for an overview of the IASB Framework for the Preparation and Presentation of Financial Statements (which in 2005 replaced the Australian Conceptual Framework)
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-10

11. 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 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 unaddressed
Limited or no progress in recent years, although there is now a joint IASB/FASB project to develop a new and improved conceptual framework
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-11

12. 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-12

13. Development of frameworks of accounting in the US (cont.)
Led to formation of Trueblood Committee in 1971 which produced 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-13

14. 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 have been jointly working towards the development of a revised conceptual framework that would be used by both boards—referred to as the 'convergence project'
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-14

15. 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-15

16. Development of a CF in the UK (cont.)
1991: ASB adopted the IASC's CF
IASC framework was generally consistent with the US and Australian frameworks—subsequently became known as the IASB Framework
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-16

17. 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-17

18. 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 Framework as a result of the decision by the Financial Reporting Council that Australia would adopt IAS/IFRS by 2005
SAC 3 and SAC 4 were abandoned
SAC 1 and SAC 2 were retained until such time that a revised IASB Framework was developed
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-18

19. Current efforts of the IASB and the FASB
From 2005 the IASB and the FASB have been jointly working towards the development of a revised conceptual framework that will be used by both parties
The need for this revised framework has arisen 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-19

20. Current efforts of the IASB and the FASB (cont.)
The IASB and FASB are 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-20

21. Building blocks of the CF
The following discussion is based on the IASB Framework currently in place
Where appropriate, reference will also be made to current work being done by IASB and FASB given that this gives an indication of what might come in the future
Building blocks of the various CFs have addressed
definition of the reporting entity
objectives of general purpose financial reporting (GPFR)
perceived users of GPFRs
qualitative characteristics that GPFRs should possess
elements of financial statements
possible approaches to measuring the elements
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-21

22. Definition of the reporting entity
The Conceptual Framework provides a definition of entities required to produce GPFRs
known as reporting entities
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-22

23. General purpose financial reports
GPFRs are defined as reports
'… 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' (SAC 1, para.6)
GPFRs are reports that comply with accounting standards and other generally accepted accounting practices (GAAPs)
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-23

24. Special purpose financial reports
By contrast, special purpose reports are provided to meet the information demands of a particular user, or group of users
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-24

25. Entities required to produce GPFRs
Not all entities are classed as reporting entities
SAC 1 states that GPFRs should be prepared when there are users:
'… whose information needs have common elements, and those users cannot command the preparation of information to satisfy their individual information needs' (para.8)
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-25

26. Factors indicative of a reporting entity (SAC 1)
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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-26

27. Objectives of GPFR
Traditional objective was to enable outsiders to assess the stewardship of management
Recent commonly accepted goal of financial reporting is to assist report users' economic decision making
less emphasis placed on the stewardship function
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-27

28. Objective embraced within CFs
Objective of GPFRs in SAC 2 is deemed to be
to provide information to users that is useful for making and evaluating decisions about the allocation of scarce resources
Objective of decision usefulness calls into question usefulness of historical cost information
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-28

29. Other objectives of GPFRs
Another objective is to enable reporting entities to demonstrate accountability between the entity and those parties to which the entity is deemed accountable
Accountability is defined as
the duty to provide an account or reckoning of those actions for which one is held responsible
Accountability is not generally embraced by CFs
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-29

30. Current thinking of the IASB and FASB
In the 2008 conceptual framework exposure draft it is stated:
The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders and other creditors in making decisions in their capacity as capital providers. Information that is decision-useful to capital providers may also be useful to other users of financial reporting who are not capital providers.
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-30

31. Current thinking of the IASB and FASB (cont.)
As we know from previous lectures, before we are prepared to accept the prescriptions provided by a normative theory we must be satisfied with the underlying assumptions made
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 framework may appear
Is this objective (above) too restrictive?
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-31

32. Users of financial reports
SAC 2 identifies three primary user groups for GPFRs
resource providers
employees, lenders, creditors, suppliers, investors and contributors
recipients of goods and services
customers and beneficiaries
parties performing review or oversight function
parliaments, governments, regulatory agencies, analysts, labour unions, employer groups, media and special interest groups
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-32

33. International perspectives on users of GPFRs
The IASB Framework
identifies GPFRs users as investors, employees, lenders, suppliers, customers, govt. agencies and the public
states that information designed to meet the needs of investors will usually meet the needs of the other groups
US: SFAC 1
main focus is present and potential investors and other users with either a direct financial interest or related to those with a direct financial interest
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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-33

34. Level of expertise expected of financial report readers
Generally accepted that readers are expected to have some proficiency in financial accounting
IASB Framework (para.25)
… users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-34

35. Current thinking of the IASB and the FASB in relation to 'users'
The 2008 exposure draft stated:
The primary user group includes both present and potential equity investors, lenders and other creditors, regardless of how they obtained, or will obtain, their interests…. Other users who have specialised needs, such as suppliers, customers and employees (when not acting as capital providers), as well as governments and their agencies and members of the public, may also find useful the information that meets the needs of capital providers; however, financial reporting is not primarily directed to these other groups because capital providers have more direct and immediate needs
Is this perspective of 'users' too restrictive?
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-35

36. Qualitative characteristics of financial reports
To ensure financial information is useful for economic decision making, we need to consider the attributes or qualities that financial information should have
According to IASB Framework
primary qualitative characteristics are understandability, relevance, reliability and comparability
related to relevance is materiality
IASB Framework appears to give greater prominence to relevance and reliability
there are issues associated with the 'trade-off' between relevance and reliability
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-36

37. Reliability
Information is considered to be reliable if it 'faithfully represents' the entity's transactions and events
Should be free from bias and undue error
Reliability is a function of representational faithfulness, verifiability and neutrality
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-37

38. Reliability—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 reliability or freedom from bias
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-38

39. 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 value
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-39

40. Materiality
A limiting factor on the disclosure of relevant and reliable material is the notion of materiality
An item is material if (IASB Framework, para. 30)
... its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements …. Materiality provides a cut-off rather than being a primary qualitative characteristic which information must have if it is to be useful
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-40

41. Uniformity and consistency
Uniformity and consistency imply advantages in restricting the number of accounting methods that can be used by reporting entities
has been argued that firms adopt particular accounting methods because they best reflect their underlying performance
restricting available methods imposes costs on reporting entities
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-41

42. Costs vs. benefits
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 professional judgement
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-42

43. Latest thinking of the IASB and the FASB regarding qualitative characteristics
In the 2008 exposure draft released as part of the conceptual framework project it is stated:
For financial information to be useful, it must possess two fundamental qualitative characteristics—relevance and faithful representation.
The draft conceptual framework has reduced the four 'primary qualitative characteristics' to two 'fundamental qualitative characteristics'
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-43

44. Latest thinking of the IASB and the FASB regarding qualitative characteristics (cont.)
The qualitative characteristic of reliability was replaced by 'faithfully representation'
The other two primary qualitative characteristics identified in the IASB Framework, these being understandability and comparability, have been renamed as 'enhancing qualitative characteristics' in the draft document released by the IASB
Two additional 'enhancing qualitative characteristics' have also been included (thereby giving a total of four enhancing qualitative characteristics), these being verifiability and timeliness
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e

45. 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 of following the standards
if they consider economic consequences then standards cannot be considered objective or neutral
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-45

46. Can GPFRs provide unbiased accounts of performance? (cont.)
If we accept the notion that preparers will be driven by self-interest (from Positive Accounting Theory) notions of objectivity or neutrality are unrealistic
Political nature of standard setting process also affects neutrality and objectivity
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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-46

47. The elements of financial reporting
The next building block considers 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-47

48. Five elements of financial reporting in the IASB Framework
Assets
Liabilities
Equity
Expenses
Income
in the IASB Framework, income is further subdivided into revenues and gains
ten elements identified in the US by FASB
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-48

49. Definition of assets
'… 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 Framework, para.49(a))
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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-49

50. 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-50

51. 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-51

52. 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'
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-52

53. 'Current thinking' of the IASB and FASB in relation to assets
Within the 2008 exposure draft the IASB and FASB thought there were shortcomings with the existing asset definition. They stated:
Some users misinterpret the terms 'expected' (IASB definition) and 'probable' (FASB 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.
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.
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-53

54. Current thinking about assets (cont.)
The IASB and FASB developed the following draft definition:
An asset of an entity is a present economic resource to which, through an enforceable right or other means, the entity has access or can limit the access of others
This definition also seems to have limitations
Some of the above terms seem rather ambiguous
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-54

55. 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 Framework, para.49(b))
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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-55

56. 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-56

57. Present thinking of the IASB and FASB in relation to liabilities
According to the exposure draft released in 2008 the IASB and FASB believe that the existing liability definition has limitations:
Some users misinterpret the terms 'expected' (IASB definition) and 'probable' (FASB definition) 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-57

58. Present thinking of the IASB and FASB in relation to liabilities (cont
The IASB and FASB proposed the following draft definition of a liability:
A liability of an entity is a present economic obligation that is enforceable against the entity.
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?
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-58

59. Approaches to determining profit
Two common approaches to determining profits
asset/liability approach links profit to changes in assets and liabilities
revenue/expense approach relies on concepts such as the matching principle
The definition of expenses and revenues in the CF based on asset/liability perspective
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-59

60. 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 Framework, para.70(b))
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-60

61. 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-61

62. 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' (SAC 4, para.70(a))
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-62

63. 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 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-63

64. 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.
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-64

65. Definition of equity
Equity is defined as 'the residual interest in the assets of the entity after deducting all of its liabilities' (IASB Framework, para.49(c))
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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-65

66. Measurement principles
To date there is very little prescription in relation to measurement provided by CFs
FASB statement provides description of various approaches to measuring elements without providing prescription
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-66

67. Current IASB and FASB work on measurement issues
In 2005 the IASB and FASB stated:
Measurement is one of the most underdeveloped areas of the two frameworks Both frameworks (the IASB and FASB Frameworks) contain lists of measurement attributes used in practice. The lists are broadly consistent, comprising historical cost, current cost, gross or net realizable (settlement) value, current market value, and present value of expected future cash flows. Both frameworks indicate that use of different measurement attributes is expected to continue. However, neither provides guidance on how to choose between the listed measurement attributes or consider other theoretical possibilities. In other words, the frameworks lack fully developed measurement concepts.
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-67

68. Current IASB and FASB work on measurement issues (cont.)
Phase C of the joint IASB and FASB Conceptual Framework Project is to address measurement issues. In this work the IASB and FASB have identified nine potential measurement bases, these being: past entry price, past exit price, modified past amount, current entry price, current exit price, current equilibrium price, value in use, future entry price, and future exit price
It is expected that it will be a number of years before any conclusion is reached about the most appropriate measurement basis for assets and liabilities
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e

69. Benefits associated with conceptual frameworks
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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-69

70. 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-70

71. 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-71

72. 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
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
Copyright  2009 McGraw-Hill Australia Pty Ltd PPTs t/a Deegan, Financial Accounting Theory 3e
6-72