ACT301 Week 5 Tutorial

Chapter 6: Normative theories of accounting: the case of

conceptual framework projects

6.1 A conceptual framework of accounting can be considered to be a normative

theory of accounting. A conceptual framework makes prescriptions in regards to
what the objectives of accounting are, what qualitative characteristics general-
purpose financial information should possess, how the elements of accounting
should be defined and when they should be recognised and how the elements of
accounting should be measured.

Within the United States, the conceptual framework has been defined as ‘a
coherent system of interrelated objectives and fundamentals that is expected to
lead to consistent standards’. It is further stated that the conceptual framework
‘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).

In May 2008, an exposure draft entitled Exposure Draft of an Improved

Conceptual Framework for Financial Reporting was released jointly by the IASB
and FASB and, according to the exposure draft, the conceptual framework is:

a coherent system of concepts that flow from an objective. The objective of

financial reporting is the foundation of the framework. The other concepts
provide guidance on identifying the boundaries of financial reporting;
selecting the transactions, other events and circumstances to be
represented; how they should be recognised and measured (or disclosed);
and how they should be summarised and communicated in financial
reports.

As this definition indicates, the objective of financial reporting is the

fundamental building block for the conceptual framework being developed by
the IASB and the FASB. Hence, if particular individuals or parties disagreed
with the objective identified by the IASB and the FASB, they would most likely
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 disagree with the various prescriptions provided within the revised conceptual
framework.

6.2 The view often promoted by various advocates of conceptual framework

projects is that it is difficult and perhaps illogical to develop systems of financial
accounting if we do not initially agree on important issues such as what general
purpose financial reporting is, what the objective of a general purpose financial
reporting system is and in relation to this, what the qualitative characteristics of
the information generated from that system should be. Further, to make the
system consistent we need to agree on how we define, recognise and measure
the elements of that system. The view taken is that there are a number of
building blocks involved in developing a logical system of accounting and that a
conceptual framework develops such building blocks in a logical order. For
example, we initially need some consensus on the definition of general purpose
financial reporting and of a reporting entity, before we can consider the objective
of financial reporting. Once we have considered the objective of financial
reporting we can then consider defining the qualitative characteristics of
financial reporting, as well as how to define the elements of financial reporting
and so forth.

Without some consensus on issues such as those mentioned above, it is likely

that the development of rules of accounting (assuming that we need rules) will
be undertaken in a rather piecemeal manner with limited consistency between
the various rules (which raises another issue: do we need consistency?). This
inconsistency appeared to be the case in many countries prior to the
development of conceptual frameworks. There was a great deal of inconsistency
between the various standards in terms of definitions (often implied) of the
elements of accounting, as well as inconsistencies in determining when the
elements should be recognised and how they should be measured. With a
conceptual framework, the accounting standards are expected to be more
consistent.

Across time, the accounting profession attracted a great deal of criticism for the
lack of agreement on key issues—so from a ‘legitimacy’ perspective, the
profession probably needed a conceptual framework.
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6.10 Both relevance and faithful representation are considered in the IASB
Conceptual Framework as ‘fundamental qualitative characteristics’ that financial
information should possess. If something is not considered to be relevant (that is,
if it is not likely to influence decisions about the allocation of scarce resources)
then one view is that the item does not really need to be disclosed, perhaps
regardless of whether it is representationally faithful or not.

However, if something is considered to be relevant to financial statement

readers, which obviously is a matter of judgement, then people are considered
likely to act on the information. It would be important that the information
faithfully represents the underlying transaction or event to which it relates
(which implies it is free from bias and undue error).

Hence, we could perhaps argue that representational faithfulness is particularly

important if an item is considered relevant, however, if it is not considered to be
relevant then it probably does not matter whether the item is representationally
faithful or not given that people might not be expected to act on it in either case.
Therefore, logically, we might argue that the initial characteristic to consider is
whether the information is likely to be relevant. Does this sound logical? By
contrast to this argument, it would appear that the IASB proposes that both
attributes must be considered at the same time. As 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.

6.20 The Corporate Report embraced a broader notion of accountability, rather than a
notion of decision usefulness. The view of the authors of The Corporate Report
was for organisations to not have any absolute right to exist within the
community and that those organisations that are given ‘permission to operate’
have a related obligation, or responsibility, to provide information about their
financial performance to members of the community in which they operate. This
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 notion of who were deemed to be the target of the disclosures was wider than
that adopted within other attempts to develop a conceptual framework. Most
other frameworks emphasise the information needs of parties with a direct
financial interest. For example the FASB framework emphasised the information
needs of ‘present and potential investors and creditors and other users in making
rational investment, credit and similar decisions’. This is similar to the position
taken within the IASB Conceptual Framework.

The former Australian Conceptual Framework—which was superseded by the

IASB Framework—emphasised the needs of ‘resource providers, recipients of
goods and services, and parties performing a review or oversight function’.
While the Australian definition of ‘users’ was broader than the United States’
position, it was narrower than the position proposed in the United Kingdom by
The Corporate Report.

6.28 Moves towards standardisation of accounting standards and also conceptual

frameworks imply a one-size-fits-all approach. As we know, this is a goal of the
IASB. Chapter 4 referred to the work of different researchers who have shown
that previous international differences in accounting standards (prior to the
efforts for international standardisation) can potentially be explained by
international differences in culture, religion and business ownership and
financing systems. The view provided by a good deal of the research indicates
that underlying differences in how people think and how they conduct their
business in turn impacts the information they require (which seems a reasonable
proposition). A number of researchers have explicitly questioned the relevance
of ‘Western-style’ accounting standards to the needs of people within
developing countries, or the relevance of ‘Anglo-American’ standards in
‘continental European’ countries.

As we know, the standard-setting process in many countries is a political process

(or perhaps ‘was’, given that domestic standard-setters are increasingly being
replaced by the IASB) in which the standard-setters invite submissions from
constituents as part of the due process of developing accounting standards. The
submissions are considered to influence the contents of the final standards.
When developed in this manner, accounting standards developed in one country
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tended to be different to standards developed in other countries. For many years
such differences were accepted as being reasonable however, such differences
no longer appear to be considered as ‘reasonable’ (particularly to parties such as
the IASB).

If we accept that people in different countries have different values and

consequently different information needs, then it is perhaps somewhat naïve to
expect that one system of accounting will meet the needs of all people within all
countries. Nevertheless, work towards international standardisation is ongoing.
Obviously those organisations that are pushing for standardisation in accounting
across the world (for example the IASB) do not consider that different people, of
different cultures and religions, require different information.