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Learning objectives
Chapter 10
Regulation and the
Conceptual Framework
©2018 John Wiley & Sons Australia Ltd
Learning objectives
10.4 describe the objectives of general purpose
financial reporting under the Conceptual
Framework
10.5 identify the qualitative characteristics for the
selection and presentation of financial
information
10.6 define assets, liabilities, equity, income and
expenses, as established under the Conceptual
Framework
Regulation and development of accounting
standards
• Brief history of regulation:
– As new types of transactions evolved in business,
accountants developed rules and practices for
recording them.
– These accounting practices came to be known as
generally accepted accounting principles (GAAP).
– GAAP consist of rules, practices and procedures,
the authority of which stems from their general
acceptance and use by the accounting profession
and the business community.
After studying this presentation you should be able to:
10.1 explain the nature of the Conceptual Framework
for Financial Reporting, and the history of the
development of the framework
10.2 describe the nature of a reporting entity under
the Conceptual Framework
Learning objectives
10.7 describe the recognition criteria, established in
the Conceptual Framework, for assets,
liabilities, income and expenses
10.8 explain the importance of measurement in the
preparation of financial statements.
Regulation and development of accounting
standards
• International Accounting Standards Board (IASB):
– The IASC issued accounting standards over a
27‐year period until it was replaced in 2001 by the
IASB.
– The main reason for replacement was that the
IASC’s standards allowed too many alternatives
and it was felt that international accounting
standards should be of a higher quality if they
were to be accepted and used for the purpose of
listing a company’s shares on securities exchanges
around the world.
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Regulation and development of accounting
standards
• The IFRS Interpretations Committee:
– The mandate of the committee is to ‘review on a
timely basis widespread accounting issues that
have arisen within the context of current IFRS and
to provide authoritative guidance on those issues’.
– The interpretations cover:
• Newly identified financial reporting issues not
specifically covered by international financial
reporting standards (IFRS) issued by the IASB.
Regulation and development of accounting
standards
• The IFRS Interpretations Committee:
– Australia’s AASB adopted the interpretations
issued by the IFRS Interpretations Committee for
use by companies in this country as from 1
January 2005.
Regulation and development of accounting
standards
• Financial Accounting Standards Board (FASB):
– The FASB and IASB had reaffirmed in June 2010
(see the FASB and IASB websites) their
commitment to improving and converging their
respective accounting standards.
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Regulation and development of accounting
standards
• The IFRS Interpretations Committee:
– Issues where unsatisfactory or conflicting
interpretations have developed, or are likely to
develop in the absence of authoritative guidance,
to try to reach consensus on the appropriate
treatment.
Regulation and development of accounting
standards
• Financial Accounting Standards Board (FASB):
– The aim was to agree on high‐quality solutions to
existing and future accounting issues and to
converge their existing standards as soon as was
practicable.
– The FASB is also subject to the directions of the
SEC in the United States.
Regulation and development of accounting
standards
• The Asian‐Oceanian Standard‐Setters Group
(AOSSG):
– The memorandum specified the following
objectives:
• Promoting the adoption of and convergence
with IFRS by jurisdictions in the region.
• Promoting consistent application of IFRS in the
region
• Coordinating input from the region to the
technical activities of the IASB.
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Regulation and development of accounting
standards
• The Asian‐Oceanian Standard‐Setters Group
(AOSSG):
– The memorandum specified the following
objectives:
• Cooperating with governments and regulators
and other regional and international
organisations to improve the quality of financial
reporting.
The Conceptual Framework
• It was hoped that development of a conceptual
framework for financial reporting would enable
regulators to:
– Develop standards that were consistent and
logically formulated.
– Provide guidance to accountants in areas where
no standards existed.
The Conceptual Framework
• Background to the development of the Conceptual
Framework:
– Step 1:
• Define the boundaries of financial reporting in
that the conceptual framework was to deal
only with general purpose financial reporting.
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The Conceptual Framework
• The effectiveness of decision makers is enhanced if
they have information that has several important
characteristics.
• Accounting standards are continually being reviewed
and revised to keep up with the increasing
complexity of economic activity, both in Australia and
at international level.
The Conceptual Framework
• It was hoped that development of a conceptual
framework for financial reporting would enable
regulators to:
– Enable users of financial reports to understand
better the standards developed.
– These aims of the Conceptual Framework are
similar to those outlined by the IFRS as part of the
Conceptual Framework project.
The Conceptual Framework
• Background to the development of the Conceptual
Framework:
– Step 2:
• Define the reporting entity.
• This second step established the criteria by
which a reporting entity is recognised to exist,
in order to determine which entities should
prepare general purpose financial reports.
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The Conceptual Framework
• Background to the development of the Conceptual
Framework:
– Step 3:
• Establish the objectives of general purpose
financial reporting. This step also identified the
users of financial reports, their information
needs, and the types of reports which best
meet those needs.
The reporting entity
• The purpose of SAC 1 Definition of the Reporting
Entity is to define and explain the concept of a
reporting entity, and to establish a benchmark for
the minimum required quality for financial reporting
by such an entity.
The reporting entity
• Tiers 1 and 2 differential reporting requirements:
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The Conceptual Framework
• Background to the development of the Conceptual
Framework:
– Step 4:
• Used the broad framework established in the
first three steps to develop the qualitative
characteristics of financial information the
elements of the reporting processes and
recognition and measurement of those
elements.
The reporting entity
• SAC 1 suggests a number of indicators to help assess
when dependent users exist and hence when an
entity is a reporting entity.
– Separation of management from economic
interest.
– Economic or political importance/influence.
– Financial characteristics.
Objectives of general-purpose financial
reporting
• The IASB’s Conceptual Framework points out that
general purpose financial reports do not, and cannot,
provide all of the information needs of users.
• Users must consider pertinent information from
other sources.
– For example, general economic conditions and
expectations, political events and political climate,
and industry and company outlooks.
• Information about a reporting entity’s financial
performance is also useful.
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Qualitative characteristics of financial
information
• The IASB’s Conceptual Framework asserts that there
are six main qualitative characteristics that financial
information should have in order to be the subject
matter of general purpose financial reports.
Qualitative characteristics of financial
information
• Fundamental characteristics:
– Relevance:
• Financial information must have a quality that
makes a difference in a decision of an economic
nature made by users.
– Faithful representation:
• For a complete faithful representation,
information must be complete, neutral and free
from material error.
Qualitative characteristics of financial
information
• Enhancing qualitative characteristics:
– Verifiability:
• It means that different knowledgeable and
independent observers could reach consensus,
although not necessarily complete agreement,
that a particular piece of information is a
faithful representation of the economic
phenomena.
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Qualitative characteristics of financial
information
• The six main qualitative characteristics:
– relevance
– faithful representation
– comparability
– verifiability
– timeliness and understandability.
Qualitative characteristics of financial
information
• Enhancing qualitative characteristics:
– Comparability:
• Comparability is the qualitative characteristic
that enables users to identify and understand
similarities in, and differences among, items.
Qualitative characteristics of financial
information
• Enhancing qualitative characteristics:
– Timeliness:
• Timeliness simply means having information
available to decision makers in time to be
capable of influencing their decisions.
– Understandability:
• Understandability, however, does not
necessarily imply simplicity.
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Qualitative characteristics of financial
information
• The cost constraints on relevant, faithfully
representative information:
– Reporting financial information imposes costs, and
it is important that those costs are justified by the
benefits of reporting that information.
– Costs could include those of collection, storage,
retrieval, presentation, analysis and
interpretation, and loss of competitive position,
most of which are incurred by the reporting entity.
Definition of elements in financial
statements
• Assets in the current Conceptual Framework:
– An asset is defined in the current Conceptual
Framework as ‘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’.
– For instance, assets are normally acquired at a
cost incurred by the entity, but it is not essential
that a cost is incurred in order to determine the
existence of an asset.
Definition of elements in financial
statements
• Liabilities in the current Conceptual Framework:
– 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.
– A present obligation needs to be distinguished
from a future commitment.
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Definition of elements in financial
statements
• The Conceptual Framework provides definitions of
important elements underlying general purpose
financial reports, namely:
– assets
– liabilities
– equity
– income
– expenses.
Definition of elements in financial
statements
• Assets in the proposed framework:
– In the Exposure Draft of the IASB Conceptual
Framework, the proposed definition of an asset is
as follows:
• An asset is a present economic resource
controlled by the entity as a result of past
events.
– Further, an economic resource is defined as:
• An economic resource is a right that has the
potential to produce economic benefits.
Definition of elements in financial
statements
• Liabilities in the proposed framework:
– The IASB and FASB suggest that the definition of a
liability should change by focusing on a liability as
an enforceable ‘economic obligation’ or present
‘economic burden’ rather than an expected future
sacrifice of economic benefits.
• A liability is a present obligation of the entity to
transfer an economic resource as a result of
past events.
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Definition of elements in financial
statements
• Equity in the current Conceptual Framework:
– The Conceptual Framework defines equity as ‘the
residual interest in the assets of the entity after
deducting all its liabilities’.
• Equity = Assets − Liabilities
– The Conceptual Framework Exposure Draft issued
by the IASB has not proposed a new definition of
equity.
Definition of elements in financial
statements
• Income in the current Conceptual Framework:
– Gains are usually disclosed in the income
statement net of any related expenses, whereas
revenues are reported at a gross amount.
Recognition of the elements
• Recognition means the process of incorporating in
the statement of financial position/balance sheet or
income statement an item that meets the definition
of an element.
• It involves the inclusion of dollar amounts in the
entity’s accounting system.
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Definition of elements in financial
statements
• Income in the current Conceptual Framework:
– The Conceptual Framework defines income as:
• 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.
Definition of elements in financial
statements
• Expenses in the current Conceptual Framework:
– The definition of expenses in the Conceptual
Framework is as follows:
• 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.
Recognition of the elements
• Asset recognition in the current Conceptual
Framework:
– An asset is to be recognised only when both the
probability and the reliable measurement criteria
are satisfied.
– The term ‘probability’ refers to the degree of
certainty that the future economic benefits will
flow to the entity.
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Recognition of the elements
• Asset recognition in the current Conceptual
Framework:
– In practice, reliable measurement of internally
generated goodwill has been difficult, and
therefore such goodwill has not been recognised
as an asset.
Recognition of the elements
• Asset and liability recognition in the proposed
framework:
– An entity recognises an asset or a liability (and any
related income, expenses or changes in equity) if
such recognition provides users of financial
statements with:
• Relevant information about the asset or the
liability and about any income, expenses or
changes in equity.
Recognition of the elements
• Asset and liability recognition in the proposed
framework:
– An entity recognises an asset or a liability (and any
related income, expenses or changes in equity) if
such recognition provides users of financial
statements with:
• Information that results in benefits exceeding
the cost of providing that information.
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Recognition of the elements
• Liability recognition in the current Conceptual
Framework:
– The Conceptual Framework states that a liability is
recognised in the statement of financial
position/balance sheet when it is probable that an
outflow of resources embodying economic
benefits will result from settling the present
obligation and the amount at which the
settlement will take place can be measured
reliably.
Recognition of the elements
• Asset and liability recognition in the proposed
framework:
– An entity recognises an asset or a liability (and any
related income, expenses or changes in equity) if
such recognition provides users of financial
statements with:
• A faithful representation of the asset or the
liability and of any income, expenses or
changes in equity.
Recognition of the elements
• Income recognition in the current Conceptual
Framework and standards:
– Income is recognised in the income statement
when an increase in future economic benefits
relating to an increase in an asset or decrease in a
liability can be measured reliably.
– Separate recognition criteria provided for each
different category of revenue.
• Revenue from sale of goods.
• Revenue from rendering services.
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Recognition of the elements
• Income recognition in the current Conceptual
Framework and standards:
– Separate recognition criteria provided for each
different category of revenue.
• Revenue from interest, royalties and dividends.
• Income from contributions.
• Liabilities forgiven.
• Government grants received.
Recognition of the elements
• Expense recognition in the current Conceptual
Framework:
– An expense is also recognised in the income
statement when the entity incurs a liability
without the recognition of any asset.
• For example wages payable.
Measurement
• Different measurement bases include the following:
– historical cost
– current cost
– realisable or settlement value
– present value.
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Recognition of the elements
• Expense recognition in the current Conceptual
Framework:
– The Conceptual Framework states that expenses
are recognised in the income statement when a
decrease in future economic benefits relating to a
decrease in an asset or increase in a liability can
be measured reliably.
Measurement
• Measurement is very important in accounting in that
it is the process by which valuations are placed on all
elements reported in financial statements.
• The current Conceptual Framework points out that a
number of different measurement bases may be
used for assets, liabilities, income and expenses in
varying degrees and in varying combinations in
financial statements.
Measurement
• Measurement in the proposed framework:
– The measurement bases listed there include
historical cost, current value measures which
encompass fair value and value in use, and
fulfilment value.
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Measurement
• Concepts of capital:
– Two main concepts of capital are discussed in the
Conceptual Framework:
• Financial capital:
–Capital is synonymous with the net assets or
equity of the entity
• Physical capital:
–Capital is seen not so much as the equity
recorded by the entity but as the operating
capability of the assets
Summary
• The objectives of general purpose financial reporting
under the Conceptual Framework.
• The qualitative characteristics for the selection and
presentation of financial information.
• Assets, liabilities, equity, income and expenses, as
established under the Conceptual Framework.
• The recognition criteria, established in the
Conceptual Framework, for assets, liabilities, income
and expenses.
Tutorial Questions – Week 2
• Discussion Questions: 4, 5, 6, 8, 11
• Exercises: 10.1; 10.3, 10.15
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Summary
• The development of accounting regulation in
Australia resulting in the issue of accounting
standards.
• The nature of the Conceptual Framework for
Financial Reporting.
• The history of the development of the framework.
• The nature of a reporting entity under the
Conceptual Framework.
Summary
• The importance of measurement in the preparation
of financial statements.
Concepts of Capital
• Financial capital
– Capital is synonymous with the net assets (equity) of the
entity
– Profit exists only after the entity has maintained its capital,
measured as the dollar value (or purchasing power) of
equity at the beginning of the period
• Physical capital
– Capital is viewed as the operating capability of the entity’s
assets
– Profit exists only after the entity has set aside enough
capital to maintain the operating capability of its assets
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