8 TA Normative - The Case of Conceptual Framework Projects

Copyright 2000 McGraw-Hill Book Co. Aust.
PPT t/a Financial Accounting Theory by Deegan

5.1
Financial Accounting Theory
Craig Deegan
Chapter 5
Normative theories of accountingthe
case of conceptual framework projects
Slides written by Michaela Rankin

Chapter 5: Conceptual framework projects
Copyright 2000 McGraw-Hill Book Co. Aust. PPT t/a Financial Accounting Theory by Deegan

5.2
Learning Objectives
In this chapter you will be introduced to
the role that conceptual frameworks 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

5.3
Learning Objectives
perceived advantages and disadvantages that arise
from the establishment and development of
conceptual frameworks
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

5.4
What is a conceptual
framework?
A coherent system of interrelated
objectives and fundamentals that is
expected to lead to consistent standards

attempts to provide a structured theory of
accounting

5.5
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

5.6
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;
what 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;
what measurement rule should be employed

5.7
Rationale for conceptual
frameworkscontinued
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

5.8
The building blocks of the
conceptual framework
The framework must be developed in a
particular order
some issues need to be resolved before moving
on to subsequent building blocks
Refer to Figure 5.1 in the text for an
overview of the Australian Conceptual
Framework

5.9
History of the development
of CFs
CFs are under development in a number of
jurisdictions including:
US, UK, Canada, Australia, New Zealand,
International Accounting Standards Committee
No standard-setters have developed a
complete CF
Limited or no progress in recent years

5.10
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 APB Statement No. 4
however accounting profession under criticism
for lack of any real framework

5.11
Development of frameworks of
accounting in the UScontinued
Led to formation of Trueblood Committee
in 1971which produced Trueblood Report
report outlined 12 objectives of accounting and
7 qualitative characteristics which financial
information should possess
objective 1 focussed on information needs of
financial statement users
objective 2need to serve users with limited
ability to demand financial information

5.12
Development of frameworks of
accounting in the UScontinued
1974 APB replaced by FASB which then
embarked on its CF project
6 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

5.13
Development of a CF in
Australia
Degree of progression has also been slow
to date only 4 SACs have been released
SAC 1: Definition of the Reporting Entity
SAC 2: Objectives of GPFR
SAC 3: Qualitative Characteristics of Financial
Information
SAC 4: Definition and Recognition of the
Elements of Financial Statements

5.14
Development of a CF in
Australiacontinued
Fifth SAC relating to measurement issues is
yet to be released
has a number of similarities to the US CF
project

5.15
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

5.16
Development of a CF in the
UKcontinued
1991the ASB adopted the IASCs CF
IASC framework is generally consistent
with the US and Australian frameworks

5.17
Building Blocks of the CF
Building blocks of the various CFs have
addressed:
definition of the reporting entity
objectives of general purpose financial
reporting
perceived users of GPFRs
qualitative characteristics that GPFRs should
possess
elements of financial statements
possible approaches to measuring the elements

5.18
Definition of the reporting
entity
The Conceptual Framework provides a
definition of entities required to produce
general purpose financial reports (GPFRs)
known as reporting entities

5.19
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 (SAC1: para. 6)
GPFRs are reports that comply with
accounting standards and other GAAP

5.20
Special purpose financial
reports
special purpose reports are provided to meet
the information demands of a particular
user, or group of users


5.21
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)

5.22
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

5.23
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

5.24
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

5.25
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

5.26
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

5.27
International perspectives
on users of GPFRs
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 organisations
operations have rights to information about the
reporting entity, not necessarily related to
resource allocation decisions

5.28
Level of expertise expected
of financial report readers
Generally accepted that readers are
expected to have some proficiency in
financial accounting
SAC 3 (para. 36):
[GPFRs] ought to be constructed having regard
to the interests of users who are prepared to
exercise diligence in reviewing those reports...

5.29
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:
primary qualitative characteristics are relevance
and reliability
related to relevance is materiality
secondary characteristics include
comparability, uniformity, consistency and
timeliness

5.30
Reliability
Information is considered to be reliable if it
faithfully represents the entitys
transactions and events
should be free from bias and undue error
reliability is a function of representational
faithfulness, verifiability and neutrality

5.31
Reliabilityimplications
for traditional accounting
Traditionally, the doctrine of conservatism
has been adopted
bias towards understating asset values and
overstating liabilities
this doctrine is not consistent with notions
of reliability or freedom from bias

5.32
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

5.33
Materiality
A limiting factor on the disclosure of
relevant and reliable material is the notion
of materiality
an item is material if (SAC 3, para. 28):
... omission, misstatement or non-disclosure of
an item of relevant and reliable information
could affect decision-making about the
allocation of scarce resources by the users of a
general-purpose financial report of an entity

5.34
Secondary characteristics
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 impose costs on
reporting entities

5.35
Secondary characteristics
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

5.36
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 consider economic consequences then
standards cannot be considered objective or
neutral

5.37
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)

5.38
The elements of financial
reporting
The next building block considers the
definition and recognition criteria of the
elements of financial reporting
definition criteriawhat attributes are
required before an item can be considered
as belonging to a particular class of element
recognition criteriaemployed to
determine whether the item can be included
in the financial reports

5.39
Five elements of financial
reporting in Australia
Assets
liabilities
equity
expenses
revenues
10 elements identified in the US by FASB
IASC adopts the five Australian elements plus
income

5.40
Definition of Assets
future economic benefits controlled by
the entity as a result of past transactions and
other past events (SAC 4, para. 14)
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 entitys control must have
occurred

5.41
Definition of Assetscontinued
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


5.42
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 pre-requisite for
establishing the existence of control
control (and not legal ownership) is required,
although controlled assets are frequently owned

5.43
Recognition of assets
An asset shall be recognised when:
it is probable that the future economic benefits
embodied in the asset will eventuate; and
the asset possesses a cost or other value that can
be measured reliably (SAC 4, para. 38)
probable is defined as more likely rather
than less likely (SAC 4, para. 40)

5.44
Definition of liabilities
Liabilities are defined as future sacrifices
of economic benefits that the entity is
presently obliged to make to other entities
as a result of past transactions or other past
events (SAC 4, para. 48)
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

5.45
Recognition of liabilities
Recognition criteria consistent with those of
assets
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

5.46
Approaches to determining
profit
Two common approaches to determine
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

5.47
Definition of expenses
consumptions or losses of future
economic benefits in the form of reductions
in assets or increases in liabilities of the
entity, other than those relating to
distributions to owners, that result in a
decrease in equity during the reporting
period (SAC 4, para. 117)
consistent with definition provided by IASC

5.48
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

5.49
Definition of revenues
inflows or other enhancements or savings
in outflows of future economic benefits in
the form of increases in assets or reductions
in liabilities of the entity, other than those
relating to contributions by owners, that
result in an increase in equity during the
reporting period (SAC 4, para. 111)

5.50
Definition of revenues
continued
Within Australian and IASC approaches,
revenues can be recognised from normal
trading relations, as well as from non-
reciprocal transfers such as grants,
donations, bequests, or where liabilities are
forgiven.
FASB definition restricts revenues to
transactions relating to ongoing major or
central operations

5.51
Recognition of revenues
Within the Australian CF revenues are
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

5.52
Definition of equity
Equity is defined as the residual interest in
the assets of the entity after deduction of its
liabilities (SAC 4, para. 78)
consistent with IASC and FASB definitions
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

5.53
Measurement principles
To date very little prescription in relation to
measurement provided by CFs
In Australia an SAC relating to
measurement has been expected for some
time
FASB statement provides description of
various approaches to measuring elements
without providing prescription

5.54
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

5.55
Benefits associated with
CFscontinued
The development of accounting standards
should be more economical
where SACs 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

5.56
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

5.57
CFs as a means of legitimising
standard-setting bodies
Some (eg. 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

8 TA Normative - The Case of Conceptual Framework Projects

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Copyright 2000 McGraw-Hill Book Co. Aust.

PPT t/a Financial Accounting Theory by Deegan

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