CONCEPTUAL FRAMEWORK
& STANDARD SETTING
GROUP B
AGENDA
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FASB’s Conceptual Framework
Successes of the Framework
Failures of the Framework
Relevance vs. Reliability
Tradeoff with Examples
FINANCIAL ACCOUNTING STANDARDS
BOARD (FASB)
• Not-for-profit organization created in 1973
• Primary purpose is to act in the public’s interest by
setting generally accepted accounting principles in the
U.S.
• Designated by the Securities and Exchange Commission
(SEC) to set standards for U.S. public companies
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
CONCEPTUAL FRAMEWORK
• Developed by FASB to provide the accounting profession
a generally accepted framework
• Wanted financial reporting to provide useful information
to decision makers
• Sets the objectives, qualitative characteristics and other
concepts that help guide the profession in choosing
which economic events should be recognized and
measured for financial reporting and how they are
presented (3 levels)
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
CONCEPTUAL FRAMEWORK
• These 3 levels are outlined in statements of financial
accounting concepts (SFACs)
• A basis on which standards are set and allows the board
to develop more useful and consistent standards over
time which allow for more reliable and relevant reporting
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
CICA SECTION 1000
• Outlines the financial statement concepts that are used
in the generally accepted accounting principles
• Section 1100 establishes the actual accounting principles
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
SUCCESSES OF THE FRAMEWORK
1. Guidance for Standard Setting
 Provides users with guidance in standards setting &
applying concepts that can be measured by their
ability to achieve the goals of the accounting function
2. Economies of FASB’s time
 Many accounting cases have common points with
other accounting issues, thus the conceptual
framework provides an effective solution to a variety
of issues
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
SUCCESSES OF THE FRAMEWORK
3. Broad, perspective concepts
 Concepts contained in the framework should be
fundamental, in order to allow other concepts to flow
from them
4. Apolitical Standards
 The framework should result in standards that have
not been developed as a result of political pressure
on the FASB
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
SUCCESSES OF THE FRAMEWORK
5. Avoids inconsistencies between standards
 The framework provides an opportunity to reconcile
concepts based on accounting principles to ensure
consistent application
 Statements of Financial Accounting Concept
 7 SFAC’s comprising the conceptual framework
 Justification of standard setting (SFAS) by the FASB
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
OPPOSING OPINIONS
Practitioners from small and mid-size firms disagrees
that a conceptual framework would add any value to the
existing problems
Hickok argues accountants merely report events of the
past, it is not up to them to be forward thinking
Out of the 63 statements and 44 interpretations issued
by the FASB between 1979 and 1985, only 28 references
to the conceptual framework was made
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
SFAC 5
Revenue recognition and measurement
 Repeats what has been said in existing standards
 Does not set insight on how to solve complex
accounting issues and what methods are preferable
 Example: Accounting for income taxes (SFAS 96)measurement and recognition of deferred taxes
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
SFAC 2
Qualitative Characteristics of Accounting Information
SFAC 2 mainly introduces the importance of reliability and
relevancy of accounting information to decision makers
SFAC 2 was bent and twisted to fit the use of FASB on foreign
exchange issues (SFAS 52)
Explains how the conceptual framework is not useful to making
consistent decisions
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
TO ILLUSTRATE…
Company A is a Canadian company that has a subsidiary in Australia
called Company B. Company has inventory recorded at historical
cost of $100 and the market value of the inventory today is $105.
The historical exchange rate at the date the inventory was acquired
is 1.5 and the exchange rate today is 1.
 Company A will need to write down inventory where Company B
uses historical cost. This presents inconsistency in information.
Historical Cost
Intro to
FASB
Market Value
Company A
$100 x 1.5 = $150 $105 x 1 = $105
Company B
$100
Successes
of the CF
Failures of
the CF
$105
Relevance
v. Reliability
Tradeoffs &
Examples
OBJECTIVES OF FINANCIAL REPORTING:
SFAC 1, 1978
• Objective: to provide useful information in order for
financial statement users to make decisions
• Stem from the primary needs of financial statement
users, to provide relevant information for decision
making
• Users are assumed to have a reasonable understanding
of business and economic activities
• Intended for a broad use, general purpose in nature
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
PRIMARY QUALITIES OF USEFUL
INFORMATION: SFAC 2, 1980
• Relevance and reliability are the 2 primary qualities
• Verifiability and Representational Faithfulness
• Neutrality
• Comparability and Consistency
• Constrained by:
• Materiality
• Cost and Benefits
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
WHAT CONSTITUTES AS RESOURCES TO AN
ENTERPRISE? SFAC 6, 1985
Basic elements of financial statements include the
following:
 Assets
 Liabilities
 Equity
 Revenues
 Expenses
 Gains
 Losses
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
WHEN SHOULD RESOURCES BE
RECOGNIZED? SFAC 5, 1984
Must meet 4 fundamental recognition criteria for a
resource to be recognized:
1. Definitions
2. Measurability
3. Relevance
4. Reliability
 Subject to Cost-benefits and materiality
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
RELEVANCE VS. RELIABILITY
Relevance: information is timely and reflects the
company’s current financial position
Reliability: information can be objectively verified by an
outside third-party source
FASB’s Concept Statement states both are equally
important
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
ACCOUNTING LOSES FOCUS ON REALITY
Accounting has lost its relevance because it fails to
recognize some intangibles
 Brand: Coke and Nike
 R&D: Microsoft
 Human Capital: McDonald’s
Accounting practices have neglected the “future
economic benefit” of intangibles and focus too much on
expenses
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
ACCOUNTING REMAINS PATIENT
As pointed out in the conceptual framework “Financial
accounting is not designed to measure directly the value
of a business enterprise”
To base usefulness on the stock market valuation would
be irrational as it would be based on a people’s nonsensical emotions
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
ACCOUNTING REMAINS PATIENT
Intangibles should be classified on the financial
statements when they can reliably measured –
“reasonably free from error”
Other characteristics not solely “future economic
benefit” are included when categorizing an element as
an asset
 Coke
 Microsoft
 McDonald’s
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
TRADE-OFFS BETWEEN RELEVANCE AND
RELIABILITY
Definition: The exchange of one thing for another of
more or less equal value, especially to affect a
compromise.
Reliability dominates relevance
 Timeliness
Relevance dominates reliability
 Errors
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
EXAMPLES OF TRADE-OFFS
After the balance sheet date but before the date of issue a
company wants to dispose of one of its subsidiaries and is in final
stages of reaching a deal but the outcome is still uncertain. If the
company waits they are expected to find more reliable information
but that would cost them relevance. The information would be
outdated and no longer very relevant.
After the balance sheet date during the time when audit is carried
out, it becomes clear which debts were realized and where were
not hence it improves the reliability of allowance for bad debts
estimate but the information loses its relevance due to too much
time being taken. Timeliness is key to relevance.
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
DIFFERENT GROUP PERCEPTIONS
Preparers of financial statements put greater emphasis
on reliability measures to pass audit scrutiny
Auditors of financial statements put greater emphasis on
reliability measures due to their legal exposure
Investors put greater emphasis on relevance on
forecasting the company’s future earnings and financial
position
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
FASB’S CONCEPT 2
“Concepts Statement 2 states: The qualities that
distinguish “better” (more useful) information from
“inferior” (less useful) information are primarily the
qualities of relevance and reliability. . . . The objective of
accounting policy decisions is to produce accounting
information that is relevant to the purposes to be served
and is reliable.” [Paragraph 15]
To be useful Concept 2 under FASB states that financial
information must be both relevant and reliable
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples
EARNINGS QUALITY
Whether a firm’s financial statements truly reflect its
financial position
The economic value of transactions can be interpreted
differently; the most “correct” way has the highest level
of earnings quality
Associated with conservative accounting policies
Related to accounting ethics
Intro to
FASB
Successes
of the CF
Failures of
the CF
Relevance
v. Reliability
Tradeoffs &
Examples