The Conceptual Framework
The Financial Reporting environment
1. What is Conceptual Framework
The Conceptual Framework
AASB is responsible for the development of a conceptual framework of
accounting, with the framework seeking to define the nature, subject, purpose
and board content of general-purpose financial reporting.
Not alone Australia, other countries and IASB have also been involved in the
development of a conceptual framework.
No “absolute” definition.
But FASB of USA has defined Conceptual
Framework
Conceptual Framework is a coherent system of interrelated objectives and
fundamentals that is expected to lead to consistent standards.
A central goal in establishing a conceptual framework will be general consensus
such as:

The scope and objectives of financial reporting;

The qualitative characteristics that financial information should possess
(Relevance etc);
The elements of financial reporting, including agreement on the

characteristics and recognition criteria for assets and liabilities;
2. Why Conceptual Framework is required ?
It is generally accepted that it is “UNWISE’, and perhaps “ILLOGICAL”, to
develop accounting standards unless there is firstly some agreement about key
issues, such as
-
What are the objectives of general purpose financial reporting,
-
What qualitative characteristics financial information should possess;
-
How and when transactions should be recognized;
-
Who is the audience of general-purpose financial reports
Therefore: Conceptual Framework is developed to provide guidance on key
issues
such as objectives, qualitative characteristics, definitions, and recognition
criteria.
1
The Conceptual Framework
However, the accounting standard setters do not hold the same point that we
need a conceptual framework before we start developing accounting standards.
Within Australia, Policy statement No.5 defines the Conceptual Framework as a
series of statement of accounting concepts finally in 1990.
The paragraph 3 of Policy statement 5 set out the concepts already adopted by
the AASB relating to the nature, subject, purpose and broad content of
general-purpose conceptual framework, the contents of the various accounting
standard should be logically consistent.
3. Benefits of a Conceptual Framework
Policy Statement 5 – Para #7 explicitly highlights the benefits having a
conceptual framework:
a.
Accounting standard are developed in the context of an orderly set of
concept could make it more consistent and logical;
b.
Increased international compatibility of accounting standards should occur,
because they are based on a conceptual framework that is similar to the
explicit conceptual frameworks used by other overseas and IASB standard
setters.
c.
AASB should be more accountable for its decision; because the thinking
behind specific requirements should be more explicit
d.
The process of communication between the Boards and their constituents
should be enhanced;
e.
Development of accounting should be more economical.
The conceptual Framework itself will ultimately comprise a set of statements of
accounting concepts (SAC).
Para #6 further notes:
Knowledge of the concepts the Boards use in developing accounting standards
should assist prepares, auditors and other parties with an interest in accounting
standards to UNDERSTAND better the general nature and purpose of
information reported in “General-purpose Financial Reports”.
2
The Conceptual Framework
4. Statement of Accounting Concept
A.
SAC 1 “Definition of the Reporting Entity’
According to SAC1, general-purpose financial report (GPFRs) should be
prepared by all entities. General-purpose financial reports are reports that
comply with statements of accounting concepts and accounting standards.
Definition: Reporting entity is determined by the information needs of the
users, and relies on professional judgement.
When information “relevant” to decision making is not accessible to users who
are judged to be dependent upon general-purpose financial reports to make and
evaluate resource reallocation decision, the entity is deemed to be a “Reporting
Entity”.
AASB 125 Para# 27 fpr the definition of a reporting entity means
An entity in respect of which it is reasonable to expect the existence of users
“dependent” on general purpose financial reports for information which will be
useful to them for making and evaluating decision about the allocation of scarce
resources, and includes but is not limited to the following:
a.
A listed company;
b.
A borrowing corporation and
c.
A subsidiary of a foreign company that is itself isted on an Australian stock
exchange
Parag. 6 of SAC1 further states that general-purpose financial 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.
It also states that GRRPs should be prepared when there are users ‘whose
information needs have common elements, and those users cannot command
the preparation of the information to satisfy their individual information
needs.’
Point to note:
If an entity is not deemed to be a reporting entity, it will not be
required to produce GPERs- it will not necessarily be required to comply with
all accounting standards.
3
The Conceptual Framework
B. SAC2 “Objective of General-purpose Financial Reporting”
It states that an objective of general-purpose financial reporting is to
provide “relevant” (para.11) information to assist report users to make
and evaluate decision about the allocation of scarce resources (para 26)
and to enable management and governing bodies to discharge their
accountability (para. 14).
Financial reports and ser of the financial information
Financial report provides a means for the controllers of the resources of
the company (management and the Board of directors) to report about
their role as stewards of those resources. This part of the reporting
process is known as disclosure.
User requires information to help them assess:
a. Whether the reporting entity is achieving its objectives and is
operating economically
and efficiently in the process;
b. The ability (i.e. entity) to continue to provide goods and services in
the future;
c.
Whether resources have been used for the purposes intended.
General-purpose financial report (GPFR)
The 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.”
GPFR is not an end in itself, but is a means of communicating relevant
and reliable information about
a reporting entity to users.
The objective specified in this Statement derives from the information
needs of those identified
as the user of GPFR. Those needs depend, in turn, on the activities of
reporting entities and
the decisions users make about them.
The focus on providing information about an entity’s economic or
financial performance, rather than about its social performance is vital as
it is “Relevant” in resource allocation and accountability.
4
The Conceptual Framework
B.
SAC2 “Objective of General-purpose Financial Reporting”
Relevant and reliable
It states that an objective of GPFR is to provide relevant and reliable
information (Para # 11)
to assist report users to make and evaluate decisions about the allocation
of scarce resources (Para #26)
and to enable management and governing bodies to discharge their
accountability (Para #14).
Disclosure and Compliance
Statement of Accounting Concept SAC 2 requires that GPRF disclose
information relevant to
the assessment of performance, financial position and financing and
investing, including information
about compliance.
Additioan Readings:
User related Studies (M1/4 – The usefulness of financial reports)
a. a.
Who the users are and their diverse needs;
b. b.
How financial report are used; and
c. c.
What information users want from financial reports
1. The users and their diverse needs
Revsine (1970) explained the decision models of users variation
Demski (1973) contended no one theory and theorized that there is a
“trade-off” of some benefits
to certain users against potential benefits to other users.
Cushing (1977) disagreed with Demski and he came into three
conclusions different from Demski.
2. Is the financial report useful?
Understandability and readability of financial report are the major concern
in accessing the
usefulness of financial report to the user.
Research studies found out that “understandability”, (i.e. the level of user
knowledge of accounting)
is considered by many as the ultimate quality for financial information.
Research of usage of published financial report conducted by Goldberg
and Clift (1968) and
Lee and Tweedie (1974) support the point of FASB in the USA in
“Decision Makers and
their characteristic” as the survey found that the directors’ report was the
most commonly
read section of the annual report.
5
The Conceptual Framework
4. Statement of Accounting Concept
C. The AASB Framework ((formerly known as SAC 3 “Qualitative
Characteristic of Financial Information”))
The AASB Framework seeks to identify the characteristics of financial
information necessary if it is to allow users to make and evaluate decisions
about the allocation of scarce resources – the objective identified in SAC 2.
Within Australia this issue was formerly covered by SAC3. The four principal
characteristics of financial reporting are identified in the AASB Framework as :
Understandability, relevant, reliability and comparability.
The primary qualitative characteristics of financial reporting are identified as
“Relevance” and “Reliability”.
Information is considered to be reliable if it is ‘faithfully represents’ the entity’s
transactions and events (Para #16). For information to be reliable, it should be
free from bias (Para #21) and from undue error (para#22).
Information is considered to be relevant if it “influences” decision relating to the
allocation of scarce resources.
AASB Framework also states that general-purpose financial reports shall
include all financial information which satisfies the concepts of relevant and
reliability to the extent that such information is material. Material is further
defined in the AASB Framework (Para #30)
AASB Framework notes that the inclusion of immaterial information in financial
reports may well impair the understandability of those reports.
The framework also states that information should be comparable, be
understandable and be produced in a timely manner.
Considerations of cost versus benefits are also required in determining whether
particular information should be disclosed.
When considering the “Qualitative characteristics’ of financial information, and
particularly the issue of understandability, some assumptions must be made
about the knowledge-base of readers is stipulated in paragraph 25 of AASB and
it provides that:
“users are assumed to have a reasonable knowledge of business and economic
activites and accounting and a willingness to study the information with
reasonable diligence.”
6