CONCEPTUAL
FRAMEWORKS
Standards Advisory Council meeting
February 2005
James J. Leisenring
IASB member
CONCEPTUAL FRAMEWORKS
• In the areas I want to discuss, there are only small
differences between the IASB and FASB framework
• Focus on the elements of financial statements and on
recognition and not measurement as both frameworks are
quite unresolved as to measurement
• FASB Conceptual Framework more expansive and I have
selected it to describe several points also made in IASB
Framework
CONCEPTUAL FRAMEWORKS
• Purposes of the two frameworks are quite similar
• Both frameworks accept decision usefulness of
information to a broad group of outsiders as the
purpose of financial reporting (IAS paragraph 12)
• More expansive use of IASB framework as a
result of IAS 8 hierarchy for establishing
accounting policies
CONCEPTUAL FRAMEWORKS
The FASB in Concepts Statement No. 1 concluded:
“. . . Financial reporting should provide information to help
investors, creditors, and others assess the amount, timing,
and uncertainty of prospective net cash inflows to the related
enterprise.” (paragraph 39)
The IASB framework:
“The economic decisions that are taken by users of financial
statements require an evaluation of the ability of an entity to
generate cash and cash equivalents and of the timing and
certainty of their generation.” (paragraph 15)
CONCEPTUAL FRAMEWORKS
“The primary focus of financial reporting is
information about an enterprise’s
performance provided by measures of
earnings and its components. Investors,
creditors, and others who are concerned with
assessing the prospects for enterprise net cash
inflows are especially interested in that
information.” (Con 1, paragraph 43)
CONCEPTUAL FRAMEWORKS
Furthermore, the Board said, “Information about
enterprise earnings and its components measured by
accrual accounting generally provides a better
indication of enterprise performance than
information about current cash receipts and
payments.” (Con 1, paragraph 44)
CONCEPTUAL FRAMEWORKS
“Financial statements prepared on the accrual basis
inform users not only of past transactions involving
the payment and receipt of cash but also of
obligations to pay cash in the future and of
resources that represent cash to be received in the
future. Hence, they provide the type of information
about past transactions and other events that is most
useful to users in making economic decisions.”
(IAS, paragraph 22)
CONCEPTUAL FRAMEWORKS
“Information about the performance of an entity, in
particular its profitability, is required in order to
assess potential changes in the economic resources
that it is likely to control in the future. Information
about variability of performance is important in this
respect. Information about performance is useful in
predicting the capacity of the entity to generate cash
flows from its existing resource base.”
(IAS, paragraph 17)
CONCEPTUAL FRAMEWORKS
• Accepting these conclusions focuses the
debate on the items to be recognized in
accrual basis earnings (profit and loss) and the
measurement of those items.
• The fundamental nature of most accounting
debates is that we don’t agree on what should
be considered earnings or profit and loss.
CONCEPTUAL FRAMEWORKS
• Controversy sometimes over amount
• Controversy usually over timing and uncontrolled
volatility
• Controversy over classification and display of items
in earnings or profit and loss
CONCEPTUAL FRAMEWORKS
Source of the Early Debates
• Assets, liabilities, or “what-you-may-call-its”
• Proper matching to avoid “distorting”
periodic
income
• Argument often used to avoid recognition of
an item is that the result will “distort” income
(earnings)
CONCEPTUAL FRAMEWORKS
APB STATEMENT NO. 4—ASSETS
• Assets—economic resources of an enterprise that are
recognized and measured in conformity with generally
accepted accounting principles. Assets also include
certain deferred charges that are not resources but that
are recognized and measured in conformity with
generally accepted accounting principles.
CONCEPTUAL FRAMEWORKS
APB STATEMENT NO. 4—LIABILITIES
• Liabilities—economic obligations of an enterprise that
are recognized and measured in conformity with
generally accepted accounting principles. Liabilities
also include certain deferred credits that are not
obligations but that are recognized and measured in
conformity with generally accepted accounting
principles.
CONCEPTUAL FRAMEWORKS
Asset
“Assets are probable future economic benefits obtained or
controlled by a particular entity as a result of past
transactions or events.” (Con 6, paragraph 25)
CONCEPTUAL FRAMEWORKS
Liability
“Liabilities are probable future sacrifices of economic
benefits arising from present obligations of a particular
entity to transfer assets or provide services to other entities
in the future as a result of past transactions or events.”
(Con 6, paragraph 35)
CONCEPTUAL FRAMEWORKS
Asset
“An asset is 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.” (IAS, paragraph 49a)
CONCEPTUAL FRAMEWORKS
Liability
“A liability is 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.” (IAS, paragraph 49b)
CONCEPTUAL FRAMEWORKS
Assets
Three essential characteristics: (Con 6, paragraph 26)
“(a) It embodies a probable future benefit that involves a
capacity, singly or in combination with other assets,
to contribute directly or indirectly to future net cash
inflows
(b) A particular entity can obtain the benefit and control
others’ access to it
(c) The transaction or other event giving rise to the
entity’s right to or control of the benefit has already
occurred.”
CONCEPTUAL FRAMEWORKS
Liabilities
Three essential characteristics: (Con 6, paragraph 36)
“(a) It embodies a present duty or responsibility to one or
more other entities that entails settlement by probable
future transfer or use of assets at a specified or
determinable date, on occurrence of a specified event,
or on demand
(b) The duty or responsibility obligates a particular entity,
leaving it little or no discretion to avoid the future
sacrifice
(c) The transaction or other event obligating the has
already happened.”
CONCEPTUAL FRAMEWORKS
Revenues
“Revenues are inflows or other enhancements of assets
of an entity or settlements of its liabilities (or a
combination of both) from delivering or producing
goods, rendering services, or other activities that
constitute the entity’s ongoing major or central
operations.” (Con 6, paragraph 78)
CONCEPTUAL FRAMEWORKS
Expenses
“Expenses are outflows or other using up of assets or
incurrences of liabilities (or a combination of both)
from delivering or producing goods, rendering
services, or carrying out other activities that constitute
the entity’s ongoing major or central operations.”
(Con 6, paragraph 80)
CONCEPTUAL FRAMEWORKS
Income
“Income is 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.”
(IAS, paragraph 70a)
CONCEPTUAL FRAMEWORKS
Expenses
“Expenses are 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.”
(IAS, paragraph 70b)
CONCEPTUAL FRAMEWORKS
IASB and FASB Framework
• Basic conclusion as to the conceptual primacy of
assets and secondarily liabilities
• Thought to be a “balance sheet” approach
• Can there be an “income statement” view?
CONCEPTUAL FRAMEWORKS
“To me, the definitions were the missing boundaries that
were needed to bring the accrual accounting system back
under control. The definitions have, I hope, driven a
stake part way through the “nondistortion” guideline.
But I am realistic enough to know, having dealt with the
subjects of foreign currency translation and pension cost
measurement, that the aversion to volatility in earnings
is so strong that the notion of “nondistortion” will not
die easily.”
(Donald Kirk)
CONCEPTUAL FRAMEWORKS
“Some individual frameworks are sharply defined and
firmly held; others are vague and weakly held; still
others are vague and firmly held.”
(Chuck Horngren—Stanford University)
CONCEPTUAL FRAMEWORKS
“Accounting is more a process of allocating transactions
to accounting periods by reference to the established
conventions of matching and prudence. . . . Assets and
liabilities do not form a natural starting point for
devising recognition rules; the balance sheet is the result
of the accounting process, not the starting point.”
(Ron Paterson—Ernst & Young—UK)
CONCEPTUAL FRAMEWORKS
“Paterson’s ‘balance sheet [that] is the result of the
accounting process’ is commonly the result of debits and
credits that have been created as the necessary offsetting
entries to achieve the ‘appropriate’ amount of revenue and
expense. Many of those debits and credits do not meet the
definitions of assets or liabilities but nevertheless are
identified as such on balance sheets. Would it be
acceptable to Paterson to accurately describe those items as
‘debit (or credit) necessary to get net income to the
“appropriate” level’? I doubt it.”
(James J. Leisenring—FASB—USA)
CONCEPTUAL FRAMEWORKS
IASB Framework
“. . .The application of the matching concept under this
Framework does not allow the recognition of items in the
balance sheet which do not meet the definition of assets or
liabilities.”
(IAS, paragraph 95)
CONCEPTUAL FRAMEWORKS
IASB Framework
“Income is recognised in the income statement when an
increase in future economic benefits related to an increase
in an asset or a decrease of a liability has arisen that can be
measured reliably.”
(IAS, paragraph 92)
CONCEPTUAL FRAMEWORKS
IASB Framework
“Expenses are recognised in the income statement when a
decrease in future economic benefits related to a decrease
in an asset or an increase of a liability has arisen that can
be measured reliably.”
(IAS, paragraph 94)
CONCEPTUAL FRAMEWORKS
For the income statement view to have any intellectual
rigor, proponents must either:
• Define revenue and expense without regard to assets and
liabilities.
• Accept that a balance sheet will contain a debit or credit
necessary to achieve the “appropriate” amount of net
income.
• Define or describe what is the “appropriate” amount of
net income
CONCEPTUAL FRAMEWORKS
• Can’t define revenues, expenses, gains, and losses
without reference to assets
• Absent independent definition of revenues, expenses,
gains, and losses (not dependent on assets and
liabilities), the income statement view is vacuous
• Measuring net income by the change in net assets
provides an anchor for resolving difficult accounting
questions
CONCEPTUAL FRAMEWORKS
Asking the Right Questions
What is the asset?
What is the liability?
Did an asset or liability or its value change?
Increase or decrease?
By how much?
Did the change result from what we call:
Investment by owners?
Distribution to owners?
Comprehensive income?
Revenue?
Expense?
Gain?
Loss?
(Storey & Storey)
CONCEPTUAL
FRAMEWORKS
Standards Advisory Council meeting
February 2005
James J. Leisenring
IASB member