Week 2: The Conceptual Framework
Financial Accounting BFA201
Learning Objectives
• Understand the development of accounting
regulation
• Understand the structure & role of the conceptual
framework
• Explain the need for an accounting standard on fair
value measurement
• Understand the key characteristics of the term ‘fair
value’
2
Readings and references
• Deegan Ch. 2
• AASB Framework, SAC 1 & 2
• Scan AASB 1053; AASB 2010-2
• Scan AASB1031; AASB13
3
What is a Conceptual Framework?
• Set of guiding principles
1.
2.
3.
Objectives of GPFS
Qualitative Characteristics
Elements
• Underpins accounting practice
4
History
• US1929 stock market crash ?accounting
– 1959 Accounting Principles Board (APB)
(profession)
APB Statement 4 ‘Basic
Concepts & Accounting Principles…’
– 1973 FASB (independent) CF
6 Statements
• CFs also developed in Aust, UK, Canada, NZ & IASC
… limited progress! In Aust:
– 1970 & 1972 AARF(profession) – adaptation of
APB Statement 4
AASB (independent)
- 2005 IASB – adopted IFRS; withdrawal of SAC3 &
4, but kept SAC1 & 2
5
Australian Conceptual
Framework
Consists of 3 documents:
1.
SAC1 ‘Definition of Reporting Entity’
2.
SAC2 ‘Objective of General Purpose Financial
Reporting’
3.
The ‘Framework for the Preparation and
Presentation of Financial Statements’
6
IASB Framework
1. Definition of Financial Reporting
2. Def. Reporting Entity
3. Def. Users & Needs
4. Objectives of Financial statements
5. Underlying Assumptions
6. Qualitative characteristics
7. Elements
8. Recognition Criteria
9. Measurement
7
SAC 1
1. GPFR = Common needs
2. External users
3. Users lack power to demand
information
•
•
Reporting Entity Concept
In accounting = Dependent User
8
SAC 2: Objective
“GPFRs shall provide information useful to users
for making and evaluating decisions about the
allocation of scarce resources” (para. 43)
• Users
• Should financial reports be understandable to all
users?
9
Differential reporting
Key Changes
• 2009 IFRS for SMEs
•
•
IFRS – costly & user needs not met
2010 ED 192 proposed:
– Remove ‘Reporting Entity’ (dependent users)
– Add ‘Public Accountability’ concept
(only external resource providers)
– No SPFR
10
Reduced disclosure regime
•
AASB 1053 Application of Tiers to Australian
Accounting Standards
(from 1 July 2013; early adoption from 1 July 2010)
–
Reduced disclosures (See AASB 2010-2)
–
Same Recognition & Measurement requirements
as full IFRS
11
AASB Framework
•
•
•
•
•
•
Purpose
Scope
Users
Objectives
Assumptions = Accrual & Going Concern
Characteristics – 2 types
1. Qualitative Characteristics
2. Constraints
12
Qualitative characteristics
1.
Understandability
2.
Relevance
3.
Reliability
4.
Comparability
13
Selection
1. Relevance
– Assists decision making
– Nature of Information & Materiality
2. Reliability
– Free from bias & material error
– Faithful representation
• Substance over form
• Neutrality
• Prudence
• Completeness
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Materiality
1.
If omission or misstatement is influential
(Framework, par 30)
2.
Test for materiality (AASB1031 par 13):
Material = > 10%
Not material =< 5%
Between 5% & 10% ???
Professional judgment
15
Presentation
1.
Understandability
–
–
2.
Assumes reasonable knowledge
Complex information
Comparability
 Across time & between entities
16
Constraints
1.
Timeliness
2.
Cost v Benefit
3.
Materiality
4.
Trade-offs; balancing
17
The 5 Elements
1. Assets
2. Liabilities
Definition
3. Equity
4. Income
Recognition
Criteria
5. Expenses
18
1. Asset definition Para 49a
Result
of past
event
Control
Expected
economic
benefits
19
2. Liability
• Definition: AASB 137 & Framework Para. 49b
20
3. Definition of Equity
Para.49c
Assets
Liabilities
Equity
21
Para 70a
Liabilities
decreases
Inflows
Assets
Increases
4. Definition of Income
Equity
22
Assets
Liabilities
Equity
Outflows
decreases
Para 70b
Increases
5. Definition of expenses
23
Recognition of Elements of Financial
Statements
2. Measured Reliably?
1. Is it Probable FEB
with flow to entity?
Financial
Statements
Para. 83
If it meets definition then ASK…
24
25
Classification (AASB101)
How should each element classify (group) items?
•
Assets & Liabilities:
– By nature
– Current/non-current
•
Equity:
– By source (contributed or earned)
1.
2.
3.
Contributed equity (Share capital)
Reserves
Retained earnings
•
Income:
– By nature
•
Expenses:
– By nature or function
BFA201_13
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Measurement
How should each element be measured?
•
What’s the value?
1. Initially?
2. Subsequently?
Different measurement bases:
•
Historical cost
•
Current cost
•
Realisable value (Fair value; MV; NRV)
•
Present value
27
Measurement of assets and liabilities
• Main measures cost & fair value for
example:
– AASB 116 Property, Plant & Equipment
• Initially recognised at cost, but choice of
revaluation model later
– AASB 9 Financial Instruments
• Financial assets measured at fair value
28
Accounting Standard AASB 13
• May 2009, IASB Exposure Draft Fair Value
Measurement = AASB ED181 in June 2009
AASB 13 Sept 2011
• Applicable from 1st Jan 2013 (can be adopted
early)
• Why was it issued?
– To establish a single source of guidance, and to reduce
complexity and improve consistency in application
– To clarify the definition of fair value in order to
communicate the measurement objective more clearly
– To enhance disclosures so that users can assess extent
to which it is used an how it is derived
29
Parts of AASB 13
• Document consists of:
– Accounting standard
– Appendix A: Defined terms
– Appendix B: Application guidance
– Above are all integral to the standard
– Basis for Conclusions
– Illustrative Examples
30
AASB 13
• Objectives (Para. 1):
– To define fair value;
– To provide a single standard for measuring fair
value;
– To require disclosure about measurement
• Application
• Definition
‘the price that would be received to sell an asset
or paid to transfer a liability in an orderly
transaction between market participants at the
measurement date’ (Para. 9)
31
Application of AASB 13
• Applies to non-financial assets, liabilities and an
entity’s own equity instruments
• 4 steps to make a fair value measurement:
– The particular asset or liability that is being
measured;
– For non-financial assets, the valuation premise
that is appropriate for the measurement;
– The principal (or most advantageous) market for
the asset or liability;
– The valuation techniques appropriate
32
Application to Non-Financial Assets
• AASB 13 Para. 11: characteristics
• Key issues: location, condition, restrictions, standalone or group
• Valuation premise is ‘highest & best use’ of asset
(Appendix A – def.)
• Principal or most advantageous market Para. 16,
Appendix A
• Valuation technique, Para. 61
– Hierarchy of inputs - Levels 1, 2 & 3
33
Lecture Case Study 1
• Entity acquires land on which a factory stands
• Currently used for industrial use
• Nearby sites have been developed for residential
use for high-rise apartments
• Recent zoning changes mean that the land could
be now used for residential purposes
• How would the highest and best use of the land be
determined?
34
Lecture Case Study 1 (cont.)
• Comparing the results from possible uses:
– Use land as is currently i.e. as a site for the factory
• Valuation premise would be the fair value of both the
land and the factory
– The land could be made into a vacant site for residential
purposes
• Valuation premise would be just the land as a standalone asset. The factory would have to be
demolished and the fair value of the land would be
calculated net of the cost of destruction of the factory
and other costs of conversion to a vacant site
35
Application to Liabilities
• Only 3 steps in measurement process
• Highest and best use does not apply
• May refer to the value of a corresponding asset in
measuring fair value
• Present value techniques may be useful where
asset is not held by other entity
• Non-performance risk (including own credit risk)
also included
36
Lecture Case Study 2
• Alpha Co and Beta Co each enter into a
contractual obligation to pay cash ($500) to
Gamma Co in 5 years.
• Alpha Co has a AA credit rating and can borrow at
6%p.a., and Beta Co has a BBB credit rating and
can borrow at 12%p.a.
• What is the fair value of each entity’s liability?
37
Lecture Case Study 2 (cont.)
• Alpha Co will receive about $374 in exchange for its
promise (the present value of $500 in 5 years at 6%).
• Beta Co will receive about $284 in exchange for its
promise (the present value of $500 in 5 years at
12%).
• The fair value of the liability to each entity (ie the
proceeds) incorporates that entity’s credit standing.
38
Disclosure Requirements
Para. 91-99
• Para 91: An entity shall disclose information that
enables users of its financial statements to
assess both of the following:
– for assets and liabilities that are measured at fair
value on a recurring or non-recurring basis … the
valuation techniques and inputs used to develop
those measurements
– for recurring fair value measurements using
significant unobservable inputs (level 3), the effect
of the measurements on profit or loss ….. for the
period
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Next Week - Topic 3
Accounting for PP&E
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