Ch02 ppt rankin

Chapter 2Contemporary Issues

in Accounting

PowerPoint Presentation by Matthew Tilling

©2012 John Wiley & Sons Australia Ltd

The Role Of A Conceptual Framework

• A Conceptual framework is a group of ideas or principles used to plan or decide something.– It is a normative theory– It prescribes the basic principles that are to be

followed in preparing financial statements– It is a coherent system of concepts, which are

guidelines to the accounting standards used for financial reporting

Conceptual Framework Versus Accounting Standard

• The Conceptual Framework is designed to provide guidance and apply to a wide range of decisions.

• Accounting standards– Specific requirements for a particular area– May go beyond the framework– Are mandatory– Sometimes conflict with the framework

History And Evolution Of TheConceptual Framework

• 1920s and 1930s attempts to draft statements of principles to guide accounting.

• 1970s development of more comprehensive and formal conceptual frameworks

• 1989 the existing Framework for the Preparation and Presentation of Financial Statements issued by the IASB

• 2010 the Conceptual Framework for Financial Reporting issued by the IASB

The Structure And Components Of The Conceptual Framework

• The Conceptual Framework can be seen as providing answers to questions such as:– What is the purpose of financial statements?– Who are they prepared for?– What are the assumptions to be made when preparing

financial statements?– What type of information should be included?– What are the elements that make up financial statements?– When should the elements of financial statements be

included?

Current Developments

• In 2004, the IASB and FASB began undertaking a project to develop a common framework.

• The project is being conducted in eight phasesA. objectives and qualitative characteristics.B. elements and recognitionC. measurementD. reporting entityE. presentation and disclosureF. purpose and statusG. application to not-for-profit entitiesH. remaining issues

Purpose, Objective And Underlying Assumption

• The Conceptual Framework states that it is concerned with general purpose financial reports.– These are financial reports intended to meet the

needs of users who are not in a position to require an entity to prepare reports tailored to their particular information needs.

• Not special purpose financial reports

Purpose, Objective And Underlying Assumption

A reporting entity is a circumscribed area of economic activities whose financial information has the potential to be useful to existing and potential equity investors, lenders, and other creditors who cannot directly obtain the information they need in making decisions about providing resources to the entity and in assessing whether the management and the governing board of that entity have made efficient and effective use of the resources provided.

Proposed definition of a reporting entity

Purpose, Objective And Underlying Assumption

• Focus on economic events and transactions, not legal form

• Designed for ‘for-profit’ entities• Does not actually set out which entities must

prepare General Purpose Financial Reports– This is a matter for individual countries to decide

at law

The Objective of Financial Reporting

The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit

The Conceptual Framework

The Objective of Financial Reporting

• Financial statements should provide information that is useful to users in making decisions.– Help predict the future– Provide feedback on previous decisions– Accountability and stewardship

The Objective of Financial Reporting

• The Conceptual Framework identifies the following users– Existing and potential investors– Lenders– Other creditors.

• Very limited list when compare with previous framework

Underlying Assumption

The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future

The Conceptual Framework

• Affects recognition and measurement

Qualitative Characteristics Of Useful Financial Information

• There is a hierarchy of qualitative characteristics: – Fundamental– Enhancing

• To be useful for decision making – Information must have both of the two

fundamental characteristics– The enhancing characteristics are not essential• But can improve the usefulness of the information

Fundamental Qualitative Characteristics

• Relevance– Aims to ensure that only useful information is

included– An important part of this concept is materiality

Fundamental Qualitative Characteristics

• Faithful Representation– What is shown corresponds to the actual events

and transactions that are being represented

• Three key elements– Complete Depiction– Neutrality– Freedom for Error

Enhancing Qualitative Characteristics

• Comparability– Achieved with consistent measurement and

presentation of items over time and between entities

• Verifiability– Information can be supported or confirmed so

that users are confident in relying on it

Enhancing Qualitative Characteristics

• Timeliness– Users need information on a timely basis

• Understandability– Financial reports are prepared for users who• Have reasonable knowledge of business and economic

activities, and • will conduct a diligent review and analysis of the

information

Determining the Relative Importance of Qualitative Characteristics

• Ideally information will have all characteristics• In reality there are often trade-offs– Timeliness versus faithful representation– Relevance versus verifiability– Relevance versus understandability

• Cost Constraint on Financial Information– Cost versus benefit

The Elements Of Financial Statements

• AssetsA resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

• LiabilitiesA 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.

The Elements Of Financial Statements

• EquityThe residual interest in the assets of the entity after deducting all its liabilities.

• IncomeIncreases 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.

• ExpensesDecreases 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.

Recognition Criteria

• Recognition is the process of incorporating an item in the balance sheet or income statement . . . It involves depiction of the item in words and by a monetary amount and the inclusion of that amount in the balance sheet or income statement totals.

• Two tests for recognition– Probability– Measurability

Probability

• An element should be recognised if (a) it is probable that any future economic

benefit associated with the item will flow to or from the entity

• Probability criteria is met if ‘the event if more likely than not to occur’.

Reliable Measurement

• An element should be recognised if(b) the item has a cost or value that can be

measured with reliability.

• Estimation is acceptable• Either a cost or a value

The Benefits Of A Conceptual Framework

• Technical Benefits– Improve the practice of accounting and to provide

a basis for answers to specific accounting questions and problems.

– It is stated that the Conceptual Framework does this in two ways:• By providing a basis and guidance for those who set the

specific accounting rules.• By helping individuals involved in preparing or auditing

or using financial statements.

The Benefits Of A Conceptual Framework

• Political Benefits– Prevent political interference in setting accounting

standards.• Accounting information has significant real-world

affects

• Professional Benefits– Protect the professional status of accounting and

accountants.

Problems & Criticisms Of The Conceptual Framework

• It is ambiguous– The principles are too vague– Too much room for alternative interpretations.

• It is descriptive not prescriptive– The Conceptual Framework simply describes

current accounting practise.– Should be prescriptive (normative) and try to

improve practice.

Problems & Criticisms Of The Conceptual Framework

• The concept of faithful representation is inappropriate

• Realist view:Financial statements . . . Are representationally faithful to the extent that they provide an objective picture of an entity’s resources and obligations

• Materialist view:Although the underlying events and transactions do exist the accounting measures that are reported are created by accountants and do not exist independently of them.

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