Chapter 5 - Conceptual Framework Learning Objectives

i. Understand the need for a conceptual framework of accounting standards ii. Understand and explain the development of a conceptual framework in relation to

financial reporting process iii. Understand and explain the scope of the IASB Framework iv. Understand the current joint project by IASB and FASB to update and converge conceptual frameworks 1.0 Introduction The need for reporting accounting information begins with the purpose of providing information to capital providers of an entity in evaluating the performance of the managers and the entity. Information about past events and transactions will provide the relevant information for the capital providers to assess past performance. However, the current reporting environment acknowledges that there are other parties that are interested in the accounting information of an entity. As these users have different information needs, the information reported need to be able to meet their various decision-making needs. In meeting these needs, the accounting information must be prepared and communicated to the various users in a manner that can facilitate their decision-making. This highlights the importance of standard-setting approach that will be able to develop standards that meet the decision-making needs of various parties. This chapter discusses the use of a conceptual framework in the development of accounting standards. 2.0 The Need for a Conceptual Framework A conceptual framework refers to a statement of generally accepted theoretical principles which forms the basis of reference for financial reporting. The financial reporting process involves application of certain rules and procedures to events and transactions engaged by an entity and communicating the information to the various users. As such, the conceptual framework should formulate a set of general accounting theory that covers the scope and objective of financial reporting, the qualitative characteristics of the information reported in order to achieve the objective, the basis for determining the events or transactions that should be accounted for, the measurement for such events or transactions and the presentation of the information to the users. In the past, where a formally constructed conceptual framework did not exist, the accounting standard setters have developed standards which allow entities to select their accounting methods within the boundaries of generally accepted accounting principles. Generally accepted accounting principles can be referred to as the rules that govern the accounting and reporting process. These rules are derived from various sources applicable to a particular country. The sources can include national company law, national accounting standards, international accounting standards and local stock exchange. As a result, many accounting standards developed in the past have resulted in many alternative accounting practices applicable to similar transactions. From one perspective, the wide accounting choices allowed entities to choose the most appropriate method applicable for certain event or transaction. Alternatively, it can lead to wide variation in the accounting practices of similar transactions, reduce comparability of the information reported and potential confusion among the users. In
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resolving these effects, some accounting regulators have increased the issuance of accounting standards in an attempt to establish the appropriate accounting practice for a particular circumstance. Where a conceptual framework does not exist, the accounting standards developed need to specify detailed requirements in order to ensure that all potential situations are taken into considerations. As new accounting issues arise in the existing standards or where there are no specific standards, there will be increase pressure from preparers, auditors and also users for accounting standard setters to develop more detailed standards. In contrast, development of accounting standards based on agreed basic principles contained in a conceptual framework provide standard setters with a conceptual defence in reducing these pressures. In the absence of a conceptual framework, accounting standards will also be developed whenever accounting issues arise. The new accounting requirements developed provide random solution to the current pressing issues. Such approach can result in inconsistencies and contradictions in basic concepts among the accounting standards. Consequently, it can lead to ambiguity, reduces the usefulness of the information to the users and ultimately reduces the credibility of the information reported to users. The advantages and disadvantages of a conceptual framework are summarized as follows; Advantages i. Development of accounting standards based on a conceptual framework reduces the probability of accounting standard setters focusing on the most important issue arising at a particular time. Instead, accounting standard setters can channeled their efforts and resources in developing new and existing standards in a more organized manner. ii. Accounting standard setters are exposed to pressures from various parties in developing the accounting standards, particularly where there are conflicts between the various parties. In this situation, the accounting standard setters work will be subject to less criticism if the accounting standards are derived from a conceptual framework. iii. Accounting standards derived from a conceptual framework reduces the need for detailed requirements as issues not addressed specifically in the standards can be referred to the conceptual framework. Disadvantages i. A single conceptual framework may not be able to provide a reference in preparing and presenting information that can meet the needs of a variety of users. ii. A single conceptual framework is used as a basis to develop accounting standards for a particular purpose. For example, the current conceptual framework focuses on concepts relevant in preparing and presenting information for general purpose. As there are diverse group of users, a variety of accounting standards may need to be developed for preparing and presenting information for other purposes. 3.0 The Development of Conceptual Framework The development of conceptual framework started between the periods 1987 to 2000 where the Financial Accounting Standard Board (FASB) in the United States issued seven concept statements covering the following topics: Objective of financial reporting by business enterprises and non-profit organizations
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Qualitative characteristics of useful accounting information Elements of financial statements Criteria for recognizing and measuring the elements Use of cash flow and present value information in accounting measurements.

In the United Kingdom, following the lead from FASB, the International Accounting Standards Committee (IASC) issued the Framework for the Preparation and Presentation of Financial Statements n July 1989. Subsequently, the International Accounting Standards Board (IASB) adopted the Framework in 2001. This framework will be explained in more detail in the section 4.0 of this chapter. In Australia, the development of conceptual framework started with the issuance of several exposure drafts (ED) and statement of accounting concepts. The exposure drafts are as follows: Exposure Drafts ED 42A Objective of financial reporting ED 42B Qualitative characteristics of financial information ED 42C Definition and recognition of assets ED42D Definition and recognition of expenses ED 46A Definition of the reporting entity ED 46B Definition and recognition of revenues ED 51A Definition of equity ED 51B Definition of recognition of revenues Date of release December 1987 December 1987 December 1987 December 1987 December 1987 December 1987 April 1988 April 1988

In 1990, the following statements of accounting concepts were released by Australian Accounting Standards Board (AASB): i. SAC 1 Definition of the Reporting Entity ii. SAC 2 Objectives of General Purpose Financial Reporting iii. SAC 3 Qualitative Characteristics of Financial Information SAC 4 Definition and recognition of the elements of financial statements was first issued by the AASB in March 1992. However, the release of SAC 4 was very controversial and after intense lobbying by the business community, it was revised and reissued in May 1995. These statements of accounting concepts were reviewed following the adoption of IASB accounting standards in Australia to determine if the Australian conceptual framework is in line with the AASB standards based on IFRSs. Following the review process, the AASB decided to retain SAC 1 Definition of the Reporting Entity and SAC 2 Objectives of General Purpose Financial Reporting in 2005. The AASB states that these two statements of accounting concepts are to ensure clear interpretations of the application paragraphs of AASB equivalents to IASB standard. In addition, the IASB has no equivalent to these two SACs. The AASB also adopts the IASB conceptual framework, which superseded SAC 3 and SAC 4. The IASB conceptual framework has also been adopted by many jurisdictions around the world that adopt IFRSs as their national standards. Similarly in Malaysia, the Malaysian
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Accounting Standards Board (MASB) has also issued the Framework for the Preparation and Presentation of Financial Statements in 2007. This statement is similar to the conceptual framework issued by the IASB. 3.1 Key Issues in Developing Conceptual Framework The issues that have been considered in the development of accounting standards include: i. Principles-based versus rules-based approaches to standard setting ii. Information for decision-making iii. Users of accounting information Principles-based versus rules-based approaches to standard setting Conceptual framework provides a point of reference in the standard-setting process in order to develop a body of coherent standards based on consistent principles. The current IASB standards are developed based on the guidelines provided in the conceptual framework. The standards developed are also known as principle-based standards. Accordingly, these standards are expected to be based on appropriate principles without too many detailed rules. However, some parties argue that some of the IASB standards also include detailed technical rules. For example, accounting standards for lease transactions, government grants and employee benefits. These parties argue that the resulting detail rules could have been due to lack or inappropriate principles being applied. Standards with detailed requirements in relation to various accounting treatments to be complied are also known as rules-based standards. The accounting standards in the United States have often been described as rules-based due to this characteristic. The rules-based standard setting approach in the United States has been influenced to a certain extent by the SEC requirements. The SEC required detailed rules in the standards in order to determine if companies are complying with the financial reporting requirements. The advantage of rules-based standards is that it reduces subjective judgement in the application of accounting treatments and consequently enhances comparability. It also facilitates auditors and regulatory authorities in verifying the reported information. However, it should not preclude the use of skills and judgement in interpreting the accounting standards. Where application of rules-based standards precludes professional judgements, it can potentially lead to fraudulent financial reporting. Some commentators argue that the rulesbased standard-setting in the United States is partly blamed for several corporate collapses. Following a series of corporate collapses in the United States, the Sarbane-Oxley Act introduced many changes to improve the quality of financial reporting and auditing. In line with this, the standard-setting approach has also been changed to principle-based approach. The FASB has also started working with the IASB on a joint project to develop a single, complete and consistent conceptual framework that can be used by both boards. Information for decision-making Reporting of accounting information begins with the stewardship function. Stewardship function refers to an environment where those who supply capital to the business want to know how the stewards, or managers, have used the economic resources entrusted to them. Based on the information, the capital providers will be able to evaluate the performance of the managers and the entity.

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The current reporting environment has moved beyond providing information for stewardship purposes. Standard setters acknowledge that there are various parties interested in the accounting information of an entity. These users have different information needs and the information reported need to be able to meet their various decision-making needs. Accordingly, the purpose of reporting accounting information shifts from merely focusing on the stewardship purpose to decision-making purpose. While accounting information reports on past events, it should also incorporate information that can facilitate information that relates to the future for decision-making purposes. For example, information on current values of resources owned by an entity provide relevant input to the users as this information is closer to the future period relative to historical values. However, information based on historical values is equally useful to users as this information is objective and can serve as a reliable source for decision-making. The current emphasis on decision-making purpose of accounting information highlights the necessity to have general concepts or principles in a conceptual framework that can give guidance for standard setters in developing standards that meet this purpose. Users of accounting information In line with the decision-making purpose of accounting information, a conceptual framework needs to identify the users of accounting information. However, it is not possible to identify every potential type of users of accounting information. In general, standard setters identify three categories of users: resource providers, recipients of goods and services and parties involved in the review or oversight function. Resource providers include investors and lenders, recipient of goods and services include customers and suppliers while parties involved in the review and oversight function include regulatory authorities and board of directors. Once the users are identified, a conceptual framework needs to identify the principles that can guide standard setters in developing standards that meet the information needs of all these users. 4.0 The IASBs Framework The Framework for the Preparation and Presentation of Financial Statements (Framework) was issued by the adopted International Accounting Standards Committee (IASC) in July 1989. Subsequently, the International Accounting Standards Board (IASB) adopted the Framework in 2001. However, it is not an International Financial Reporting Standard for any particular measurement or disclosure issues. Instead, the Framework describes the basic concepts that underlie the preparation and presentation of Financial Statements in conformity with IFRSs. It serves as a guide to the IASB in developing accounting standards. Where a particular accounting issue is not addressed directly by a particular accounting standard or Interpretation, the principles in the Framework will be used. In this situation, IAS 8 (revised, 2003) requires management to use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making the judgement, IAS 8 requires management to consider the following: i. requirements and guidance of Standards and Interpretations dealing with similar and related issues, and ii. definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. The above requirement by IAS 8 strengthened the importance of the Framework in the preparation and presentation of financial statements even though it is not mandatory.
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However, where there are contradictions between the Framework and individual Standard or Interpretation, the Standard or Interpretation takes precedence. In such situation, the principles in the Framework cannot be used to justify a particular accounting treatment that contradicts the particular Standard or Interpretation. 4.1 Purpose of the Framework The introduction to the Framework provides a list of the purpose of the Framework as follows: i. The Framework guides the IASB in the development of future IFRSs and in the review of existing accounting standards. For example, in developing an accounting standard that deals with liability with uncertain amount or timing, the IASB will refer to the definitions of the elements of financial statements in discussing the issues relating to whether the liability meets the definition of a provision or contingent liability. With the presence of the definitions in the Framework, the discussions are centered around the definition of a liability while reducing the divergence of opinions. At the same time, such approach towards standard setting enhances consistency among the body of standards. ii. The Framework assists the IASB in promoting harmonization of accounting standards, accounting procedures and regulations in relation to the presentation of financial statements as it reduces the number of alternative accounting treatments allowed in the IFRSs. iii. The Framework also assists national standard setters in developing national standards. iv. The Framework provides guidance to preparers and auditors in resolving accounting issues particularly where there are no specific standards or interpretations. v. The Framework promotes development of accounting standards from the principlebased perspective instead of as opposed to developing accounting standards with detailed ruled that can cover various potential situations. vi. The Framework reduces the volume of each standard as accounting issues not addressed specifically by the standards can be resolved by referring to the Framework. As it facilitates the exercise of judgement, it reduces the need for interpretations and other detailed implementation guidance. vii. Assists users of financial statements in interpreting the information presented in financial statements which have been prepared in conformance with IFRSs. The knowledge that the standards have been developed based on the guidance of the Framework and the rigorous process enhances the credibility of the information reported. 4.2 Scope of the Framework The scope of the Framework deals with general purpose financial statements that an entity prepares and presents at least annually in order to provide the needs of a wide range of users external to the entity. Hence, the Framework may not apply to financial reports prepared for special purpose, such as reports to tax authorities, prospectuses in relation to issue of new shares and regulatory authorities. In addition, the Framework focuses on the financial statements prepared by business entity. This entity can be privately owned or state-owned. It does not focus on the financial statements of other entities such as not-for-profit organizations and public sector entities. A complete set of financial statements includes: statement of financial position statement of comprehensive income
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statement of changes in financial position notes and other statements.

In relation to users of general purpose financial statements, the Framework identifies the following categories of users: investors, employees, lenders, suppliers and other trade creditors, customers, government and their agencies, and public.

The Framework acknowledges that the above users rely on information in the financial statements in making various economic decisions. However, such information cannot meet the information needs of all users. For instance, the financial statements provide information regarding past transactions and events while most users need to make decisions related to future transactions and events. In addressing this issue, the Framework concludes that there are information needs that are common to all these users. In addition, the Framework focuses on meeting the need of the investors as providers of risk capital. It is expected that meeting the needs of the investors will be able to satisfy the information needs of the other users. The common information need is related to the ability of an entity to generate cash and cash equivalents and also the timing and certainty of those future cash flows. By focusing on the information needs of the investors, the Framework regards the investors as the most important user group relative to the other categories of users. The primary responsibility for the preparation and presentation of financial statements lies with the management of an entity. This is noted in the financial statements. The scope of the Framework includes: i. the objective of financial statements; ii. the qualitative characteristics that determine the usefulness of information in financial statements; iii. the definition, recognition and measurement of the elements from which financial statements are constructed; and iv. concepts of capital and capital maintenance. 4.3 The Objective of Financial Statements The Framework states that the objective of financial statement is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of user in making economic decisions. Examples of economic decisionmaking include: decision to invest, hold or sell equity investment assess entitys ability to pay employees assessment of entitys ability to settle amount lent to the entity determination of tax policies regulations of entitys activities

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Economic decision-making relates to the future. In contrast, certain decisions are related to the past. For example, management performance in the last three years, prior year liquidity position and operating costs for the last five years. These decisions are also referred to as fulfilling the stewardship objective of financial statements. The Framework argues that the economic decision-making objective overrides the stewardship objective because the past information provided in financial statements allows users to make future-oriented decisionmaking. Financial Position The financial position of an entity is reported in the statement of financial position, also known as the balance sheet. The statement of financial position provides users with the following information: - assets owned by an entity, - liabilities owed by and entity, and - residual equitys interests in an entitys net assets. Performance Information on performance of an entity is reported in the income statement and/or statement of comprehensive income. Information on performance reveals an entitys ability to earn profit from the resources invested into the entity. In assessing the performance of an entity, it is also important to refer to information reported in the statement of changes in equity as some items of income and expenses are reported directly in equity and not through the income statement. For instance, when an entity adopts a fair value model in subsequent measurement of its property, plant and equipment, it is possible that in certain situation, the surplus on revaluation is reported directly in equity. Changes in Financial Position Changes in financial position of an entity are reported in the statement of cash flows. This statement provides users with information about the sources and use of an entitys cash and cash equivalents during a particular reporting period. Sources of an entitys cash and cash equivalents are reported under three broad categories: operating activities, investing activities and financing activities. These information provide users with the insights into an entitys cash and cash equivalents during a reporting period. For example, an investor will be able to assess an entity ability in paying dividend and a creditor will be able to assess an entitys ability to settle the amount lend to the entity. 4.4 Qualitative Characteristics of Financial Statements In order to report information that is useful to users, the financial statements must have certain qualitative characteristics. The four main qualitative characteristics identified by the Framework are summarized in the following diagram.

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Qualitative Characteristics of Financial Statements

Understandability

Comparability

Relevance - Materiality - Timeliness

Reliability - Representational faithfulness - Substance over form - Neutrality - Prudence - Completeness -

Diagram 1: Qualitative Characteristics of Financial Statements Understandability The financial statements should present information in such a way that it is readily understandable to users who have a reasonable knowledge of business and economic activities as well as accounting knowledge. Relevance Information reported in financial statements is relevant when it influences the economic decisions of users. This is possible as the information allows users to evaluate past, present and future performance and financial position of an entity. Accordingly, it can confirm or correct past evaluations made by the users. The Framework identifies the following two components that make information reported relevant: materiality timeliness

Information is material if its omission or misstatement could influence the economic decisions of users. Alternatively, information that does not influence the economic decisions of users is information that is immaterial and lacks relevance. However, the Framework and various IFRSs do not provide the specific measure in determining the level of materiality for a particular event or transaction. In addition to materiality, information can only influence the economic decisions of users if the information is reported within the time period that is most likely to have some influence on the decisions of the users. In contrast, information reported beyond this time period will not influence the decisions of users as it is no longer relevant.

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Reliability The Framework states that information in financial statements is reliable if it is free from material error and bias and can be depended upon by users to represent events and transactions faithfully. In making the information reliable, the Framework identifies the following attributes that information should have: representational faithfulness substance over form neutrality prudence completeness

Representational faithfulness Reliable information must represent accurately the events and transactions reported in financial statements. For instance, an entity reported its plant in the statement of position at cost less accumulated depreciation. During the current reporting period, the recoverable amount for the plant has fallen below the amount of its carrying value. It is important that the value of the plant be reduced to its recoverable amount if it is to reflect accurately the effect of certain events on the value of the plant if it is to represent accurate information to the users. Substance over form Information reported in financial statements should reflect the economic substance of the transaction even though in some situations, it differs from the legal form. For instance, when an entity leases a machine under a non-cancellable lease agreement for the entire life of the machine and the total amount of the lease payments approximates the purchase consideration of the machine if it was purchased by the entity, the machine must be accounted for similar to accounting treatment for purchase asset. Even though the machine is not legally owned by the entity, the economic nature of the transaction is equivalent to purchase of asset where the entity is the legal owner of the asset. Hence, it is treated similar to purchase of asset. Neutrality Information is neutral if the information is not presented in a way that it will influence certain economic decisions. This means that the information must not be presented in a way that it will influence the users to make economic decisions that the preparers want the users to make. Instead, it should provide users with information that can facilitate their economic decisions if the information is neutral. For example, an entity is being sued by regulatory authority for not fixing smoke filters to its factories and the entity is expected to incur some penalty costs. In this case, the entity should assess the likelihood of the potential liability and discloses the information to users in the financial statements. Disclosure decisions must be based on appropriate assessments of the potential liability and should not be influenced by the entitys decision to influence the users. Disclosure of neutral information enhances the reliability of the information reported to the users. Prudence The Framework states that an entity must exercise some degree of caution in making judgement regarding estimates required under conditions of uncertainty. For example, an assets and income should not be overstated while liabilities and expenses should not be
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understated. In exercising caution, the Framework highlights that it should be considered in the context of other qualitative characteristics of the financial statement, particularly relevance and faithful representation. Completeness Financial statement can only provide useful information to users if all information is reported completely. However, preparation and presentation of complete information by an entity is usually subject to costs implication and materiality level of the information. Nevertheless, an entity must report a reasonably complete information as incomplete information lacks reliability and reduces relevance to the users. The principle in relation to the costs and benefits of information is that the benefits to the users should exceed the costs of obtaining the information and presenting it. However, the evaluation of benefits and costs is a subjective area. The benefits can also accrue to parties other than the intended users. For example, the potential benefit to the reporting entity is that it can reduce its costs of capital. Similarly, the costs of preparing and presenting the information can also include other indirect costs. For example, indirect costs to an entity resulting from benefits gained by competitors based on the information reported in the financial statements. Hence, while it is difficult to apply the costs and benefits analysis, preparers and users of information should be aware of such constraint. Comparability Information presented in financial statements of an entity must be able to be compared over several reporting periods in facilitating users to evaluate the performance and financial position of an entity. At the same time, the information must also be able to be compared with information presented in financial statements of another entity. In facilitating comparison of these information, it is paramount that an entity discloses the accounting policies adopted for events and transactions reported in the financial statements. Such disclosure will provide information regarding the various accounting policies adopted by an entity during a particular reporting period as there are several accounting policies allowed by IFRSs and statutes. 4.5 Trade-off between Relevance and Reliability In some situations, a trade-off between relevance and reliability is necessary in reporting information that meets the objective of financial statements. Examples of situations where there is a trade-off between relevance and reliability are as follows: i. Reporting an entitys assets based on fair value provides more relevant information to users. However, it may not be possible to get a reliable measure of fair value measure for certain asset. In this case, the relevant accounting standard usually allows an entity to report on an alternative measurement basis. This highlights that a judgement is required to provide an appropriate balance between these two qualitative characteristics in reporting some information. ii. An entity has entered into a transaction but not all aspects relating to the transaction are known. If the entity delays the reporting of the transaction until all aspects of the transaction are known, it may be too late and the information has become irrelevant. On the other hand, reporting the information with lesser detail may compromise the reliability of the information. In making judgement as to the timing and amount of
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detail relating to the transaction, management must make the decisions that is best to satisfy the economic decision-making of the users. 4.6 Elements of Financial Statements The information presented in the financial statements are grouped into broad classes according to their economic characteristics in order to potray their financial effects. The broad classes are the elements of the financial statements. The elements and the respective financial statement are shown in the following diagram.

Elements of Financial Statements

Statement of Financial Position: - Assets - Liabilities - Equity

Measurement of Performance in the Income Statement: - Income - Expenses

Diagram 2: Elements of Financial Statements Under each of the above elements, further sub-classification is made in presenting the information to users. For example, assets are classified into non-current assets and current assets in order to show the nature and function of each category of assets in the business. It should be noted that the statement of cash flow does not present additional elements of financial statements as it reflects both elements in the income statement and statement of financial position. Definitions of the Elements in the Statement of Financial Position The Elements in the Statement of Financial Position are defined as follows: Assets A resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity. Liabilities 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. Equity The residual interest in the assets of the entity after deducting all its liabilities. The term economic benefits in the above definitions refer to future flows of cash or other assets. In addition, the definitions also refer to past events. This criteria has been used in many
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accounting standards to prohibit an entity from recognizing an asset and liability if a particular past event has not occurred. For example, an intention by an entity to purchase an asset does not meet the definition of an asset as past event related to the purchase has not occurred. Definitions of the Elements Relating to Performance The elements relating to performance are defined as follows: Income 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. Expenses Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. The definition of income includes revenue and gains. Revenue arises in the course of ordinary activities of an entity, such as from the sales of goods and rendering of services. Examples of revenue are sales, rental income and fees. Income generated by other activities is usually referred to as gains. For example, an entity sells its no-current asset at a selling price that is higher than the carrying value of the non-current asset. The net profit made on the sale of the non-current asset is a gain. The definition of expenses includes expenses arising in the course of ordinary activities of the entity as well as losses arising from other activities. Examples of expenses include salaries, administrative expenses and interests expense. Examples of losses are those arising from sale of non-current assets and fall in the value of an entitys investments. 4.7 Recognition of the Elements of Financial Statements Information on certain transaction or event can only be reported in the financial statements if it meets the definition of an element and also satisfies the following recognition criteria: it is probable that any future economic benefits associated with the item will flow to or from the entity. the item has a cost or value that can be measured with reliability.

Based on the above criteria, the recognition criteria for assets, liabilities, income and expenses are summarized as follows: Item Asset Financial statement Statement of financial position Recognition It is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably. It is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably.
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Liability

Statement of financial position

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Income

Statement of comprehensive income

Expenses

Statement of comprehensive income

An increase in future economic benefits related to an increase in as asset or a decrease of a liability has arisen that can be measured reliably. A decrease in future economic benefits related to an increase in as asset or a decrease of a liability has arisen that can be measured reliably.

Most IFRSs specify the principles for recognizing specific types of assets, liabilities, income and expenses. The recognition criteria for equity is not specified because it represents a difference between assets and liabilities. 4.8 Measurement of the Elements of Financial Statements Measurement refers to the process of determining the monetary amounts at which the elements of the financial statements are to be recognized and reported in the financial statements. It usually involves the selection of a particular basis of measurement from a variety of measurement bases. These bases are used to different degrees and in varying combinations for reporting purposes. The measurement bases include: historical cost current cost net realizable value present value

Historical cost Historical cost is the most common basis used by entities. Under this basis, assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given at the acquisition date. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business. Current cost At current cost, assets are recorded at the amount of cash or cash equivalents that would have been paid if the similar asset was acquired currently. Net realizable value Net realizable value is the amount of cash or cash equivalents that could be obtained by selling an asset in an orderly manner. In relation to liability, it is the amount of cash or cash equivalents expected to be paid to settle the liability in the normal course of business. Present value Present value is based on current estimate of the present discounted value of the future net cash flows in the normal course of business. To date, the Framework does not prescribe a particular concept in applying the measurement bases to the various elements in the financial statements. Consequently, this could lead to an ad hoc approach in measurement requirements in the standards developed by the IASB. The IASB has recognized this issue and is working on a conceptual measurement project.

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4.9 Concepts of Capital and Capital Maintenance The concept of capital maintenance refers to a term that means an enterprise has maintained as much capital at the end of the period as it had at the beginning of the period. Hence, where the amount at the end of the period exceeds the amount at the beginning, the net amount is profit for the period. Concepts of capital maintenance can be divided into: - financial capital maintenance; and - physical capital maintenance. Under financial capital maintenance concept, profit is the difference between the opening and closing financial or money amount of the net assets, after excluding any distributions to or contributions from the owners during the period. For example, the net assets at the beginning of the year was RM1,000,000 and at the end of the year the net assets was RM1,200,000. If there were no capital contribution or withdrawal during the year, profit earned during the year is RM200,000. The maximum profit that can be withdrawn is RM200,000 in order to maintain the opening capital at RM1,000,000. Under physical capital maintenance, profit is earned only if the physical productive capacity (also called operating capability) of the enterprise at the end of the period exceeds the physical productive capacity at the beginning of the period. Price changes in the value of the net assets are viewed as changes in the measurement of the physical productive capacity of the entity. Adjustments for these are treated as part of equity and not as profit. Using the above example, if the price level increases by 5% for the net assets at the end of the year, the opening net assets need to be adjusted to RM1,050,000. The profit earned for the year is RM150,000. Hence, the maximum amount of withdrawals is limited to RM150,000 in order to maintain the opening capital at RM1,000,000. 5.0 IASBs Current Conceptual Framework Project The IASB and FASB are currently working on a joint project aims to update and refine the existing conceptual framework. The overall objective of this project is to create a sound foundation for future accounting standards that are principles-based, internally consistent and internationally converged. The project is being conducted in 8 phases: A. B. C. D. E. F. G. H. objectives and qualitative characteristics definitions of elements, recognition and derecognition measurement reporting and concepts boundaries of financial reporting, presentation and disclosure purpose and status of the framework application of the framework to not-for-profit entities remaining issues if any

Exposure draft for the Objectives and Qualitative Characteristics (Phase A) was issued on 29 May 2008. On 28 September 2010, the IASB and FASB announced the completion of this phase. The proposals in the exposure drafts include: i. 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. General purpose financial reporting is directed at users who provide resources to an entity but
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lack the ability to compel the entity to provide them with the information they need to be able to make decisions. ii. Primary users of accounting information comprise of existing and potential investors, lenders and other creditors. These parties are providing, or are considering providing, resources to the entity; and (b) do not have the power to compel the entity to provide information directly to them and must rely on general purpose financial reports. Other potential users, such as regulators, were not identified as primary users because they often have the power to demand the information needed. iii. Qualitative characteristics deal with the attributes that make financial information useful. They are relevance and faithful representation, identified as the fundamental qualitative characteristics. Comparability, timeliness, verifiability and understandability identified as enhancing the qualitative characteristics that distinguish more useful information from less useful information. In addition to the above exposure draft, the boards have also issued a discussion paper for The Reporting Entity (Phase D) on 29 May 2008. Subsequently an exposure draft was issued on 11 March 2010. 6.0 Summary Financial reporting process involves application of certain rules and procedures to events and transactions engaged by an entity and communicating the information to the various users. The main objective of reporting this information is to provide useful information to a wide range of users in making their economic decisions. In meeting this objective, it is paramount that the information is prepared and presented in accordance with certain requirements. Under the current reporting environment, these requirements are developed based on generally accepted concepts or principles developed in a conceptual framework. Hence, a conceptual framework forms the basis of reference for financial reporting. This is also referred to as principle-based approach in standard-setting. In many jurisdictions around the world, national standard setters are adopting the IASB Framework as the basis of their accounting standards. The IASB convergence efforts to harmonise accounting standards around the world has contributed to the increase in the principle-based approach relative to rules-based approach in the standard-setting process. Currently, the IASB and FASB are jointly working on a project to revise and conform their conceptual frameworks.

Questions
1. What is a conceptual framework? 2. Why is a conceptual framework needed in the development of accounting standards? 3. Discuss the key issues influencing the development of a conceptual framework? 4. Discuss the advantages and disadvantages of having a conceptual framework? 5. Explain the advantages and disadvantages of principles-based and rules-based standards. 6. Relevance and reliability are two of the qualities of the information in financial statements. Explain these two qualitative characteristics.
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7. Explain what is meant by the trade-off of relevance and reliability in accounting information. Give examples in your explanation. 8. What is the difference between consistency and comparability of accounting information? 9. Explain why does the IASB and FASB need a common conceptual framework? 10. The following statement was made by a senior financial executive of a public listed company: I always ensure that all events and transactions reported in the company financial statements are in compliance with the accounting standards issued by MASB. However, I am not so concerned if the accounting information is in compliance with the Framework issued by the MASB as it is not an accounting standard. Required: Comment on the above statement. References 1. MASBs, Framework for the Preparation and Presentation of Financial Statements, Malaysian Financial Reporting Standards, 2007, www.masb.org.my. 2. International Accounting Standards Board, Framework for the Preparation and Presentation of Financial Statements, International Financial Reporting Standards, London: IAC Foundation, www.iasb.org.

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