Chapter 5

A conceptual framework for

accounting and reporting, and
accounting standards

Conflicts of interest
Financial statements result from the interaction
of three groups:
firms, which by their operational, functional
and extraordinary activities, justify the
production of financial statements
users, which include investors, financial
analysts, bankers, creditors, consumers,
employees, suppliers and government
agencies
the accounting profession, which acts
principally as auditor in charge of verifying
that financial statements conform to
generally accepted accounting principles

Cyert and Ijiris three

approaches

Simply stated, these are:

1. the firm-oriented approach

2. the profession-oriented approach
3. the user-oriented approach

The user-oriented approach is

employed by the SACs in Australia,
by the FASB in the USA and by The
Corporate Report in the UK

Conceptual framework
A conceptual framework is a formal
set of interrelated concepts
specifying the function, scope and
purpose of financial accounting and
reporting
In Australia, the SACs represent the
conceptual framework or constitution
for financial reporting

Conceptual framework (contd)

A conceptual framework can be
descriptive, prescriptive or a mixture of
both:
a descriptive framework attempts to
develop a set of interrelated concepts,
which serves to codify and explain
existing financial reporting practices
a prescriptive framework attempts to
develop a conceptual basis for what
financial accounting practices should
be

History of the conceptual framework

The need for a conceptual framework was
recognised in the USA after the stock market
crash of 1929
Leaders of the profession recognised the
need to:
establish basic principles on which to base
company reporting
correct permissive accounting practices of
the 1920s
restore public confidence in professional
accountants

Elements and Meaning of Conceptual Framework

Basic objectives
Subsidiary objectives
Qualitative characteristics
Information needs
Fundamentals of accounting and reporting
Accounting and reporting standards
Interpretations of standards
Accounting practices

Objectives
Objectives are basis on which the
superstructure of accounting theory
can be created.
The AICPA dissolved the Committee on
Accounting Procedure (CAP) and
appointed the Accounting Principles
Board
(APB).
The
accounting
research division of the APB was
created to motivate research on the
basic postulates and principles of
accounting.

The Accounting Principles Board

(APB)
The APB was established in the USA in
1959 to accelerate the development of
a conceptual framework
The APB set itself the following tasks:
to establish basic postulates
to formulate a set of broad principles
to establish rules to guide the application
of principles in specific situations
to base the entire program on research

APB Statement No.4

This statement was titled Basic
Concepts and Accounting Principles
Underlying Financial Statements of
Business Enterprises
Basically descriptive, it did not provide
a conceptual framework, but influenced
Australian attempts to formulate
objectives of financial statements and
to develop a conceptual framework

Objectives according to
APB Statement No. 4
Paul Grady was commissioned by the APB
in 1963 to develop a more descriptive
framework, which was reflected in the
objectives of APB Statement No. 4:
1. Particular objectives of financial
statements are to present fairly, and in
conformity with GAAP, financial position,
results of operations and other changes in
financial position

Objectives according to
APB Statement No. 4 (contd)

2. The general objectives are:

a. to provide reliable information about the
economic resources and obligations of a
business enterprise in order to:
i. evaluate its strengths and
weaknesses
ii. show its financing and investments
iii. evaluate its ability to meet its
commitments
iv. show its resource base for growth

Objectives according to
APB Statement No. 4 (contd)

b. to provide reliable information about

changes in net resources resulting from a
business enterprises profit-directed
activities in order to:
i. show expected dividend return to
investors
ii. demonstrate the operations ability to
pay creditors and suppliers, provide
jobs for employees, pay taxes and
generate funds for expansion
iii. provide management with information
for planning and control

Objectives according to
APB Statement No. 4 (contd)
c. to provide financial information that
can be used to estimate the earnings
potential of the firm
d. to provide other necessary information
about changes in economic resources
and obligations
e. to disclose other information relevant
to statement users needs

Objectives according to
APB Statement No. 4 (contd)
3. The qualitative objectives of
financial accounting are:
a.
b.
c.
d.
e.
f.
g.

relevance
understandability
verifiability
neutrality
timeliness
comparability
completeness

Development of the US
conceptual framework
In 1971, The American Institute of
Certified Practicing Accountants
formed two study groups:
1. the Wheat Committee, which was a
study group on the establishment of
accounting principles, and which
was charged with the task of
improving the standard-setting
process

Development of the US conceptual

framework (contd)
2. the Trueblood Committee, which was
charged with developing the objective
of financial reporting in terms of:
a. who needs financial statements
b. what information they need
c. how much of this information can be
provided through accounting
d. what framework is required to provide
the information

Objectives of financial
statements
The Trueblood Report identified six
objective-levels:
1. The basic objective to provide
information on which to base economic
decisions
2. Four objectives that specify the diverse
users and uses of accounting information
3. Two objectives that specify enterprise
earning power and management ability
as the type of information needed

Objectives of financial statements

(contd)
4. One objective (No. 6) that specifies the
nature of the needed information as
factual and interpretive
5. Four objectives that describe the
financial statements required to meet
objective No. 6
6. A number of specific recommendations
for the financial statements are made
in order to meet each of the preceding
objectives

Qualitative characteristics of
reporting
The Trueblood Report mentioned seven
qualitative characteristics of reporting:
1.
2.
3.
4.
5.
6.
7.

relevance and materiality

form and substance
reliability
freedom from bias
comparability
consistency
understandability

1.Financial reporting should provide

information that is useful to present
and potential investors and creditors
and other users in making rational
investment,
credit,
and
similar
decisions. The information should be
comprehensible to those who have a
reasonable
understanding
of
business and economic activities and
are willing to study the information

2. Financial reporting should provide information to help present

and potential investors and creditors and other users in
assessing the amounts, timing, and uncertainty of prospective
cash receipts from dividends or interest and the proceeds from
the sale, redemption, or maturity of securities or loans. The
prospects for those cash receipts are affected by an
enterprises ability to generate enough cash to meet its
obligations when due and its other cash operating needs, to
reinvest in operations, and to pay cash dividends and may also
be affected by perceptions of investors and creditors generally
about that ability, which affect market prices of the
enterprises securities. Thus, financial reporting should provide
information to help investors, creditors, and others assess the
amounts, timing, and uncertainty of prospective net cash
inflows to the related enterprise.6

3. Financial reporting should provide

information about the economic
resources of an enterprise, the
claims to those resources
(obligations of the enterprise to
transfer resources to other entities
and owners equity), and the effects
of transactions, events, and
circumstances that change resources
and claims to those resources.

4. Financial reporting should provide

information about an enterprises financial
performance during a period. Investors and
creditors often use information about the past
to help in assessing the prospects of an
enterprise. Thus, although investment and
credit decisions reflect investors and
creditors expectations about future enterprise
performance, those expectations are
commonly based at least partly on
evaluations of past enterprise performance

5. The primary focus of financial reporting is information about

an

enterprises

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
6. Financial reporting should provide information about how an
enterprise obtains and spends cash, about its borrowing and
repayment of borrowing, about its capital transactions,
including cash dividends and other distributions of enterprise
resources to owners, and about other factors that may affect
an enterprises liquidity or solvency.

7. Financial reporting should provide information

about how management of an enterprise has
discharged its stewardship responsibility to
owners (stockholders) for the use of enterprise
resources entrusted to it.
8. Financial reporting should provide information
that is useful to managers and directors in
making decisions in the interests of owners.
Although this Statement is concerned primarily
with providing information to external users,
managers and directors are responsible to
owners (and other investors) for enterprise
performance as reflected by financial reporting
and they are judged at least to some extent on
the enterprise performance reported.

Objectives of financial reporting by

non-business organizations
General:
Financial reporting by nonbusiness organizations
should provide information that is useful to present
and potential resource providers and other users in
making rational decisions about the allocation of
resources to those organizations.
Specific:
1. Financial reporting should provide information to
help present and potential resource providers and
other users in assessing the services17 that a
nonbusiness organization provides and its ability to
continue to provide those services

2.Financial reporting should provide information

that is useful to present and potential resource
providers and other users in assessing how
managers of a nonbusiness organization have
discharged their stewardship responsibilities and
about other aspects of their performance
3. Financial reporting is limited in its ability to
distinguish the performance of managers from
that of the organization itself
4. Financial reporting should provide information
about the economic resources, obligations, and
net resources of an organization and the effects
of transactions, events, and circumstances that
change resources and interests in those
resources

5. Financial reporting should provide

information about the amounts and
kinds of inflows and outflows of
resources during a period.
6. Financial reporting should provide
information about how an
organization obtains and spends cash
or other liquid resources, about its
borrowing and repayment of
borrowing, and about other factors
that may affect its liquidity