A Copcetual Framework

The role of a conceptual framework

A conceptual framework of accounting aims to provide a structured theory of
accounting. At the next fundamental conceptual level, it identifies and defines the
qualitative characteristics of financial information ( such as relevance, reliability,
comparability, timeliness and understandability) and the basic elements of accounting
(such as assets, liabilities, equity, revenue, expenses and profit). For example, the
FASB has defined the conceptual framework as: a coherent system of interrelated objectives
and fundamentals that is expected to lead to consistent standards and that prescribes the
nature, function and limits of financial accounting and reporting. Such words as 'coherent
system' and 'consistent' indicate that the FASB advocates a theoretical and non-
arbitrary framework, and the word 'prescribes' supports a normative approach.
The benefits of a conceptual framework have been summarised by Australian
standard setters as follows:
(a) Reporting requirements will be more consistent and logical because they
will stem from an orderly set of concepts.
(b) Avoidance of reporting requirements will be much more difficult because
of the existence of all-embracing provisions.
(c) The boards that establish the requirements will be more accountable for their
actions in that the thinking behind specific requirements will be more explicit,
as will any compromises that may be included in particular accounting
standards.
(d) The need for specific accounting standards will be reduced to those
circumstances in which the appropriate application of concepts is not clear-cut,
thus minimising the risks of over-regulation.
(e) Preparers and auditors will be able to better understand the financial
reporting requirements they face.
(f) The setting of requirements will be more economical because issues
should not need to be re-debated from differing view points.

Objectives of conceptual frameworks

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. This objective is seen to be achieved by reporting
information that is:
• useful in making economic
decisions
• useful in assessing cash flow
prospects
• about enterprise resources, claims to those resources and changes
in them.

Developing a conceptual framework

The IASB states that the Framework
  defines the objectives of financial statements
 identifies qualitative characteristics that make information in financial statements useful
 defines the basic elements of financial statements and the concepts for recognising and
measuring them in financial statements.

IAS 8 (paragraph 10) requires that in the absence of an IASB standard or

interpretation that specifically applies to a transaction, other event or
condition, management must use its judgement in developing and applying
an accounting policy that results in information that is:
• relevant to the economic decision making needs of users
• reliable, in that the financial statements:
(i) represent faithfully the financial position, financial performance and cash flows of the
entity;
(ii) reflect tbe economic substance of transactions, other events and conditions,
and not merely the legal form;
(iii) are neutral, i.e. free from bias;
(iv) are prudent; and
(v) are complete in all material respects.

Developing a conceptual framework

Principles-based and rule-based standard setting
Conceptual frameworks have an important role in the standard setting process as
they provide a framework for the development of a body of coherent standards
based on consistent principles. . While the IASB aims to be a principles-based
standard setter, standards such as IAS 39 have been criticised as being overly rule-
based. Nobes suggests that the reasons standards become rules-based is that they are
inconsistent with the conceptual frameworks of standard setters.
IAS 17 classifies leasesas finance leasesor operating leases, but this is mere words. Finance
leases correspond to the Financial Accounting Standards Board's capital leases. There are
five criteria for determining whether a lease is a finance lease; they are:
• The lease transfers ownership to the
lessee;
• The lease contains a bargain purchase option to purchase that is expected to
be exercised;
• The lease is for the major part of the economic I ife of
the asset;
• The present value of the minimum lease payments amounts to substantially
all of the fair value of the leased asset;
• Only the lessee can use the leased
asset.

Information for decision making and the decision-theory approach

Accounting data are for decision making or evaluative purposes in relation to a specific
entity. Accounting information for decision making begins with the stewardship function.
The decision-theory approach to accounting is helpful to test whether accounting achieves
its purposes. If the individual systems provide useful information, then the theory on which
the systems are based can be considered effective or valid. Financial information may have
a wider range of users. For example, the IASB Framework includes investors, employees,
lenders, suppliers and trade creditors, customers, governments and their agencies, and the
public as potential users.

International developments: the IASB and FASB Conceptual Framework

In October 2004, the FASB and IASB added a joint project to their agendas to
develop an improved, common conceptual framework. The FASB states that the
project will do the following:

1. Focus on changes in the environment since the original frameworks were

issued, as well as omissions in the original frameworks, in order to
efficiently and effectively improve, complete, and converge the existing
frameworks.
2. Give priority to addressing and deliberating those issues within each
phase that are likely to yield benefits to the Boards in the short term; that
is, cross-cutting issues that affect a number of their projects for new or
revised standards.
3. Initially consider concepts applicable to private sector business
entities.

Entity vs proprietorship perspective

the entity and proprietorship perspectives represent different approaches to financial
reporting. The Boards recommended that financial reports should be prepared from the
perspective of the entity rather than the perspective of the owners or a particular class of
owners.
Primary user group
The Boards proposed that the primary user group for general purpose financial reporting is
present and potential capital providers.
Decision usefulness and stewardship
The objective of financial reporting should be 'broad enough to encompass all the
decisions that equity investors, lenders, and other creditors make in their capacity as
capital providers, including resource allocation decisions as well as decisions made to
protect and enhance their investments.
Qualitative characteristics
The IASB Framework includes four principal qualitative characteristics, namely
understandability, relevance, reliability and comparability. The exposure draft
proposes that the qualitative characteristics that make information useful are
relevance, faithful representation, comparability, verifiability, timeliness and
understandability, and that the pervasive constraints on financial reporting are
materiality and cost. The qualitative characteristics are distinguished as either
fundamental(relevance, faithful representation) or enhancing (comparability,
verifiability, timeliness and understandability), depending on how they affect the
usefulness of information.
A critique of conceptual framework projects
There are two approaches we can use in our analysis. The first is to assume that the
conceptual framework should be a 'scientific approach based on the methods used in other
areas of scientific inquiry. The second is a professional approach that concentrates on
determining the 'best course of action using 'professional values'.
Ontological and epistemological assumptions
Throughout the conceptual framework project, the focus is on providing information to users
of financial statements in an objective and unbiased manner. Freedom from bias, or
neutrality, has been defined as 'the quality of information that avoids leading users to
conclusions that secure the particular needs, desires, or prejudices of its makers'.
Circularity of reasoning
As we have seen, one of the purposes of the conceptual framework is to guide the day-to-day
practice of accountants. For example, in FASB Statement No. 2, the quality of information
such as reliability is stated to depend on the achievement of other qualities, such as
representational fidelity, neutrality, and verifiability.
An unscientific discipline
Is accounting a science? The conceptual framework may have tried to adopt a deductive
(scientific) approach, but this approach is questionable if accounting does not qualify as a
science to begin with.
Positive Framework
It has been argued that the basic focus of the conceptual framework project is providing
financial information to help users make economic decisions - ignoring the empirical findings
of positive accounting research.
The conceptual framework as a policy document
As a body of general knowledge, conceptual frameworks fail a number of 'scientific' tests.
Although reality is a mere social construction, the deductive process in a conceptual
framework cannot change the situation into something that is expected. Another way of
looking at the conceptual framework deductively or normatively can be done by provoking it
as a policy model. Ijiri distinguishes between the normative model and the policy model.
Professional values and self-preservation
Explanations of the conceptual framework in terms of self-preservation and professional
values may seem contradictory at first. 'Self-preservation' implies the pursuit of self-interest,
whereas 'professional values' denotes idealism and altruism. Gerboth considers this sense of
personal responsibility - the essence of professionalism - is what makes an objective
accountant decision. Hines argues that the ability of the accounting profession to retain
legitimacy as a profession will be judged by society in terms of the apparent theoretical
defensibility of the profession's body of knowledge.