MMGT 6003

Session 3
Conceptual Framework
and IFRS

Daniel Murphy

The University of Sydney Page 1

 Case Study: Groupon and the
SEC
Case study rules of
engagement
Please raise your hand when
you intend to contribute
But only do this after
someone else has finished
As soon as someone has the
floor, please lower your hand
Listen, not just be waiting to
speak, to ensure a
continuous conversation
Be prepared to be cold called
The University of Sydney Page 2
 Case Study: Groupon and the SEC

1) What sources of information are most useful to

an investment decision?

2) What are the future prospects of this business?

3) What does Groupons accounting tell us about

accounting?

4) What does Groupons accounting tell us about

Groupon?

The University of Sydney Page 3

 What is a conceptual framework?
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 financial
statements (Statement of Financial Accounting
Concepts No. 1: Objectives of Financial Reporting
by Business Enterprises 1978)

It attempts to provide a structured theory of

accounting

The University of Sydney Page 4

 Conceptual frameworks as
normative theories
Conceptual frameworks provide prescription so
they can be considered as normative theories
of accounting
What is a normative theory?
A revised conceptual framework:
In recent years the FASB and IASB had been jointly
working towards the development of an improved
conceptual framework
This stalled in 2010, and was later reactivated in
2012
The IASB took over the project from 2012 as the
FASB decided it would concentrate on other
priority areas at this time
The University of Sydney Page 5
 Conceptual framework: Why
bother???
Rationale for conceptual frameworks
To develop the practice of financial reporting logically and
consistently we need to address and agree upon such
issues as:
what we mean by 'financial reporting' and what should
be its scope;
which organisational characteristics indicate that an
entity should produce financial reports;
the 'objective' of financial reporting;
qualitative characteristics financial information should
possess for it to be useful;
what are the elements of financial reporting; and
what measurement rule(s) should be employed.

The University of Sydney Page 6

 Conceptual framework: Why
bother???
Rationale for conceptual frameworks (cont.)
Proponents argue that without agreement on
these issues accounting standards will be
developed in an ad hoc manner
There will be limited consistency between
accounting standards in the absence of a
conceptual framework

The University of Sydney Page 7

 The 'building blocks' of the
conceptual framework
The framework must be developed in a particular
order
some issues (or assumptions) need to be
resolved before moving on to subsequent
'building blocks'
One obvious issue that needs early agreement
would be what is meant by 'financial reporting,
and in particular general purpose financial
reporting.
Because the rest of the framework flows from
key assumptions about the 'objective of
general purpose financial reporting, if we reject
these assumptions, then we personally might be
prepared to reject the prescriptions provided by
the framework
The University of Sydney Page 8
 Scope of the conceptual
framework
The Framework deals with:
a) the objective of financial statements;
b) the qualitative characteristics that determine
the usefulness of information in financial
statements;
c) the definition, recognition and measurement of
the elements from which financial statements
are constructed; and
d) concepts of capital and capital maintenance.

The University of Sydney Page 9

 Components of a conceptual
framework of accounting

The University of Sydney Adapted from Deegan (2014) Financial Accounting Theory 4e
Page 10
 Conceptual Framework and IFRS

Levels of the Framework

1. Purpose and Status

2. Definition of the Reporting Entity
3. Qualitative Characteristics
4. Underlying assumptions
5. The Elements of Financial Statements
6. Recognition
7. Measurement

The University of Sydney Page 11

Purpose and status of the
conceptual framework
Sets out concepts that underlie the preparation
and presentation of financial statements for
external users
Specifies the function, scope and purpose of
financial accounting and reporting
Discussion:
What is the authoritative status of a conceptual
framework?
Why is a conceptual framework so important to
the accounting profession?

The University of Sydney Page 12

Objective of General Purpose of
Financial Reporting
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
Decisions involve buying, selling or holding equity and debt
instruments, and providing or settling loans and other forms of
credit
Allows assessment of the reporting entitys liquidity
and solvency,
its needs for additional financing; and
how successful it is likely to be in obtaining that
financing
Information about the return the entity has produced
provides an indication of how well management has
discharged its responsibilities to make efficient and
effective use of the reporting entitys resources.
The University of Sydney Page 13
 History of the development
of CFs
CFs were developed in a number of jurisdictions
including
US, UK, Canada, Australia, New Zealand,
International Accounting Standards
Committee
In recent years many countries have adopted
the IASB Conceptual Framework given that they
have decided to adopt the accounting standards
released by the IASB
No standard-setters had developed a complete
CF; measurement issues typically remained
unaddressed
Since 2012 the IASB increased its work towards
completing a revised conceptual framework

The University of Sydney Page 14

 Development of a CF in Australia
Degree of progression was slow
Only four Statements of Accounting Concepts (SACs) were
released
SAC 1: Definition of the Reporting Entity
SAC 2: Objectives of General Purpose Financial Reporting
SAC 3: Qualitative Characteristics of Financial Information
SAC 4: Definition and Recognition of the Elements of
Financial Statements
Fifth SAC relating to measurement was never released
Had a number of similarities to the US CF project
2005: Australia adopted the IASB Conceptual Framework
as a result of the decision by the Financial Reporting
Council that Australia would adopt IAS/IFRS by 2005

The University of Sydney Page 15

 Why a Conceptual Framework?
Standard-setters in Australia, the United States and
elsewhere have given explicit justifications for their
respective CF projects, particularly in terms of the following
observations from practice over the past two decades:
Two or more methods of accounting can be accepted for
the same facts.
Less conservative accounting methods are being used
rather than the earlier, more conservative methods.
Reserves are used to artificially smooth earning
fluctuations.
Financial statements fail to warn of impending liquidity
crunches.
Deferrals are followed by big bath write-offs.
Unadjusted optimism exists in estimates of recoverability.
Form is more important than substance.

The University of Sydney Page 16

 Why a Conceptual Framework?
Off balance-sheet financing (that is,
disclosure in the notes to the financial
statements) is common.
An unwarranted assertion of immateriality has
been used to justify non-disclosure of
unfavourable information or departures from
standards.
Standard-setting bodies have attracted
particular criticism because they are authorities
charged with the primary responsibility for
promoting best financial reporting practices.

The University of Sydney Page 17

 Australian Conceptual Framework?

Manifested in:
Statement of Accounting Concepts SAC 1
Definition of the Reporting Entity (1990)
Framework for the Preparation and
Presentation of Financial Statements
(2016) the Australian equivalent to the
IASBs Framework
SAC 2, SAC 3 and SAC 4 have been
superseded

The University of Sydney Page 18

 Accounting Conceptual Framework?
Levels of the Framework
1. Purpose and Status
2. Definition of the Reporting Entity
3. Qualitative Characteristics
4. Underlying assumptions
5. The Elements of Financial Statements
6. Recognition
7. Measurement

The University of Sydney Page 19

 General purpose financial
statements
The Conceptual Framework provides guidance for
general purpose financial statements and not
special purpose financial statements
GPFSs are financial statements
intended to meet the information needs
common to users who are unable to command
the preparation of reports tailored so as to
satisfy, specifically, all of their information
needs
By contrast, special purpose financial statements
are provided to meet the information demands of
a particular user, or group of users
GPFSs are financial statements that comply with
accounting standards and other generally
accepted accounting practices (GAAPs)
The University of Sydney Page 20
 Who is required to prepare GPFSs?

But which entities are expected to

prepare general purpose financial
statements?

The answer is .
Reporting entities are required to
produce general purpose financial
statements

Okay, but what is a reporting entity?

The University of Sydney Page 21
 Definition of the reporting entity
In 2010 the IASB released an exposure draft entitled
Conceptual Framework for Financial Reporting: The
Reporting Entity in which it defined a reporting entity
as:
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 management and the governing
board of that entity have made efficient and
effective use of the resources provided.
The University of Sydney Page 22

Simple.
 Simple Definition of the Reporting
Entity
Reporting entities are all entities (including
economic entities) in respect of which it is
reasonable to expect the existence of users
dependent on general purpose financial
reports for information which will be useful to
them for making and evaluating decisions
about the allocation of scarce resources.

Reporting entities shall prepare general

purpose financial reports. Such reports shall
be prepared in accordance with Statements of
Accounting Concepts and Accounting
Standards.
The University of Sydney Page 23
 Users of General Purpose
Financial Statements:
Moving forwards or going
Inbackwards?
this regard, paragraph OB 5 of the IASB Conceptual Framework (2010) states:
Many existing and potential investors, lenders and other creditors
cannot require reporting entities to provide information directly to them
and must rely on general purpose financial reports for much of the
financial information they need. Consequently, they are the primary users
to whom general purpose financial reports are directed

The definition of users provided in 2010 by the IASB can be contrasted with
the definition provided in the former IASB Framework for the Preparation and
Presentation of Financial Statements (1989). It had formerly defined users as
encompassing investors, employees, lenders, suppliers, customers,
government and their agencies, and the public.
This former definition is therefore much broader than the definition now used
by the IASB.
Do we think that the definition of users is too restrictive? Why or why not?

The University of Sydney Page 24

 Reporting entity concept
Discussion:
Should they prepare financial reports and
comply with Accounting Standards?
church or tennis club
non-for profit entity
large charity
government department or agency

The University of Sydney Page 25

 Accounting Conceptual Framework
Levels of the Framework
1. Purpose and Status
2. Definition of the Reporting Entity
3. Qualitative Characteristics
4. Underlying assumptions
5. The Elements of Financial Statements
6. Recognition
7. Measurement

The University of Sydney Page 26

 Fundamental Qualitative
Characteristics
If financial information is to be useful, it must be
relevant and faithfully represent what it
purports to represent.
Relevant financial information is capable of
making a difference in the decisions made by users.
To be a perfectly faithful representation, a
depiction would have three characteristics. It would
be complete, neutral and free from error.
Traditionally, the doctrine of conservatism and the
acceptance of 'prudence' has been adopted by
accounting
A bias towards understating asset values and
overstating liabilities
This doctrine is not consistent with notions of
representational faithfulness

The University of Sydney Page 27

 Fundamental Qualitative
Characteristics
Materiality
Information is material if omitting it or
misstating it could influence decisions
that users make on the basis of
financial information
Enhancing qualitative characteristics
The usefulness of financial information
is enhanced if it is comparable,
verifiable, timely and understandable.
Hmmmdo GPFRs achieve this?

The University of Sydney Page 28

 Accounting Conceptual Framework
Levels of the Framework
1. Purpose and Status
2. Definition of the Reporting Entity
3. Qualitative Characteristics
4. Underlying assumptions
5. The Elements of Financial Statements
6. Recognition
7. Measurement

The University of Sydney Page 29

 Going Concern
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.
It is assumed that the entity has
neither the intention nor the need to
liquidate or curtail materially the scale
of its operations.

The University of Sydney Page 30

 Accounting Conceptual Framework
Levels of the Framework
1. Definition of the Reporting Entity
2. Purpose and Status
3. Qualitative Characteristics
4. Underlying assumptions
5. The Elements of Financial Statements
6. Recognition
7. Measurement

The University of Sydney Page 31

 Five elements of financial
reporting in the IASB
Framework
assets
liabilities
equity
expenses
income
in the IASB Conceptual Framework,
income is further subdivided into
revenues and gains
ten elements formerly identified in
the US by FASB
The University of Sydney Page 32
 The elements of financial
reporting
The next building block of a conceptual
framework would consider the
definition and recognition criteria of the
elements of financial reporting
Definition criteriawhat attributes
are required before an item can be
considered as belonging to a particular
class of element
Recognition criteriaemployed to
determine whether the item can be
included in the financial statements
The University of Sydney Page 33
 The Elements of Financial
Statements
Financial Position
Assets
Liabilities
Equity
Performance Measures
Income
Expenses

Capital Maintenance Adjustments

The University of Sydney Page 34

 Financial position

An asset is a resource controlled by the

entity as a result of past events and
from which future economic benefits
are expected to flow to the entity.
A liability is 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 is the residual interest in the
assets of the entity after deducting all
its liabilities.
The University of Sydney Page 35
 Assets: future economic benefits

Control relates to the capacity of the

entity to benefit from the asset in the
pursuit of its objectives, and to deny or
regulate the access of others to that
benefit.
The concept of control is not
constrained to legal ownership or
possession.

The University of Sydney Page 36

 Assets: future economic benefits

The future economic benefits

embodied in an asset may flow to the
entity in a number of ways.
For example, an asset may be:
a) used singly or in combination with
other assets in the production of goods or
services to be sold by the entity;
b) exchanged for other assets;
c) used to settle a liability; or
d) distributed to the owners of the entity.
The University of Sydney Page 37
 Liabilities: giving up resources

Operative word is the present obligation

to pay to parties external to the entity
Most obligations are legally enforceable
because they result from legally binding
contracts or are government imposed
(income taxes or employer
superannuation contributions)
However, the definition of liabilities
extends beyond the concept of legal
enforceability to include equitable
obligations (arising from moral or social
sanctions)
The University of Sydney Page 38
 Liabilities: giving up resources

The settlement of a present obligation by

giving up resources embodying economic
benefits in order to satisfy the claim
a) payment of cash;
b) transfer of other assets;
c) provision of services;
d) replacement of that obligation with
another obligation
e) conversion of the obligation to equity
f) creditor waiving or forfeiting its rights
The University of Sydney Page 39
 Liabilities: giving up resources

1) Board approval to secure $150m senior

loan facility
2) Executed engagement letter with
investment bank for advisory services @
$20k per month for 12 months
3) Selling product under a contract that
offers future rebate to a wholesaler based on
annual purchase levels
4) Your company completes construction,
creates provision for payments to be made
under an existing warranty
The University of Sydney Page 40
 Equity and the accounting identity

Assets = Liabilities + Equity

or
Equity = Assets Liabilities

Residual interest in the assets of the entity

after the deduction of its liabilities. This net
amount constitutes a claim or right to the
net assets of an entity.
The equity and liabilities of an entity are
mutually exclusive interests in the entitys
assets by parties external to the company
The University of Sydney Page 41
 Equity: Residual interest

May be sub-classified in the balance sheet if

relevant to the decision-making needs of the
users:
a) funds contributed by shareholders
(different rights or classes)
b) retained earnings
c) reserves representing appropriations of
retained earnings
d) reserves representing capital maintenance
adjustments

The University of Sydney Page 42

 Equity: Residual interest

Ranks after liabilities as a claim to the

assets of an entity
Increased by profitable operations
(revenues exceed expenses) and
contributions by owners
Conversely, diminished by distributions to
owners and unprofitable operations
(expenses exceed revenues)
Because the Framework defines equity as a
residual, the recognition of equity will be
consequential to procedures used to
recognise assets and liabilities
The University of Sydney Page 43
 The Elements of Financial
Statements
Financial Position
Assets
Liabilities
Equity
Performance Measures
Income
Expenses
Capital Maintenance Adjustments

The University of Sydney Page 44

 Performance measures: 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.

The Framework states that income can be

decomposed into revenues and gains

The University of Sydney Page 45

 Income: Revenues and Gains

Revenue arises in the course of the

ordinary activities of an entity and is
referred to by a variety of different names
including sales, fees, interest, dividends,
royalties and rent.
Gains represent other items that meet the
definition of income and may, or may not,
arise in the course of the ordinary activities
of an entity.
Gains represent increases in economic
benefits and as such are no different in
nature from revenue. Hence, they are not
regarded as constituting a separate
The University of Sydney Page 46
 Income: Gains

disposal of non-current assets

revaluation of marketable securities
(unrealised)
increases in the carrying amount of long-
term assets (unrealised)

Discussion question:
What is the underlying rationale for
displaying gains separately from income?

The University of Sydney Page 47

 Case discussion:

Mirvac

The University of Sydney Page 48

 Case Study: Mirvac

Issues around recognition of assets and fair

value
*Handout excerpt 2009 Mirvac Financial
Statements

First lets find out a little about them

http://www.mirvac.com/

The University of Sydney Page 49

 Performance measures: expenses
Decreases 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.
Expenses: losses
In a similar vein to revenues and gains:
Losses represent other items that meet the
definition of expenses and may, or may not, arise in
the course of the ordinary activities of the entity.

Losses represent decreases in economic benefits

and as such they are no different in nature from
other expenses. Hence, they are not regarded as a
separate element in this Framework.
The University of Sydney Page 50
 The Elements of Financial
Statements
Financial Position
Assets
Liabilities
Equity
Performance Measures
Income
Expenses
Capital Maintenance Adjustments

The University of Sydney Page 51

 Capital Maintenance Adjustments
The revaluation or restatement of assets and
liabilities gives rise to increases or decreases in
equity.
While these increases or decreases meet the
definition of income and expenses, they are not
included in the income statement under certain
concepts of capital maintenance.
Instead these items are included in equity as
capital maintenance adjustments or revaluation
reserves.

Financial capital maintenance

A profit is earned only if the financial (or money)
amount of the net assets at the end of the period
exceeds the financial (or money) amount of net
assets at the beginning of the period, after
The University of Sydney Page 52
excluding any distributions to, and contributions
 Accounting Conceptual Framework
Levels of the Framework
1. Purpose and Status
2. Definition of the Reporting Entity
3. Qualitative Characteristics
4. Underlying assumptions
5. The Elements of Financial Statements
6. Recognition
7. Measurement

The University of Sydney Page 53

 Recognition of the Elements of
Financial Statements
An item that meets the definition of an element
should be recognised if:
it is probable that any future economic benefit
associated with the item will flow to or from the
entity; and
the item has a cost or value that can be
measured with reliability.

Remember:
Information is reliable when it is complete,
neutral and free from error.

The University of Sydney Page 54

 Case discussion:

Austin Engineerings equipment

order

The University of Sydney Page 55

 Case discussion: Austin Engineering
Austin Engineering (ASX:ANG) is a leading designer
and manufacturer of customised dump truck bodies
for the mining industry. It hopes to shave $2.8
million off annual operating costs after closing the
doors at its manufacturing facility in Brisbane. The
closure at Carole Park was to be completed by the
end of September 2016, following a rationalisation of
operations along the east coast. The Company
ordered a new $1.2m manufacturing equipment that
is scheduled for delivery in late August.
http://
www.businessnewsaus.com.au/articles/austin-announce
s-brisbane-facility-closure.html

Can Austin recognise the coal mining equipment

The University of Sydney Page 56
 Case discussion:

Network Ten v Seven Network

The University of Sydney Page 57

 Case discussion: recognition asset and
income
Veteran programmer John Stephens defected to
Channel Ten from Seven in March, only to backflip on
the deal days later and remain with Seven. Ten sued
Seven, alleging it induced Mr Stephens to breach the
contract and sought to stop him working for its rival
for two years, with the case heard by the Supreme
Court of NSW last month. Justice Stevenson ruled on
Friday that Ten must pay the legal costs of Seven
and Mr Stephens, which amounts to about $500,000.
A statement from Ten said there was speculation
Seven was overreaching on its legal fees and that
rumoured figures were overblown and
extortionate".

Network Ten will fight its claim every step of the

The University of Sydney Page 58
way through the cost assessment process over the
 Accounting Conceptual Framework
Levels of the Framework
1. Purpose and Status
2. Definition of the Reporting Entity
3. Qualitative Characteristics
4. Underlying assumptions
5. The Elements of Financial Statements
6. Recognition
7. Measurement

The University of Sydney Page 59

 Bases of measurement
This aspect of the framework sets out, inter alia, the
bases and techniques of measurement that should
be employed when recognising the elements of
financial statements.

Should assets and liabilities be measured at some

market-determined value or at historical cost?

This area of the Conceptual Framework is

undoubtedly the most contentious and problematic.

(which in part explains why SAC 4 on measurement

was never completed/released)

The University of Sydney Page 60

 Bases of measurement
Options include:
a) Historical cost: Assets are recorded at the
amount of cash or
cash equivalents paid or the fair value of the
consideration
given to acquire them at the time of their
acquisition.

b) Current cost: Assets are carried at the amount

of cash or cash
equivalents that would have to be paid if the same
or an
equivalent asset was acquired currently i.e., buying
prices.
The University of Sydney Page 61
 Bases of measurement
Options include:

c) Realisable (settlement) value: Assets are

carried at the amount of cash or cash equivalents
that could currently be obtained by selling the asset
in an orderly disposal (also called fair value).

d) Present value: Assets are carried at the present

discounted value of the future net cash inflows that
the item is expected to generate in the normal
course of business.

The University of Sydney Page 62

 Bases of measurement
The measurement basis most commonly adopted in
preparing a financial report is historical cost. This
is usually combined with other measurement bases.
For example,
inventories are usually carried at the lower of cost
and net realisable value,
Marketable securities may be carried at market
value, and
pension liabilities are carried at their present
value.

In Australia, revaluation of non-current assets is

permitted
At least 12 IFRS standards allows or encourages
use of fair values
The University of Sydney Page 63
 Australias Shift to IFRSs

Why did Australia move to International Financial

Reporting Standards in 2005?

What are the implications of Australia adopting the

IASB conceptual framework?

The University of Sydney Page 64

 Perceived Benefits of IFRSs

Hang over from corporate failures, HIH and Royal

Commission
Lower cost of capital for Australian business
Increased access to overseas capital markets
More transparent and understandable standards
Improved quality of financial reports

Is this what the business community believed?

See survey results of Jones and Higgins (2006)

Australias switch to international financial
reporting standards: a perspective from account
preparers
*available in Extension Resources folder in subject E-Learning
The University of Sydney Page 65 site
 Perceived Benefits of IFRSs

In some respect Australia gained new standards

under the IFRS regime (on Intangibles, Financial
Instruments, Investment Properties - with more of an
explicit emphasis on fair values in many IFRSs)
In another sense IFRSs allow too many reporting
options e.g., cash flow reporting standard permits
either direct or indirect method (previously Australia
had one of the most robust reporting regimes in the
world for cash flow reporting i.e. the direct method
was mandatory).

The University of Sydney Page 66

 Feasibility of a Global Set of Accounting
Standards
Much of the recent literature has focused on the
IASBs mission to create a globally compatible set
of accounting standards and CF
In some respects the IASB is closer to achieving
this end following the decisions by the European
Union and Australia to adopt IASB standards by
January 2005.
100+ countries now report on an IFRS basis
Also, the IASBFASB convergence project offered
some possibility of future agreement on an
internationally compatible set of accounting
standards that would be acceptable to the FASB and
the SEC.
But US seems no closer to converging with IFRS
The University of Sydney Page 67