CONCEPTUAL FRAMEWORK FOR

FINANCIAL REPORTING

IFRS Edition
 Conceptual
Conceptual Framework
Framework
A conceptual framework is “a coherent system of interrelated
objectives and fundamentals that can lead to consistent
standards and that prescribes the nature, function, and limits
of financial accounting and financial statement.

Second Level: Third Level:

Conceptual First Level:
Fundamental Recognition and
Framework Basic Objectives Measurement
Concepts

Need Qualitative Basic

Development characteristics assumptions
Basic elements Basic
principles
Constraints
 Conceptual Framework

Conceptual Framework establishes the concepts

that underlie financial reporting.

Need for a Conceptual Framework

Rule-making should build on and relate to an established

body of concepts.

Enables IASB to issue more useful and consistent

pronouncements over time.
 Conceptual Framework
Development of a Conceptual Framework
IASB and FASB are working on a joint project to
develop a common conceptual framework

Framework will build on existing IASB and FASB

frameworks.
Project has identified the objective of financial
reporting and the qualitative characteristics of
decision-useful financial reporting information.
 Conceptual Framework
Overview of the Conceptual Framework

Three levels:

First Level = Basic objective

Second Level = Qualitative characteristics and

elements of financial statements

Third Level = Recognition, measurement, and

disclosure concepts
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition Third
4. Full disclosure
level
4. Periodicity
5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities Second level
2. Enhancing 3. Equity
qualities 4. Income
5. Expenses
Illustration 2-7
Framework for Financial
Reporting OBJECTIVE
Provide information about the
reporting entity that is useful
to present and potential
equity investors, lenders, and First level
other creditors in their
capacity as capital
Providers.
 First Level: Basic Objective

OBJECTIVE
“To provide financial information about the reporting entity
that is useful to present and potential equity investors,
lenders, and other creditors in making decisions in their
capacity as capital providers.”

 Provided by issuing general-purpose financial statements.

 Assumption is that users have reasonable knowledge of business
and financial accounting matters to understand the information.
 Second Level: Fundamental Concepts

Qualitative Characteristics of Accounting

Information

IASB identified the Qualitative Characteristics of

accounting information that distinguish better (more useful)
information from inferior (less useful) information for
decision-making purposes.
Second Level: Fundamental Concepts
Illustration: Hierarchy
of Accounting Qualities
 Second Level: Fundamental Concepts

Fundamental Quality - Relevance

Relevance is one of the two fundamental qualities that make
accounting information useful for decision-making.
 Second Level: Fundamental Concepts

Fundamental Quality – Faithful Representation

Faithful representation means that the numbers and descriptions
match what really existed or happened.
 Second Level: Fundamental Concepts
Enhancing Qualities

Distinguish more-useful information from less-useful information.

 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition Third
Basic
Basic Elements
Elements
4. Periodicity 4. Full disclosure
level
5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities Second level
2. Enhancing 3. Equity
qualities 4. Income
5. Expenses
Illustration 2-7
Framework for Financial
Reporting OBJECTIVE
Provide information about
the reporting entity that is
useful to present and
potential equity investors, First level
lenders, and other
creditors in their
capacity as capital
Providers.
Second Level: Basic Elements
 Second Level: Basic Elements
Exercise 2-4: Identify the qualitative characteristic(s) to be used given
the information provided. Characteristics
(a) Qualitative characteristic being employed Relevance
when companies in the same industry are Faithful representation
using the same accounting principles. Predictive value
(b) Quality of information that confirms users’ Confirmatory value
earlier expectations. Neutrality
(c) Imperative for providing comparisons of a Completeness
company from period to period. Timeliness
(d) Ignores the economic consequences of a Verifiability
standard or rule. Understandability
Comparability
LO 5
 Second Level: Basic Elements
Exercise 2-4: Identify the qualitative characteristic(s) to be used given
the information provided. Characteristics
(e) Requires a high degree of Relevance

consensus among individuals on Faithful representation

a given measurement. Predictive value
Confirmatory value
(f) Predictive value is an ingredient Neutrality
of this fundamental quality of Completeness
information.
Timeliness
(g) Qualitative characteristics that Verifiability
enhance both relevance and Understandability
faithful representation. Comparability
LO 5
 Second Level: Basic Elements
Exercise 2-4: Identify the qualitative characteristic(s) to be used given
the information provided. Characteristics
(h) Neutrality and completeness are Relevance

ingredients of this fundamental Faithful representation

quality of accounting information. Predictive value
Confirmatory value
(i) Two fundamental qualities that make Neutrality
accounting information useful for Completeness
decision-making purposes.
Timeliness
(j) Issuance of interim reports is an Verifiability
example of what enhancing Understandability
ingredient? Comparability
LO 5
 Third Level: Recognition, Measurement, and
Disclosure Concepts
These concepts explain how companies should recognize,
measure, and report financial elements and events.

Recognition, Measurement, and Disclosure Concepts

ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition
4. Periodicity 4. Full disclosure
5. Accrual

Illustration 2-7
Framework for
Financial Reporting
 Third Level: Assumptions

Basic Assumptions
Economic Entity – company keeps its activity separate from its
owners and other business unit.
Going Concern - company to last long enough to fulfill objectives
and commitments.
Monetary Unit - money is the common denominator.
Periodicity - company can divide its economic activities into time
periods.
Accrual Basis of Accounting – transactions are recorded in the
periods in which the events occur.
 Third Level: Assumptions
E2-8: Identify which basic assumption of accounting is best
described in each item below.
(a) The economic activities of FedEx Corporation (USA)
are divided into 12-month periods for the purpose of Periodicity
issuing annual reports.
(b) Total S.A. (FRA) does not adjust amounts in its Monetary
financial statements for the effects of inflation. Unit
(c) Barclays (GBR) reports current and non-current
classifications in its statement of financial position. Going Concern
(d) The economic activities of Tokai Rubber Industries
(JPN) and its subsidiaries are merged for accounting
and reporting purposes. Economic
Entity
 Third Level: Principles

Principles
Measurement
Cost is generally thought to be a faithful representation
of the amount paid for a given item.
Fair value is “the amount for which an asset could be
exchanged, a liability settled, or an equity instrument
granted could be exchanged, between knowledgeable,
willing parties in an arm’s length transaction.”
IASB has taken the step of giving companies the option
to use fair value as the basis for measurement of
financial assets and financial liabilities.
 Third Level: Principles

Revenue Recognition - revenue is to be recognized when it is

probable that future economic benefits will flow to the company and
reliable measurement of the amount of revenue is possible.

Illustration :
Timing of Revenue Recognition
 Third Level: Principles

Expense Recognition - outflows or “using up” of assets or

incurring of liabilities (or a combination of both) during a period as a
result of delivering or producing goods and/or rendering services.
Illustration 2-4
Expense Recognition

“Let the expense follow the revenues.”

 Third Level: Principles

Full Disclosure – providing information that is of sufficient

importance to influence the judgment and decisions of an informed
user.

Provided through:
Financial Statements
Notes to the Financial Statements
Supplementary information
 Third Level: Principles
BE2-9: Identify which basic principle of accounting is best
described in each item below.
(a) Parmalat (ITA) reports revenue in its income statement Revenue
when it is earned instead of when the cash is collected. Recognition
(b) Google (USA) recognizes depreciation expense for a
machine over the 2-year period during which that Expense
machine helps the company earn revenue.
Recognition
(c) KC Corp. (USA) reports information about pending
lawsuits in the notes to its financial statements.
Full
(d) Fuji Film (JPN) reports land on its balance sheet at the Disclosure
amount paid to acquire it, even though the estimated fair
market value is greater.
Measurement
 Third Level: Constraints

Constraints

Cost – the cost of providing the information must be weighed

against the benefits that can be derived from using it.

Materiality - an item is material if its inclusion or omission would

influence or change the judgment of a reasonable person.
 Third Level: Constraints

E2-11: What accounting constraints are illustrated by the items

below?

(a) Willis Company does not disclose any information

in the notes to the financial statements unless the Cost
value of the information to users exceeds the
expense of gathering it.
(b) Beckham Corporation expenses the cost of
Materiality
wastebaskets in the year they are acquired.
Summary of
the Structure

IFRS
Summary of
the Structure

US GAAP

LO 2
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Historical cost 1. Cost-benefit
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Matching 3. Industry practice
4. Periodicity 4. Full disclosure 4. Conservatism

QUALITATIVE
CHARACTERISTICS ELEMENTS
Relevance Assets, Liabilities, and Equity
Investments by owners
Reliability Distribution to owners
Comparability Comprehensive income
Revenues and Expenses
Old Consistency Gains and Losses

OBJECTIVES
1. Useful in investment
and credit decisions
2. Useful in assessing

US GAAP future cash flows

3. About enterprise
resources, claims to
resources, and
changes in them
Third Level: Constraints (USGAAP-Old)
Cost Benefit – the cost of providing the information
must be weighed against the benefits that can be
derived from using it.
Materiality - an item is material if its inclusion or
omission would influence or change the judgment of
a reasonable person.
Industry Practice - the peculiar nature of some
industries and business concerns sometimes requires
departure from basic accounting theory.
Conservatism – when in doubt, choose the solution
that will be least likely to overstate assets and
income.
 The existing conceptual frameworks underlying U.S. GAAP and IFRS
are very similar.
 The converged framework should be a single document, unlike the
two conceptual frameworks that presently exist.
 Both the IASB and FASB have similar measurement principles, based
on historical cost and fair value. However, U.S. GAAP has a concept
statement to guide estimation of fair values when market-related data
is not available (Statement of Financial Accounting Concepts No. 7,
“Using Cash Flow Information and Present Value in Accounting”). The
IASB is considering a proposal to provide expanded guidance on
estimating fair values.
Earnings Management
What is Earnings Management
“…a purposeful intervention in the external financial reporting process,
with the intent of obtaining some private gain
(Schipper, 1989: “Commentary Earnings Management”, Accounting Horizon).

“Earnings management occurs when managers use judgment in financial

reporting and in structuring transactions to alter financial reports to either
mislead some stakeholders about the underlying economic performance
of the company, or to influence contractual outcomes that depend on
reported accounting numbers”
(Healy dan Wahlen, 1999: “A Review of the Earnings Management”, Accounting Horizon)

Given that managers can choose accounting policies from a set of

policies (for example, GAAP), it is natural to expect that they will choose
policies so as to maximize their own utility and/or the market value of the
firm. This is called earnings management
(Scott, 2003, “Financial Accounting Theory” , Third Edition)
 The Distinction between Earnings
Management and Fraud
Earnings management includes the whole spectrum, from conservative
accounting through fraud, a huge range for accounting judgment, given the
incentives of management.

Conservative Moderate Aggressive Fraud

Accounting Accounting Accounting

The objective of accounting information is to explain financial and economic

reality, including both performance and the financial position of company. The
chief financial officer (CFO) develops a perspective on what this economic
reality is and how it should be reported.
With this approach, earnings management is the planning and control of the
accounting and reporting system to meet the personal objective of
management
(Giroux, 2004 “Detecting Earnings Management”)
 Accounting Choices “Real” Cash Flow Choices
Within GAAP
“Conservative” Overly aggressive recognition of provisions or Delaying sales
Accounting reserve Accelerating R&D or Advertising
Overvaluation of acquired in-process R&D in expenditures
purchase acquisition
Overstatement of restructuring charges and asset
write-offs

“Neutral” Earnings that result from a neutral operation of

Earnings the process

“Aggressive” Understatement of the provision for bad debts Accelerating sales

Accounting Drawing down provisions or reserves in an overly Postponing R&D or Advertising
aggressive manner expenditures

Violate GAAP
“Fraudulent” Recording sales before they are “realizable”
Accounting Recording fictitious sales
Backdating sales invoices
Overstating inventory by recording fictitious
inventory

Dechow & Skinner, 2000

Motivations For Earnings Management
Capital Market Motivations
The widespread use of accounting information by investors and financial
analysts to help value stocks can create an incentive for managers to
manipulate earnings in attempt to influence stock price performance (include
meeting analysts expectation, or maximizing proceed from initial share issues).

Contracting Motivations
Accounting data are used to help monitor and regulate the contracts
between the firm and its many stakeholders (lending contracts, or management
compensation contracts)

Regulatory Motivations
The effects of two forms of regulation : industry specific regulation and anti
trust regulation. Accounting standard setters have demonstrated an interest
in earnings management to circumvent industry regulation (banking, utility
industries). Standard setters may also be interested in earnings
management for anti-trust purposes.
Other Motivations For Earnings Management

Taxation Motivations
Income taxation is perhaps the most obvious motivation for earnings
management (firms use LIFO for tax purposes). However, taxation
authorities tend to impose their own accounting rules for calculation of
taxation income, thereby reducing firms’ room to maneuvers.

Changes of CEO
CEOs of poorly performing firms may income-maximize to prevent or
postpone being fired.
Alternatively, CEOs may take a bath so as to increase the probability of
positive future earnings. This motivation also applies to new CEOs,
especially if large write-offs can be blamed on the previous CEO.
 Earnings Management Techniques
The most common of earnings management techniques involves simply using
the flexibility that exists in GAAP (include changing depreciation method, changing
the useful lives and the estimates of salvage value for depreciation, determining the
allowance for uncollectible accounts receivable, estimating the stage of completion of
percentage-of-completion contract, etc)

Abusive earnings management (Levitt, 1998) include big bath charges,

creative acquisition accounting, cookie jar reserves, materiality, and revenue
recognition.

Earnings management techniques (Giroux, 2004) include:

- Aggressive revenue recognition (recognizing revenues early in the
operating cycle),
- Capitalizing rather than expensing operating cost,
- Allocating costs over longer period (increasing the estimated useful
lives of fixed assets)
Is Earnings Management Good or Bad
Contracting Perspective (Scott, 2003)
Good earnings management.
Under ”efficient contracting”, it is desirable to give managers some ability to
manage earnings in the face of incomplete and rigid contracts (bonus, debt
covenant, & political). Thus, we would expect some earnings management to
persist for efficient contract.
In “a financial reporting context, earnings management ca be a device to
convey inside information to the market, enabling share price to better reflect
the firm’s future prospects.

Bad earnings management.

From contracting perspective, this can result from opportunistic manager
behavior. Example, the tendency of managers to use earnings management to
maximize their bonuses (Healy, 1985), debt covenant violations (Dechow, et al., 1996).
In a financial reporting context, earnings management can be used to increase
reported net income in the short run for raising new share capital. Example:
speeding up revenue recognition, lengthening the useful life of assets, etc.
Is Earnings Management Good or Bad

CEO Perspective (Mulford & Comiskey, 2002, p.82)

Good earnings management as reasonable and proper practices that are
part of operating a well-managed business and delivering value to
shareholders
Bad earnings management, that is, improper earnings management, is
intervening to hide real operating performance by creating artificial accounting
entries or stretching estimates beyond a point of reasonableness.

Abusive earnings management (Levitt, 1998)

“Abuses such as earnings management occur when people exploit flexibility in
accounting. Trickery is employed to obscure actual financial volatility. This, in
turn, mask the true consequences of management’s decisions.
 Earnings Management Environment
Corporate Governance
The governance structure includes the board of directors, the functions of the
committees, the interaction of the board with management, and auditing.

Auditing
The external auditors must have the ability to discover significant
discrepancies with GAAP (competence) and willingness to report the
discrepancies to the audit committee or other relevant bodies (independence)

Accounting regulation and Standard Setting

Securities and Exchange Commission (SEC) is responsible for regulating the
entire equity capital market structure.

Earnings restatement
An earnings restatement is the revision of public financial information that was
previously reported. It represents real evidence of past earnings manipulation.
 How to Detect Earnings Management

Analysis of earnings management often focuses on management’s

use of discretionary accruals.

Discretionary Accruals Model :

• Healy Model (1985)

Tests for earnings management by comparing mean total
accruals (scaled by lagged total assets) across the earnings
management partitioning variable.

Σt TAt
NDAt = --------
T
Discretionary Accruals Model
DeAngelo Model (1986)
Tests earnings management by computing first differences in total
accruals, and by assuming that the first differences have an
expected value of zero under the null hypothesis f no earnings
management.
NDAτ = TA τ-1

Jones Model (1991)

The model attempts to control for the effect of changes in a firm’s
economic circumstances on nondiscretionary accruals.

NDAτ = α1 (1/Aτ-1) + α2 (ΔREVτ) + α3 (PPEτ)

Manajemen Laba di 34 Negara

Sumber: Bhattacharya, et al. (2003, p.670)

 Earnings Aggresiveness Loss Avoidance Earnings Smoothing Overall Earning Opacity
(Earnings Management)
Least, 1 Portugal Brazil Turkey United States
Belgium Mexico United States Norway
The Netherlands Australia Brazil Portugal
Germany United States Norway Brazil
Switzerland Norway Mexico Belgium
United States Ireland Canada Mexico
Denmark Denmark Australia Canada
2 France France Taiwan France
Spain United Kingdom Spain Australia
Finland Belgium France Spain
Austria Sweden Thailand United Kingdom
Canada Portugal Sweden Denmark
Thailand Canada United Kingdom Switzerland
Norway Hong Kong India Sweden
3 Italy The Netherlands Hong Kong Germany
United Kingdom South Africa Portugal The Nederlands
Pakistan Austria Indonesia Finland
Ireland Singapore Malaysia Austria
Australia South Korea Switzerland Thailand
Sweden Malaysia Finland Ireland
Singapore Germany Singapore Hong Kong
4 Taiwan Italy Belgium Singapore
Chile Spain South Africa Taiwan
Japan Switzerland Austria Turkey
South Africa Japan Germany South Africa
Brazil Finland Ireland Malaysia
Mexico Pakistan Pakistan Italy
Hong Kong Chile Denmark Pakistan
Most, 5 Malaysia Greece Chile Japan
South Korea Turkey Greece Chile
Indonesia Taiwan Japan India
India Thailand The Nederlands Indonesia
Greece India Italy South Korea
Turkey Indonesia South Korea Greece
 Kasus : PT Indofarma

 PT Indofarma merupakan perusahaan milik negara (BUMN) di

bidang farmasi.

 Tahun 2002, manajemen melakukan mark-up atas laba yang

dilaporkan.
Triwulan 1 : perseroan meraih laba hanya Rp.6,62 Miliar,
dilaporkan laba sebesar Rp.15,92 Miliar
Triwulan 2 : perseroan rugi Rp.12,62 Miliar, dilaporkan laba
Rp45,31 Miliar
Triwulan 3 : perseroan rugi Rp.1,41 M, dilaporkan laba
Rp88,57 Miliar
 Faktor-faktor Penyebab Kesalahan (Mark-up)

 Tidak akuratnya data tentang stok produksi di 29 cabang milik perusahaan, yaitu
PT Indofarma Global Medika, mengakibatkan selisih Rp.57,16M

 Nilai barang dalam proses overstated, disajikan pada laporan keuangan 2001,
akibatnya HPP understated & laba bersih mengalami overstated.
Tidak akuratnya perhitungan HPP, manajemen mengira masih ada marjin laba
yang cukup besar sehingga meningkatkan diskon dari 27% sampai triwulan III
menjadi 43% di triwulan IV.

 Tahun 2002 perusahaan merugi karena adanya tekanan beban pokok penjualan
yang meningkat 70% selama 2,5 tahun terakhir.
 Tindakan Bapepam

 PT Indofarma dikenakan denda Rp.500juta

 Direksi lama PT Indofarma dikenakan denda Rp.1 Miliar

 Partner KAP Hadori Tuanakotta & Mustofa (HTM) didenda

Rp.100 juta, karena dinyatakan tidak berhasil mengatasi risiko
audit dalam mendeteksi adanya penggelembungan laba yang
dilakukan olek kliennya.