International Journal of Governmental Financial Management1

A Science-Based Approach to the Conceptual Framework forGeneral Purpose Financial Reporting by Public SectorEntities

Petri Vehmanen -petri.vehmanen@uta.fi

University of Tampere, Finland

Abstract

The International Public Sector Accounting Standards Board (IPSASB) has recently pub-lished a Consultation Paper on its Conceptual Framework for General Purpose Financial Reporting by Public Sector Entities. The author considers that there are problems in theConsultation Paper, and the aim of this paper is to analyze conceptually four of the problemsin detail. These are:1.

the meaning of the term “conceptual framework” in general purpose financial reporting by public sector entities2.

the objectives of financial reporting by public sector entities3.

the scope of financial reporting by public sector entities, and 4.

the qualitative characteristics of information included in general purpose finan-cial reports.Conclusions are derived on each topic. The meaning of the term “conceptual framework” isunderstood as a set of coherent principles and underlying concepts that are formulated toenhance understanding rather than as a deductive conceptual system for which the truth isestablished empirically by applying scientific method. The two objectives of financialreporting (i.e., accountability and decision-usefulness) in the IPSASB Framework should be prioritized to cope with the tension that is inevitably between them. The scope of financial reporting by public sector entities is wider than that of business entities which has implications for the concept formation. This should be given additional attention. Finally, the most signifi-cant result of the paper is its revised system of the qualitative characteristics of informationincluded in general purpose financial reports.

Keywords

: Conceptual framework, scientific method, faithful representation, measurement,relevance, reliability

Introduction

The International Public Sector Accounting Standards Board (IPSASB) has recently pub-lished a Consultation Paper (IPSASB CP, 2008) covering the following four areas of itsproposed conceptual framework:

•

The Objectives of Financial Reporting

•

The Scope of Financial Reporting

•

The Qualitative Characteristics of Information Included in General Purpose FinancialReports (GPFRs), and

•

The Reporting Entity.

International Journal of Governmental Financial Management2

The author considers that there are problems with the Consultation Paper and the aim thispaper is to discuss the four most important problems and to propose some revisions. Morespecifically, the following four topics are covered:1.

The

meaning

of the term “conceptual framework” in the phrase “internationalconceptual framework for general purpose financial reporting (briefly, financialreporting) by public sector entities”;2.

The

objectives

of financial reporting by public sector entities;3.

The

scope

of financial reporting by public sector entities; and4.

The

qualitative characteristics

of information included in general purposefinancial reports (GPFRs).1.

A conceptual framework may have two distinct meanings. Each meaning iscommunicated using different concepts and terminologies. The problem with the IPSASBFramework is that it takes the meaning for the conceptual framework from the oneapproach but the concepts and terminology from the other approach. This will result inmisunderstandings. The most harmful of these is the illusion of certainty that the IPSASBFramework is likely to create.2.

The

objectives

of financial reporting by public sector entities are seen in the IPSASBFramework as providing information about the reporting entity useful to users of GPFRsfor two kinds of purposes: accountability purposes and decision-making purposes(IPSASB CP, 2008, p.8). The problem lies with the breadth (or extensiveness) of theseobjectives. Accountability is related with the past, or more specifically, with the controlof the managerial actions taken in the past while decision-usefulness is related with thefuture, that is, with the usefulness of information in forecasting relevant outcomes of future phenomena. There is a clear tension between these two perspectives. Financialstatements report past events but may use valuations based on future costs or revenues;the choice does to some extent influence their usefulness for, respectively, accountabilityor decision making. Hence it is difficult to construct the financial statements of an entitywithout giving the priority to one perspective or the other. Thus it should be explicitlysaid which perspective is used in preparing these “general purpose” financial statementsand which perspective is then accounted for by supplying additional information. Usingthe term “general purpose” is actually hiding the problem and the term is thereforesomewhat misleading.3.

The

scope

of financial reporting encompasses the provision of financial and non-financialinformation about a total of five items including the two that are familiar from thebusiness environment:(1) economic resources and claims to those resources (the balance sheet) and(2) the effect of transactions, other events and activities that change the economicresources and claims to those resources (the income statement and the statement of cashflows).The additional three items are:(3) the reporting entity’s compliance with relevant legislation or regulation and legallyadopted or approved budgets used to justify the raising of monies from taxpayers andratepayers;(4) the reporting entity’s achievement of its service delivery objectives; and

International Journal of Governmental Financial Management3

(5) prospective financial and other information about the reporting entity’s future servicedelivery activities and objectives, and the resources necessary to support those activities.The additional items make the scope of public sector financial reporting larger than that forprivate sector business entities and reflect the wider range of potential users of the GPFRs of public sector entities.The problem is that the proposed conceptual framework does not sufficiently acknowledgethat this wider scope may have implications for the definition and measurement of some keyconcepts, particularly the definition and measurement of an asset. In the context of businessentities in the private sector the objective is to provide financial information about thereporting entity that is useful to present and potential equity investors, lenders and othercreditors in making decisions in their capacity as capital providers. The context of public sec-tor entities is more diverse (cf. IASB ED, 2008, p.14 and IPSASB CP, 2008, p.18) thusrequiring further analysis of the definition and measurement of an asset.4.

The qualitative characteristics of information included in GPFRs are defined as the attrib-utes that make that information useful to users for accountability purposes and for makingvarious decisions. There are at least three problems concerning these attributes. The firstof them, which is also acknowledged in the Consultation Paper, is that in practice all thegiven qualitative characteristics may not be fully achieved, and therefore a balance ortrade-off between certain of them may be necessary (IPSASB CP, 2008, p.31). That, of course, is true and requires no further comment.The second problem concerns the derivation of the qualitative characteristics. They are just enumerated in the Consultation Paper without an explicit attempt to derive them fromthe concept of usefulness. To describe the process, the Consultation Paper only explainsthat these qualitative characteristics have been “developed” after considering thequalitative characteristics in the IASB Framework (IASB ED, 2008). Obviously some“development” has been required. As the Consultation Paper indicates, the qualitativecharacteristics of information included in GPFRs must:(a) respond to the objectives of GPFRs of public sector entities (which are to some extentdifferent from those of the business entities in the private sector), and(b) reflect a potentially broader scope of financial information than that which the IASBhas currently identified (IPSASB CP, 2008, p.31).Despite these deficiencies in the process of “developing” the qualitative characteristics, theprocess itself will not be further commented on in this paper. Instead the focus will be on theoutcome, that is, on the qualitative characteristics themselves, wherein the third problem lies.This is the terminology of the qualitative characteristics and the underlying concepts. Theconcept of faithful representation that has been borrowed from the theory of measurementshould be replaced with the more familiar concept of reliability. Relevance and reliabilityshould be regarded as the two fundamental qualitative characteristics of useful financialreporting information (cf. IASB ED, 2008, pp.35-38). The concept of verifiability should beconsidered subordinate to reliability and given its customary, more restricted scientificmeaning (to be explained later). Moreover, to fill the resulting gap, the new concept of supportability should be introduced and defined. In addition, all the constraining factorsshould be regarded as elements of sufficiency (also to be explained later). Therefore, toensure usefulness of the reported information, it should have the fundamental qualitativecharacteristics of relevance and reliability (or freedom from error, if preferred) under the