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In Chapter 3 we established that accounting theory constitutes the frame of reference on which the

development of accounting techniques is based. This frame of reference, in turn, is based primarily on the
establishment of accounting concepts and principles. Of vital importance to the accounting discipline is that the
accounting profession and other interest groups accept these concepts and principles. To ensure such
consensus, a statement of the reasons or objectives that motivate the establishment of the concepts and
principles must be the first step in the formulation of an accounting theory.
A statement of the objectives of financial statements has always been recognised as urgent and essential if
debate over alternative standards and reporting techniques is to be resolved by reason and logic. For example,
in 1960, Devine argued that:
... the first order of business in constructing a theoretical system for a service function is to establish the
purpose and the objectives of the function. The objectives and purposes may shift through time, but for
any period, they must be specified or specifiable.'
Watts and Zimmerman note that financial accounting theory has had little substantive, direct impact on
accounting theory and practice, and offer the following explanation:
Often the lack of impact is attributed to basic methodological weaknesses in the research. Or, the
prescriptions offered are based on explicit or implicit objectives that frequently differ from writers. Not
only are the researchers unable to agree on the objectives of financial statements, but they also disagree
over the methods of deriving the prescriptions from the objectives. 2
Aware of their importance, the accounting professions in Australia, the United States, the United Kingdom
and Canada have made various attempts to formulate the objectives of financial statements. In Australia, the
accounting profession has formalised the objectives of financial statements in the release of various discussion
papers and in Statements of Accounting Concepts (SACs). Together, the SACs represent the Australian
conceptual framework or constitution for financial reporting. In the United States, the importance of the
development of financial statements objectives was first expressed by the report of the Study Group on the
Objectives of Financial Statements,3 and later in the attempts of the FASB to develop a conceptual framework 4
In the United Kingdom, the importance of these objectives was highlighted by the publication of The Corporate
Report by the Institute of Chartered Accountants in England and Wales'> In Canada, interest in the sub ject
resulted in the publication of Corporate Reporting: Its Future Evolution. 6 Although relatively recent, all of
these efforts have been directly influenced by Chapter 4 of APB Statement No.4 'Basic Concepts and
Accounting Principles Underlying Financial Statements of Business Enterprises'.

In this chapter, we will elaborate on the attempts by the AARF, the AASB and the accounting profession to
formulate the objectives of financial statements and to develop a conceptual framework for financial reporting
in Australia. Emphasis is also given to the conceptual framework in the United States because developments in
this jurisdiction proved influential on the development of the Australian SACs. Furthermore, this chap ter
considers the development of conceptual framework projects in the United Kingdom and Canada.

5.1 The search for a conceptual framework: historical

In its simplest form a conceptual framework is a formal set of interrelated concepts that specify the
function, scope and purpose of financial accounting and reporting. A conceptual framework can be
descriptive, prescriptive or a mixture of both. A descriptive framework is one that attempts to develop a set
of interrelated concepts which serves to codify and explain existing financial reporting practices. A
prescriptive framework is one that attempts to develop a conceptual basis for what financial accounting
practices should or ought to be. In other words, it seeks to modify or change existing accounting
practices. It will be seen that the level of description and prescription applied in various conceptual
framework projects tends to vary across different accounting jurisdictions.
Concern with a conceptual framework that would guide company financial reporting practices and
accounting standard setting has occupied the attention of professional accountants, academics and
regulators for over fifty years. Historically considered, the Wall Street crash in 1929 has had much to do
with a professional push for a conceptual framework. The share market crash resulted in an international
economic depression and the collapse of numerous companies worldwide. Professional accountants in the
United States, and to a lesser extent in the United Kingdom, were criticised and assigned considerable
blame for the events of 1929. These criticisms related to a lack of self-regulation on the part of the
profession. There was also much criticism of permissive accounting practices adopted by accountants
during the 1920s, especially in connection with the notorious asset valuation practices of this period. 8
Nevertheless, around 1953 the Roosevelt administration envisaged a great potential for the accounting
profession to participate in national economic recovery. Moreover, it was recognised that professional
accountants, by producing reliable company financial reports and adopting consistent accounting
practices, could help restore investor confidence in the nation's shattered capital markets. 9 The needs of
the Roosevelt administration and the aspirations of the accounting profession were well synchronised.
Following the events of 1929, the accounting profession in the United States experienced one of the most
introspective phases of its history. Prominent leaders within the profession, notably Eric Kohler and
George O. May, were conscious of the need to establish the basic principles on which company reports
were based, to correct the permissive accounting practices of the 1920s and to reaffirm public and
investor confidence in professional accountants. There was a consensus at this time that improved
financial reporting by companies and the development of coherent set of accounting principles and
concepts was a pivotal factor in creating this confidence, This resulted in the American accounting
profession sponsoring a number of research initiatives to identify and codify the accounting principles
and concepts underlying financial accounting practices and reports. This was exemplified by the 1936
publication of 'A Tentative Statement of Accounting Principles Affecting Corporate Financial Reports' by
the American Accounting Association, largely under the influence of its president, Eric Kohler. This early
statement anticipated future research and policy positions of the profession. It also stated a desire on the
part of the profession to distance itself from the 'valuation follies' of the 1920s. To some extent the
accounting profession achieved this objective by establishing the historical cost principle as the
cornerstone of financial accounting practice.

This was expanded further in the classic studies of Sanders, Hatfield and Moore, Paton and Littleton, and
further still in Littleton's treatise on accounting principles 'Structure of Accounting Theory'. 10.11,12 Since
these formative efforts to develop a coordinated body of accounting concepts and principles, there has
been a flurry of research interest devoted to establishing a uniform and internally consistent body of
accounting theory to guide the development and implementation of accounting practice and policy.
The first standard-setting body was established in 1936 when the American Institute of Accountants
formed a Committee on Accounting Procedure. The Committee published accounting research and
terminology bulletins that provided authoritative opinions or recommendations on preferred accounting
practices. A less formal standard-setting arrangement was observable in the United Kingdom, where
professional debate over preferred or 'best' accounting practices had been in progress since the inception
in 1871 of the Institute of Accountants' prestigious journal, The Accountant.
Although the bulletins of the Committee on Accounting Procedure provided recommended solutions
to particular financial reporting problems, they did not result in a conceptual framework. This failure on
the part of the committee was in fact much criticised, and its authority in accounting matters was
By the mid-1950s, there was a good deal of academic and professional opinion that stressed the
inadequacies of company financial reporting. The discontent arose from two directions. First, the
historical cost model, generally accepted in accounting practice at this time, was not being applied
consistently, nor were the principles underlying historical cost accounting well understood or properly
explained in research writings.
Second, a tradition was developing amongst academics, including some practitioners in the United
States, that was against the whole principle of historical cost accounting. For example, the early studies
of Sprague and Hatfield were critical of historical cost accounting because the model did not reflect the
economic reality of changing price levels. 13,14 The accounting profession rook steps in this period to
redress these concerns by sponsoring research projects to consider some alternative accounting models
or, at the very least, make the historical cost model more logical and internally consistent. On the whole,
the accounting profession's early attempts to redress criticism had met with some success. This was partly
due to the influence of Littleton's 1953 monograph, which answered concerns about the internal
consistency and logical coherence of the historical cost model. In particular, Littleton provided extensive
justifications for its continued use. Littleton's study, however, was insufficient to quell widespread
concerns that the historical cost model was flawed. It was not until the early 1960s that this controversy
would be addressed by the accounting profession. The AICPA established the Accounting Principles
Board (APB) in 1959. The objective of the APB was, inter alia, to accelerate the development of a
conceptual framework. Specifically, the APB set itself the following tasks:
1 to establish basic postulates;
2 to formulate a set of broad principles;
3 to establish rules to guide the application of principles in specific situations; and 4 to

base the entire program on research.

The Accounting Research Division of the AICPA commissioned studies by Moonitz, and Sprouse and
Moonirz.l5,'6 It was hoped that these studies would answer some specific problems and concerns on the
issue of changing price levels. These studies, intet alia, proposed that the accounting profession adopt
some form of current cost accounting.

However, the works met with the same fare as previous current cost studies, including Henry Sweeney's
'Stabilized Accounting' in 1936 and Hatfield's 'Modern Accounting' in 1928. The studies of Moonitz, and
Sprouse and Moonitz, were regarded as too radical and normative in their approach. Subsequently, the
APB recommended that the objectives of accounting be defined in more descriptive terms. In 1963, the
APB commissioned Paul Grady to develop this more descriptive framework. This approach was reflected
in APB Statement No.4, 'Basic Concepts and Accounting Principles Underlying Financial Statements of
Business Enterprises', which was based on Grady's study and served to codify existing accounting
practices. Although Statement No.4 was basically descriptive, which diminished its chances of providing
the first accounting conceptual framework, it did influence Australian attempts to formulate the objectives
of financial statements and to develop a basic conceptual framework for the field of accounting. Chapter
4 of APB Statement No.4 classifies objectives as particular, general and qualitative, and places them
under a set of constraints.
The particular objectives of financial statements are to present fairly and in conformity with generally
accepted accounting principles, financial position, results of operations and other changes in financial
2 The general objectives of financial statements are:
a To provide reliable information about the economic resources and obligations of a business enterprise in
order to:
i evaluate its strengths and
ii show its financing and
iii evaluate its ability to meet its commitments;
iv show its resource base for growth.
b To provide reliable information about changes in net resources resulting from a business enterprise's
profit-directed activities in order to:
i show ex peered dividend return to investors;
ii demonstrate the operation's 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; and iv show its long-term profitability.
C To provide financial information that can be used to estimate the earnings potential of the firm.
d To provide other needed information about changes in economic resources and obligations.
e To disclose other information relevant to statement users' needs. 3 The
qualitative objectives of financial accounting are:
a relevance. which means selecting the information most likely to aid users in their economic decisions;
b understandability, which implies not only that selected information must be intelligible, bur also that the
users can understand it.;
C verifiability, which implies that the accounting results may be corroborated by independent measures,
using the same measurement methods;
d neutrality, which implies that the accounting information is directed toward the common needs of users,
rather than the particular needs of specific users;
e timeliness. which implies an early communication of information, to avoid delays in economic decision

comparability, which implies that differences should not be the result of different financial
accounting treatments; and
9 completeness. which implies that all the information that 'reasonably' fulfils the requirements of the other
qualitative objectives should be reported.
The objectives expressed by APB Statement No.4 appear to provide a rationale for the form and
content of conventional financial reports. The statement even admits that the particular objectives are
stated in terms of accounting principles that are generally accepted at the time the financial statements
are prepared. It is noteworthy that the general objectives fail to identify the informational needs of
users. The statement implicitly recognises these limitations when it admits that 'the objectives of
financial accounting and financial statements are at least partially achieved at present'. Despite these
limitations, APB Statement No.4 has been a necessary step toward the development of a more
consistent and comprehensive structure of financial accounting and of more useful financial
information, both in the United States and elsewhere. In 1973, the APB was replaced by the FASB,
which continued and extended the conceptual framework project initiated by the APB.

ill- The Australian conceptual framework:

background and issues
In Australia, the development of a conceptual framework followed a similar pattern to that of the
United States. The Australian accounting profession also recognised the need to develop a system of
coordinated concepts and objectives which would guide the development of consistent and improved
accounting practices. The absence of what Paton and Littleton called 'a coherent, coordinated,
consistent body of doctrine' within which to develop accounting standards was widely believed to be a
cause of perceived inconsistencies and inadequacies in Australian accounting practices, particularly
during the 1960s and beyond. 17 When the FASB accelerated work on the development of a conceptual
framework, the Australian profession followed suit. However, because the conceptual framework
project had already been in motion in the United States for some time, the Australian accounting
profession was in a position to evaluate and adapt APB and FASB initiatives for Australian conditions.
In a similar vein to the works of Sprouse and Moonitz, Australian academics such as Mathews and Grant, 18 and
Chambers, 19 were also conscious of the problem of changing price levels and proposed that the accounting
profession abandon the conventional historical cost system in favor of some form of current cost accounting
system. Chambers was particularly forceful in his criticisms of the inconsistencies and conceptual deficiencies
underpinning the historical cost mode1.20 Largely as a response to this academic push the accounting profession
commissioned John Kenley, the then director of the Accountancy Research Foundation (later reconstituted as
the AARF), to adapt the AICPA studies of Paul Grady to Australian conditions. This adaptation by Kenley was
followed by a further study by Kenley and Staubus2122 While the study was intended to be an Australian
adaptation of APB Statement No.4, the book ended up adopting a largely prescriptive approach to accounting
concepts and objectives. The adoption of this more normative or prescriptive approach represented a
fundamental departure from the United States model, which has attempted to blend descriptive and prescriptive
elements to enhance the operationality and general acceptance of their conceptual framework. In hindsight, the
works of Kenley and Kenley and Staubus have proved very influential as the AARF to this day have persisted
with the development of a largely prescriptive framework.

However, the Australian conceptual framework did not make significant progress until the 1980s. One
reason for the tardiness is that during the 1970s standard-setters were preoccupied with the issue of
current cost accounting. As we will see in Chapter 12, this was a period when current cost accounting
attracted considerable interest and debate among academics, international standard-setting bodies and
some practitioners. During the 1970s, standard-setters expended considerable resources to develop
comprehensive current cost regulations for Australian companies. However, in the late 1970s and early
1980s, it became apparent that the AARF's current cost initiatives were not welcomed by the industry.
This caused the AARF to refocus its attention on a narrower range of topics, including the con ceptual
framework. The Australian strategy to develop a conceptual framework has been stated by a previous
director of the AARF.23 The elements of this strategy included the following:
1 The use of FASB thinking would be maximised.
2 The importance of a conceptual framework would not be over-sold, but unveiled gradually.
3 The first stage of development would be the tentative identification of the building blocks of a workable
4 The second stage would be the selection of certain building blocks to formalise specific projects.
5 The third stage would be the investigation of interrelationships between the building blocks and any
consequential redefinition of those blocks.
6 The fourth stage was to be the commissioning of projects for the remaining blocks. 7 Publication of
Statements of Accounting Concepts would begin.
The AARF kept to its game plan. In the late 1980s, six exposure drafts were released for public
comment. Exposure drafts ED 42A (objectives of financial reporting), ED 42B (qualitative characteristics
of financial information), ED 42C (definition and recognition of assets) and ED 42D (definition and
recognition of liabilities) were all released simultaneously in December 1987. Exposure drafts ED 46A
(definition of the reporting entity) and ED 46B (definition and recognition of expenses) were released
together in May 1988. Exposure drafts ED 51A (definition of equity) and ED 51B (definition and
recognition of revenues) were released in August 1990. All these exposure drafts were preceded by
discussion papers and accounting theory monographs commissioned by the AARF from academics within
Australia and overseas. Furthermore, in August 1990, three 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'.
In the early 1990s, the development of a conceptual framework was given greater momen tum by
certain amendments to Australian corporations law. In addition to developing accounting standards,
Section 226(1) of the Corporations Law (1991) specifically charged the AASB with the responsibility of
developing a conceptual framework for financial reporting. This gave added authority to the AARF to
develop further SACs. The controversial SAC 4, 'Definition and Recognition of Elements of Financial
Statements' (which combined exposure drafts ED 42B-D, ED 46B and ED 51A-B), was released in March
1992, but was amended in March 1995. (Both versions of SAC 4 will be discussed in this chapter) SAC 4
specifies the definition of and rules for the recognition of assets, liabilities, equity, revenues and expenses
in the financial reports of companies. The first release of SAC 4 in 1992 symbolised the AARF's
ideological commitment to a largely prescriptive or

normative conceptual framework. Implicit in the requirements of SAC 4 would be significant departures
from conventional accounting practices. (In a later seer ion we will show that Australia's experimentation
with a radical prescriptive framework has been vigorously challenged by companies and other interest
groups in the past two years.) The corporate backlash to SAC 4 resulted in the mandatory status of the
SACs being withdrawn in December 1993, followed by significant amendments to the Statement. The
SACs had initially been made mandatory under APS 1 'Conformity with Statements of Accounting
Concepts and Standards' and AASB Release 100 'Nature of Approved Accounting Standards and
Statements of Accounting Concepts and Criteria for the Evaluation of Proposed Approved Accounting
Finally, it should be noted that the Australian conceptual framework is still evolving.
Important aspects of the framework, particularly in the areas of measurement and the scope of financial
reporting, are yet to be addressed by the AARF and its Boards.

The nature and goals of a conceptual framework

Standard-setters in Australia, the United States and elsewhere have given explicit justifi cations fot theit
respective conceptual framework projects. For example, in the process of embarking on a conceptual
framework project, the FASB (as did the AASB) acknowledged the erosion of the credibility of financial
reporting in recent years and specifically criticised the following situations:
t Two or more methods of accounting are accepted for

the same facts.

t Less conservative accounting methods are being used

rather than the earlier, more conservative methods.

t Reserves are used to artificially smooth earning
t Financial statements fail to warn of
impending liquidity crunches.
t Deferrals are followed by 'big bath' writeoffs.
t Unadjusted optimism exists in estimates of
t Off balance-sheet financing (that is, disclosure in the
notes to the financial statements) is common.
t An unwarranted assertion of immateriality has been
used to justify non-disclosure of unfavorable
information or departures from standards.
t Form is relevant over substance. 24
Standard-setting bodies have attracted particular criticism because they are authorities charged with
the primary responsibility for promoting 'best' financial reporting practices. The absence of a coherent
and rigorous body of accounting theory to guide accounting practice has been seen as a major factor
leading to a de-professionalisation of accounting in different jurisdictions. 25 Gerboth notes: 'suffice it to
say that accounting is now painfully self-conscious about the intellectual standing of its reasoning
The FASB and the AASB have instituted conceptual framework projects to correct some of these
situations and to provide a more rigorous way of setting standards and increasing financial statement
users' understanding and confidence in financial reporting. The FASB described a conceptual framework
as follows:
conceptual framework is a constitution, 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 statements. The objectives identity the goals and the
purposes of accounting. The fundamentals are the underlying concepts of accounting - concepts that guide
the selection of events to be accounted for, the measurement of those events and the means of
summarizing and communicating to interested parties. Concepts of that type are fundamental in the sense
that other concepts flow from them and repeated references to them will be necessary in establishing,
interpreting and applying accounting and reporting standards.27

The conceptual framework, therefore, is intended to act as a constitution for the stan dardsetting process. The AARF's Guide to Proposed Statements of Accounting Concepts (issued in
December 1987 with Series 1 of the proposed Statements of Accounting Concepts), defines the
conceptual framework in similar terms: 'a set of inter-related concepts which will define the
nature, subject, purpose and broad content of financial reporting. It will be an explicit rendition
of the thinking which is governing the decision-making of (standard-setters).'


Advantages of a conceptual framework

The AASB and the AARF expect the conceptual framework to have a number of advantages28
The framework is perceived to be particularly useful in the development of more consistent
and logical standards and in removing the necessity to re-debate conceptual issues when
preparing new accounting standards. Furthermore, the issue of standards 'overload' can be
potentially reduced because a conceptual framework can enable resolution of partic ular
accounting problems which avoids the necessity of issuing new accounting standards. A
conceptual framework can also lead to better communication among accountants, auditors and
users because all parties would be using a common set of definitions and criteria. Another
potential benefit of a conceptual framework is that it can potentially reduce the activities of
lobbies and interests groups (who may have self-serving motivations) in attempting to
influence the standard-setting process. 29 As suggested by Solomons, conflicts between
economic interests could be avoided if the theoretical foundations of accounting were more
soundly based. 30

A conceptual framework can also lead to specific improvements in accounting practice and
financial reporting by companies. For example, comparability in company financial reports
can be enhanced by a reduction in the amount of accounting alternatives available to preparers.
The AARF's Guide to Proposed Statements of Accounting Concepts explicitly states the
potential benefits of the conceptual framework as follows:
(a) reporting requirements should 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 which set down 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 mitigating the risks of over-regulation;
(e) preparers and auditors should be able to better understand the financial reporting requirements they face; and,
(f) the setting of requirements should be more economical because issues should not need to be re-debated from differing

5.2.2 Strategic objectives for a conceptual

Political motivations and pressures for a conceptual framework also need to be considered. Literature
indicates that conceptual framework projects have been developed as an instrument for the selfpreservation of the accounting profession. That is, standard-setters assert their authority and
legitimacy in setting accounting standards as a defensive measure against public criticism of the


Hines, for instance, asserted that conceptual framework projects are undertaken as a

'strategic manoeuvre to assist in socially constructing the appearance of a coherent differentiated

knowledge base for accounting standards, thus legitimising standards and the power, authority and
self-regulation of the accounting profession'.


One test Hines used to determine whether conceptual

framework projects can more appropriately be viewed as technical enterprises or as strategic

manoeuvres was to ascertain whether these projects were undertaken at times of threat to their
legitimacy (public criticism of accounting standards and/or company financial reporting deficiencies),
or at times of competition from other regulators (possible intervention by government, stock
exchange regulations). Hines concludes:
A brief study of the countries and circumstances of the conceptual framework projects

suggested that the major rationale for undertaking conceptual frameworks was not functional
or technical, it was a strategic manoeuvre for providing legitimacy ro standard-setting boards
during periods of competition or threatened government intervention 33
The same conclusion was forged by Dopuch and Sunder, who argued that disagreements which
are centred on diverse accounting standards are always the target of public criticism of the profession
and threaten their authority and control over the standard-setting process.''! Solomons noted that ' ...
an explicitly theoretical foundation is an indispensable defence against political inrerference,.35
Horngren suggests that: 'The more plausible the assumptions and the more compelling the analysis of
the facts, the greater the chance of winning support of diverse interests- and retaining and enhancing
the Board's (FASB) power,.36
Finally, although preparers, auditors and external users are expected to gain from the conceptual
framework, it appears that standard-setters are likely to be the primary beneficiaries. 37 However,
whether the conceptual framework can achieve some or all of its stated benefits will depend heavily
on the ultimate acceptance of the framework by the Australian business community and other
commercial interest groups. Later we will see that some essential features of the Australian
conceptual framework have been strongly criticised by commercial interests. Furthermore, the
AARF's future position on more contentious issues, notably measurement in the financial statements,
will undoubtedly attract opposing positions and viewpoints from within the business community.
These issues are important for evaluating the present and future viability of conceptual framework

5.3 Classification and conflicts of interest

Formulating the objectives of accounting depends on resolving the conflicts of interest that exist in
the information marker. More specifically, financial statements result from the interaction of three
groups: firms, users and the accounting profession 38

t Firms comprise the main party engaged in the accounting process. By their operational, financial and
extraordinary (that is, non-operational) activities, they justify the production

of financial statements. Their existence and behavior produce financial results that are partly
measurable by the accounting process. Firms are also the preparers of accounting information.
t Users comprise the second group. The production of accounting information is influenced by their
interests and needs. Although it is not possible ro compile a complete list of users, the list
would include investors, financial analysts, bankers, creditors, consumers, employees,
suppliers and governmental agencies.
t The accounting profession constitutes the third group that may affect the information to be included in
financial statements. Accountants act principally as 'auditors' in charge of ver ifying that
financial statements conform to generally accepted accounting principles.
Following Cyert and Ijiri's analysis, the interaction between these three groups may be
represented by a Venn diagram, as shown in Exhibit 5.1, where circle U represents the interests of
the users in the information deemed useful for their economic decision making, circle C
represents the set of information that corporations publish and disclose (whether or not it is
within the boundaries of generally accepted accounting principles) and circle P represents the set
of information that the accounting profession is capable of producing and verifying. The area
labelled I represents the set of information that is acceptable to all three groups. In other words,
these data are disclosed by the firm, accountants are capable of producing and verifying them and
they are perceived as relevant by users. Areas II-VII represent areas of conflicts of interest.

Given these conflicts, Cyert and Ijiri examine three possible approaches to the formula tion of
accounting objectives. The first approach considers the set of information that the firm is ready
to disclose and attempts to find the best means of measuring and verifying it. (In other words,
circle C is kept fixed and circles P and U are moved toward it.) The sec ond approach considers
the information that the profession is capable of measuring and verifying and attempts to
accommodate users and firms through various accounting options. (In other words, circle P is
kept fixed and circles C and U are moved toward it.) The third

approach views the set of information deemed relevant by users as central and encourages the profession
and the firms to produce and verify that information. (In other words, circle U is kept fixed and circles P
and C are moved toward it.)39
Stated simply, the first approach is firm-oriented, the second approach is profession-oriented and the third
approach is user-oriented. Needless to say, given the dominance of the political and legislative approaches
to the formulation of an accounting theory, as we saw in Chapter 3, the user-oriented approach will
prevail when future objectives of financial statements are formulated. In fact, the user-oriented approach
is employed by the SACs in Australia, the FASB in the United States and The Corporate Report in the
United Kingdom.

The structure of the conceptual framework

Conceptual framework issues
In the process of developing a conceptual framework, the AARF and its Boards have had to resolve and
take an explicit position on a number of fundamental conceptual issues that would determine the nature
and content of the SACs.' These issues are now discussed.
Issue 1. Balance sheet versus profit and loss account orientation
There are two distinct approaches to determining an entity's income during a reporting period:
t the asset/liability view; and

t the revenue/expense view.

The asset/liability view, also called the balance-sheet or capital-maintenance view, maintains that
revenues and expenses result only from changes in the values of assets and liabilities. Revenues represent
increases in assets and decreases in liabilities; expenses are decreases in assets and increases in liabilities.
Some increases and decreases in net assets are excluded from the definition of income - namely, capital
contributions, capital withdrawals, corrections of income of prior periods and, depending on the concept
of capital maintenance adopted, holding gains and losses. The asset/liability view should not be
interpreted as an abandonment of the matching principle. In fact, matching revenues and expenses result
from clear definitions of assets and liabilities.
The revenue/expense view, also called the profit and loss account or matching view, holds that revenues
and expenses result from the need for a proper matching. This view of income is transaction based, as
revenues are only recognised when realised through a sales transaction. Income is merely the difference
between revenues in a period and the expenses incurred in earning those revenues. Matching, the
fundamental measurement process in accounting, comprises two steps:
'Most of these issues had already been given detailed consideration by the FASB in its Discussion Memorandum 'Conceptual Framework for Financial Accountmg and ReportlOg: Elements

of Financial Statements and Their Measuremenf (1976).

The FASB also specifically considered a third option - the 'non-articulated' view. For both the asseVliability view and the revenue/expense view, the statement of earnlOgs
'articulates' with the statement of financial position, in the sense that they are both part at the same measurement process. The difference between revenues and expenses is also
equivalent to the increase in net capital.

The non-articulated view is based on the beliet that articulation leads to redundancy, 'since all events reported in the profit and loss statement are also reported 10 the
balance sheet, although from a different perspective'. According to this view, the definitions of assets and liabilities may be critical In the presentation of flOancial position and
the definitions of revenues and expenses may dominate the measurement of earnings. The two financial statements have independent exis tence and meanings; therefore,
different measurement schemes may be used for them. An example of the non-articulated view would be the use of LIFO in the Income statement and of FIFO in the balance
sheet. The non-articulated view has gained some ground recently. In facf, the Amencan Accounting AssoCiation's Statement of Basic Accounting Theory criticises articulation:
We find no logical reason why external finanCial reports should be expected to 'balance' or articulate with each other. In fact, we find that forced balanc mg and articulation have
frequently restricted the presentatIon of relevant Information. The important guide should be the disclosure of all relevant information with measurement procedures that meet the other
standards suggesfed in ASOBAT [A statement of Basic Accounting Theory].

1 revenue recognition or timing through the realisation principle;

2 expense recognition in three possible ways:
a associating cause and effect, such as for cost of goods sold;
b systematic and rational allocation, such as for depreciation;
c immediate recognition, such as for selling and administrative costs.
Thus, contrary to the asset/liability view, the revenue/expense view primarily emphasises measuring
the income of the firm and not the increase or decrease in the value of net assets. Assets and liabilities,
including deferred charges and credits, are considered residuals that must be carried to future periods in
order to ensure proper matching and to avoid distortion of income.
Which view of profit should be adopted as the basis of a conceptual framework for finan cial
accounting and reporting) The choice between these two views rests on which view constitutes the
fundamental measurement process. 40
1 measurement of the attributes of assets and liabilities and changes in them; or
2 the matching process.
If measurement of the attributes of assets and liabilities and changes in them is deemed the
fundamental measurement process (as in the asset/liability view), then income is only the consequence
and the result of changes in the value of assets and liabilities. On the other hand, if the matching process
is deemed the fundamental measurement process (as in the revenue/expense view), then changes in assets
and liabilities are merely the consequences and results of revenues and expenses. A major criticism of the
revenue/expense orientation is that it has led to the recognition in the statement of financial position of
such items as 'deferred charges', 'deferred credits' and 'reserves', which do not represent economic
resources and obligations but which are necessary to ensure a proper matching of costs and revenues in
the income determination process. Furthermore, the revenue/expense view places much emphasis on the
importance of the historical cost and revenue realisation principles. As we will see in Chapters 12-14, this
approach has been criticised for undermining the relevance of the balance sheet to users.
The asset/liability view would exclude debit and credit items (as result, for example, in intra-period tax
allocation) because they do not constitute economic benefits or resources available to the entity. By
rejecting these items in the balance sheet, the asset/liability view faces a major criticism, which concerns
its unwillingness to recognise as revenues and expenses anything except current changes in economic
resources and obligations to transfer resources, making it incapable of dealing with the complexities of
the modern business world.
A choice between these views would provide not only an underlying basis for a conceptual framework
for financial accounting and reporting but also definitions of the elements of financial statements.

Issue 2. Definition of assets. liabilities. equity. revenues and

Definitions of each element of financial statements may be provided by both the asset/liability view and
the revenue/expense view.
According to the asset/liability view, assets are the economic resources of a firm; they represent future
benefits that are expected to result directly or indirectly in a positive net cash inflow. Alternatively, we
may exclude from the definition of 'assets' economic resources that do not have the characteristics of
exchangeability or severability. In either case, based on

the asset/liability view, assets are restricted to representations of economic resources of the firm. The economic
resources of the firm are:
1 productive resources of the enterprise
2 contractual rights to productive resources 3 products

4 money
5 claims to receive money
6 ownership interests in other enterprises. 41
According to the revenue/expense view, assets include not only the assets defined from the asset/liability
viewpoint, bur also all items that do not represent economic resources bur are required for proper matching and
income determination.
A third view of assets arises from the perception of the balance sheet not as a statement of financial position,
bur as 'a statement of the sources and composition of company capi tal'. According to this view, assets constitute
the 'present composition of invested capital,42
If we exclude the problem of the element of 'deferred charges' on the statement of finan cial position, the
definitions of assets presented in these three different views have the following characteristics in common:
1 An asset represents potential cash flow to a firm.

2 Potential benefits are obtainable by the firm.

3 The legal concept of property may affect the accounting definition of assets.
4 The way an asset is acquired may be part of the definitions. It may have been acquired in a past or current
transaction or event; the event includes either an exchange transaction, a non-reciprocal transfer from
owners or non-owners, or a windfall and may exclude executory contracts.
5 Exchangeability may be an essential characteristic of assets.
Which of these definitions or modifications of these definitions should comprise the substance of a definition
of 'assets' for a conceptual framework for financial reporting) What is needed is a definition that lends itself to
the generality of application required for a conceptual framework. Such a definition should take into account the
following characteristics:
1 An asset represents only economic resources and does not include 'deferred charges'.

2 An asset represents potential cash flows to a firm.

3 Potential benefits are obtainable by the firm.

4 An asset represents the legal binding right to a particular benefit, results from a past or current transaction and
includes all commitments, as in wholly executory contracts.
5 Exchangeability is not an essential characteristic of assets except for 'deferred charges', in order to keep most
intangibles as assets and exclude 'deferred charges'.
The second element to be defined is liabilities. According to the asset/liability view, liabilities are the
obligations of the firm to transfer economic resources to other entities in the future. We may expand this
definition to exclude items that do not represent binding obligations to transfer economic resources to other
entities in the future.
According to the revenue/expense view, liabilities comprise not only the liabilities defined from the
asset/liability viewpoint bur also certain deferred credits and reserves that do not represent obligations to
transfer economic resources bur that are required for proper matching and income determination.
A third view of liabilities arises from the perception of the balance sheet as 'a statement of the sources and
composition of company capital'. According to this view, liabilities con-

stitute sources of capital and include certain deferred credits and reserves that do nor represent obligations to
transfer economic resources.
If we disregard the element of 'deferred credits', the definitions of liabilities presented in these three different
views have the following characteristics in common:
1 A liability is a future sacrifice of economic resources.
2 A liability represents an obligation of a particular enterprise.
3 A liability may be restricted to legal debt.
4 A liability results from past or current transactions or events.
Which of these definitions or modifications of these definitions should comprise the substance of a
definition of , liabilities' for a conceptual framework) As in the case of assets, what is needed is a definition of
liabilities that lends itself to the generality of application required for a conceptual framework.
The third element to be defined is income. According to the asset/liability view, income is the net assets of
the firm except for 'capital' changes. According to the revenue/expense view, income results from the marching
of revenues and expenses and, perhaps, from the gains and losses. Gains and losses, therefore, may be
distinguished from the revenues and expenses, or they may be considered part of them. Each possible
component of income (revenues, expenses, gains and losses) may be defined as follows:
1 Revenues and expenses: according to the asset/liability view, revenues, which encompass gains and losses, are
defined as increases in the assets or decreases in the liabilities that do nor affect capital. Similarly,
expenses, which encompass gains and losses, are defined as decreases in the assets or increases in the
liabilities arising from the use of economic resources and services during a given period.
According to the revenue/expense view, revenues, which encompass gains and losses, result from the
sale of goods and services and include gains from the sale and exchange of assets other than inventories,
interests and dividends earned on investments and other increases in owners' equity during a period ocher
than capital contributions and adjustments. Similarly, expenses comprise all of the expired costs that
correspond to the revenues of the period. If gains and losses are defined as a separate element of income,
however, revenues are defined as measures of an entity's outputs that result from the production or delivery
of goods and the rendering of services during a period. Similarly, expenses are the expired costs
corresponding to the revenues of the period.
Which of these definitions of income should comprise the substance of 'revenues' and 'expenses' for a
conceptual framework) In other words, which definition lends itself to the generality of application needed
for a conceptual framework)
The definitions generated by the revenue/expense viewpoint rely on a listing of all items that may be
perceived as revenues or expenses. First, such a list is nor necessarily exhaustive and second, the items in
the list may change. As a result, the revenue/expense view of income and the ensuing definitions of
revenues and expenses may lack the generality of application needed for a conceptual framework.
2 Gains and losses: according to the asset/liability view, gains are defined as increases in net assets other than
increases from revenues or from changes in capital. Similarly, losses are defined as decreases in net assets ocher
than decreases from expenses or from changes in capital. Thus, gains and losses constitute that part of income
nor explained by revenues and expenses

According to the revenue/expense view, gains are defined as the excess of proceeds over the cost of
assets sold, or as windfalls and other benefits obtained at no cost or sacrifice. Similarly, losses are
defined as the excess over the related proceeds, if any, of all or an appropriate portion of the costs of
assets sold, abandoned, or wholly or partially destroyed by casualty (or otherwise written off), or as
costs that expire without producing revenues. Thus, according to the revenue/expense view, gains and
losses are independent from the definitions of other elements of financial statements.
Which of these definitions of gains and losses contains the generality of application required for a
conceptual framework? According to the revenue/expense view, the definitions are independent of the
definitions of the other elements and may, for that reason, be viewed as lacking generality of
application. According to the asset/liability view, the definitions are derived from the other definitions
and emphasise the incidental nature of gains and losses; they appear to contain the generality of
application required for a conceptual framework.
In any case, gains and losses may be either gains and losses from exchanges, 'holding' gains and
losses resulting from a change in the value of assets and liabilities held by the firm, or gains and losses
from non-reciprocal transfers.
3 Relationships between income and the component of income: three major relationships exist between
income and the component of income:
a Income = Revenues - Expenses + Gains - Losses
b Income = Revenues - Expenses
c Income = Revenues (including gains) - Expenses (including losses)
In the first relationship, each component is separate and essential to a definition of income. The
different sources of income are distinguished, thereby providing greater flexibility in the classification
and analysis of a firm's performance.
In the second relationship, gains and losses are not separate and are not essential to the definition of
income. All increases and decreases are treated similarly as either revenues or expenses. Such a
definition does not fit all the gains and losses from non-reciprocal transfers, windfalls, casualties and
holding gains and losses.
In the third relationship, although gains and losses are separate concepts, they are part of revenues
and expenses. Such a definition has the same advantages as the first relationship and avoids the
disadvantages of the second relationship. The definitions of revenues and expenses, however, must
mix different items and may require a complete identification and listing of the items that comprise
revenues, expenses, gains and losses.
The first relationship appears to present the least disadvantage according to both the asset/liability
view and the revenue/expense view. It allows identification and disclosure of the three kinds of gains
and losses: gains and losses from exchanges, holding gains and losses, and gains and losses from nonreciprocal transfers, windfalls and casualties.
4 Accrual accounting: the elements of financial statements are accounted for and included in financial
statements through the use of accrual accounting procedures. Accrual accounting measures the effects
of transactions (and other events) having cash consequences for an entity as they are incurred, not
simply as cash is received or paid - they are recorded in accounting records and reported in the
financial statements of the reporting period to which they relate. Naturally, the acquisition of resources
used to provide goods and services and the provision of goods and services by an entity during a
period usually do not coincide with the cash receipts and payments of the period. Hence, accrual

reflects credit and barter transactions and changes in the forms of assets and liabilities resulting from
relevant internal and external events, in addition to an entity's cash transactions. Accrual accounting
provides information about all of an entity's assets, liabilities (and consequently residual equity),
revenues, expenses and the changes in them that cannot be obtained by accounting only for cash
receipt and outlays or modified systems of accrual accounting.
Accrual accounting tests on the concepts of accrual, deferral, allocation, amortisation, realistrion
and recognition.
The FASB opted for the following definitions of these concepts:
Accrual is the accounting process of recognizing non-cash events and circumstances as they occur; specifically,
accrual entails recognizing revenues and related increases in assets and expenses and related increases in
liabilities for amounts expected to be received or paid, usually in cash, in the future ...
Deferral is the accounting process of recognizing a liability for a current cash receipt or an asset for a current
cash payment (or current incurrence of a liability) with an expected future impact on revenues and expenses ...
Allocation is the accounting process of assigning or distributing an amount according to a plan or a formula.
It is a broader term than 'amortisation'; that is, amortisation is an allocation process ...
Amortisation is the accounting process of systematically reducing an amount by periodic payments, or writedowns ...
Realisation is the process of converting non-cash resources and rights into money; it is most precisely used in
accounting and financial reporting to refer to sales of assets for cash or claims of cash. The related terms,
'realised' and 'unrealised', therefore identify revenues or gains and losses on assets sold and unsold,
respectively ....
Recognition is the process of formally recording or incorporating an item in the accounts and financial
statements of an enterprise. Thus, an element may be recognized (recorded) or unrecognised (unrecorded).
'Realisation' and 'recognition' are nor used synonymously, as they sometimes are in the accounting and

Issue 3. Concepts of capital maintenance

The concept of capital maintenance allows us to make a distinction between the return on capital, or
income, and the return of capital, or cost recovery. Income follows from recovery or maintenance of
capital. Two concepts of capital maintenance exist: the financial capital concept and the physical capital
concept. Both concepts use measurements in terms of units of money or units of the same general
purchasing power, resulting in four possible concepts of capital maintenance:
1 financial capital measured in units of money;
2 financial capital measured in units of the same general purchasing power;
3 physical capital measured in units of money; and
4 physical capital measured in units of the same general purchasing power.
We will examine the conceptual and operational differences among these concepts in Chapters 12-14.
Note, however, that the comprehensive income is a return on financial capital, as distinguished from a
return on physical capital. The essential difference between the two concepts is that 'holding gains and
losses' are included in income under the financial capital concept, bur are treated as 'capital maintenance
adjustments' under the physical capital concept.

Issue 4. Which measurement method should be adopted ?

The issue of measurement method concerns the determination of both the unit of measure and the
attribute to be measured. As far as the unit of measure is concerned, the choice is between actual dollars
and general purchasing power adjusted dollars. As far as the particular attribute to be measured is
concerned, we basically have five options:
1 historical cost method
2 current cost
3 current exit value
4 expected exit value
5 present value of ex peered cash flows.
These different measurement bases will be explored in depth in Chapters 12-14.

Issue 5. Applicability of the conceptual framework to the public

For financial reporting purposes, Australian standard-setters have nor maintained a strong distinction
between the private sector, the public sector and not-for-profit entities in the private sector. Indeed,
Australia is one of the few countries in the world that has made its conceptual framework equally
applicable to all entities, including public sector entities.~
Standard-setters have paid more than just lip service to this policy stance. Accrual accounting
principles and professional accounting standards (AASs) are applicable to all nor-for-profit entities in the
private and public sectors. The relevance of accrual accounting to nor-for-profit entities has also been
emphasised by some authoritative pronouncements in the United States. For example, the Statement of
Po sir ion 78-10 'Accounting Principles and Reporting Practices for Certain Non-profit Organisations
The accrual basis of accounting is widely accepted as providing a more appropriate record of all an
entity's transactions over a given period of time than the cash basis of accounting. The cash basis or any
basis of accounting other than the accrual basis does not result in the presentation of financial information
in conformity with generally accepted accounting principles (pagel0, paragraph 11).
In the United States, Statement of Financial Accounting Concepts No.4 'Objectives of Financial
Reporting by Nonbusiness Organisations', recommends adoption of accrual accounting principles for
non-business entities in the private sector. However, the Governmental Accounting Standards Board,
which oversees the development of accounting standards and concepts statements for government entities
in the United States, only recommends the use of modified accrual systems for the public sector. In
contrast to Australia, standard-setters in the United States have tended to maintain greater distinctions
between profit-seeking and nor-for-profit entities (in both the private and public sectors). For example,
Anthony strcsses that resource providers to not-for-profit entities (both in the private and public sectors)
do not expect to receive repayment or economic benefits proportionate to resources provided, nor do they
possess rights to a residual interest in the net assets of the entity in the event of liquidarion. 44 As a result,
resource providers are nor assumed to be overly concerned with the financial status and performance of
the entity. Presumably these users are more concerned that contributed funds have been used

in accordance with the objectives of the entity and within the confines of any imposed resource restrictions.
Australia has adopted a different view. Comprehensive accrual accounting has been progressively
introduced into the public sector. Recent accounting standards now requite the adoption of comprehensive
accrual accounting for all local government authorities and government departments throughout Australia. For
example, AAS 29 'Financial Reporting by Government Departments' requires all government departments in
Australia to prepare an annual balance sheet, operating statement and statement of cash flows consistent with
all relevant private sector accounting standards. Furthermore, government departments are required to disclose
all assets, liabilities, revenues and expenses that meet the definition and recognition criteria of SAC 4. AAS 29
asserts that accrual accounting better reflects the performance, financing and investing activities, financial
position and compliance of government departments than cash or modified accrual systems. Implicit in AAS 29
requirements for accrual accounting is the presumption that private and pub lic sector entities have a number of
economic and operating characteristics in common. Many of these arguments have been explicitly and
implicitly stated in AAS 29. According to AAS 29, government departments would have the following
similarities to private sector entities:
Similarities in the economic environment. Government departments achieve their operating objectives by
providing goods and services to consumers and/or recipients. In so doing, these entities must use scarce
economic resources. Government departments must obtain scarce resources from external resource providers
and, therefore, are accountable to providers of resources or their representatives in how resources have been
used consistent with the objectives of the entity. These entities must also control assets and incur liabilities in
carrying out their operating objectives. Furthermore, they must be financially viable by having sufficient
resources available to meet their operating objectives and must meet their operating objectives under
conditions of economic uncertainty.
2 Similarities in user needs for information. The most fundamental presumption of AAS 29 (paragraphs 18-23)
is that government departments constitute reporting entities - that is, it can reasonably be expected that
there exist external users dependent on the general purpose financial reports of these entities. AAS 29
identifies these users to include parliament, regulators, other government departments, media and specialinterest groups, consumers, taxpayers and resource provers (paragraph 21). These users are assumed to
have common information needs and to be interested in, inter alia, (a) how effectively and efficiently
resources have been used to meet operating objectives, (b) the extent to which costs have been recovered
from revenues, (c) a government department's capacity to provide goods and services into the future, and
(d) its present and future funding requirements.
3 Similarities in the objectives of the financial statements. In a similar vein to private sector standards, AAS 29
states that the primary objective of the financial statements of government departments is to serve the
information needs of a potentially wide range of users (paragraph 18). With respect to economic decision
making, AAA 29 (paragraph 5) asserts that general purpose financial reports will be particularly relevant to
users for assessing (a) performance, (b) financial position, (c) financing and Investing activities, and (d)
compliance of government departments.

5.4.2 Building blocks of the conceptual framework

The structure of the Australian conceptual framework is shown by the tentative building blocks displayed
in Exhibit 5.2

As you can see, the conceptual framework can be divided into six levels. At its highest level
the conceptual framework defines the scope of financial reporting. The scope of finan cial
reporting deals with the type of information that should be included in general purpose financial
reports (GPFRs). The next two levels of the framework define the concept of the

reporting entity and the objectives of GPFRs. The reporting entity concept was developed as a guide for
determining the types of entities that should be required to prepare GPFRs and comply with Accounting
Standards and associated Statements of Accounting Concepts. Level 4 deals with the qualitative characteristics
that financial information should possess before inclusion in GPFRs. It also covets the definition of basic
elements of financial reports - the assets, liabilities, equity, revenues and expenses of an entity. Level 5 deals
explicitly with how these elements are to be recognised and measured. Lower levels of the framework deal with
the display (disclosure) of information, standard-setting policy and policy enforcement procedures.
The following provides a more detailed description of the different levels of the framework.

Part 1. Definition of financial reporting

This part of the conceptual framework deals with the type of information that should be included within the
scope of financial reporting, and how the scope of company financial reporting is, or should be, determined. The
scope of company financial reports has changed greatly over the years. In the nineteenth century, the primary
financial statement disclosed by companies was a balance sheet. In the early decades of the twentieth century, it
became common for companies to disclose additional information in the form of a profit and loss account 45 By
the 1940s and 1950s many companies also disclosed funds statements. Today, the scope of financial reporting
has extended to cash flow statements, including many other forms of information voluntarily disclosed by
companies, such as financial summaries, future-orientated information and comparative figures.
A number of factors have affected the scope of financial reporting over the years. One important factor is the
incidence of financial crises. Share market crashes and economic depressions have usually resulted in more
stringent disclosure regulations imposed on companies by regulators such as the stock exchange, the AARF and
legislators. For example, the share market crash of 1987 was an important precursor of new regulations on the
cash flow statement46
Demands for information by investors and other users of company financial reports have also influenced the
scope of financial reporting over the years."7 Investors need relevant information for making economic
decisions. Companies have been willing to provide greater quantities of information to investors on a voluntary
basis because companies compete with each other for the capital resources of investors.

Determining the scope of financial reporting

Determination of information to be included in the scope of financial reporting will guide the jurisdiction of
accounting standards and standard setting, and associated SACs. However, this part of the conceptual
framework remains largely undeveloped. For instance, there is no generally accepted definition of general
purpose financial reporting or its scope. However, SAC 2 'Objective of General Purpose Financial Reporting'
provides an indication that the scope of financial reporting may extend beyond financial information:
Financial reporting encompasses the provision of financial statements and related financial and other
information. (paragraph 10)
Paragraph 10 is more specific when it mentions that GPFRs include:

be read with the financial statements ... However, other information can best be provided, or can only be
provided, outside financial reports.

Other passages of paragraph 10 obscure the issue completely:

This Statement does not attempt to draw a clear distinction between financial reports and financial
reporting, nor does it attempt to define the boundaries of general purpose financial reporting.
Hence, the scope of financial reporting can be potentially very broad. The absence of clear definitions is
troublesome. Determination of the scope of GPFR has important implications for standard setting and other
facets of the conceptual framework, particularly in light of the growing incidence of various forms of voluntary
disclosure by companies over the years. These disclosures include environmental disclosures, value-added
statements, financial summaries, trend data, future-oriented information and non-financial performance
indicators. It is important to know whether these types of information should be included within the scope of
GPFR in Australia. If they do, they can potentially become the subject of accounting standard setting and
statements of accounting concepts.
A critical issue evidently concerns what criteria should be used to determine which information will or will
not be included within the scope of financial reporting. To some extent the scope of financial reporting will be
determined by reference to other components of the conceptual framework, in particular SAC 2 'Objective of
General Purpose Financial Reporting' and SAC 3 'Qualitative Characteristics of Financial Information'. SAC 2
specifies that the overall objective of GPFRs is to provide relevant information for economic decision making
by users. SAC 3 specifies the necessary characteristics that information should possess before qualifying for
inclusion in GPFRs. In particular, the relevance and reliability of information are emphasised as the primary
characteristics. Following this approach, only information that can reliably be determined and is demonstrably
relevant for economic decision making would be included in the scope of financial reporting. For example,
broad economy-related information might be excluded from the scope of financial reporting because, while this
information could be relevant for economic decision making, it cannot be measured reliably. On the other hand,
value-added statements might be included within the scope of financial reporting because this information can
be more reliably measured.
In conclusion, it is unlikely that a definition of the scope of financial reporting will be accomplished easily.
Any definition must take into consideration not only the present financial reporting environment, bur the
changing nature of its scope over time.

This part of the conceptual framework deals with the types of entities that should be prepar ing GPFRs and
which entities should be complying with Accounting Standards. Should a local council, a tennis club, a church
or a family business be required to prepare financial reports and comply with Accounting Standards'
SAC 1 states that only reporting entities should be required to prepare financial reports and comply with
Accounting Standards. The definition of the reporting entity is provided in SAC I 'Definition of the Reporting
Entity'. Reporting entities are defined as:
entities (including economic entities) in respect of which it is reasonable to expect the existence of users
dependent on GPFRs for information which will be useful to them for making and evaluating decisions
about the allocation of scarce resources. (paragraph 40)

These users would include shareholders, investors, creditors, suppliers, employees and other users who
need financial reports as a basis for assessing an entity's financial position, profitability and performance.
The definition implies that for those entities where major external users are not expected to exist, then these
entities should not have to prepare GPFRs or comply with Accounting Standards. For example, private
companies, trusts, sole traders and family businesses would nor qualify as reporting entities under SAC 1,
because it would be reasonable to assume that there will be no external users.
Because the definition of the reporting entity is linked to the information needs of external users, the
existence of a reporting entity will not depend on:
1 the sector (whether public or private sector) within which the entity operates;
2 the purpose for which the entity was created (whether business or not-for-profit); or 3 the manner in
which the entity is constituted (whether legal or otherwise).
SAC 1 provides some general guidance in determining whether dependent external users are likely to
exist. For many entities it will be readily apparent whether dependent users are likely to exist (paragraph
19). For example, larger companies normally have many creditors, investors, suppliers and employees of
different descriptions. However, SAC 1 acknowledges that it will not always be clear whether dependent
external users exist. The Statement provides three general guidelines to assist in this determination. These
guidelines need to be considered together:
1 Separation of management from economic interests. SAC 1 argues that the greater the spread of
ownership/membership and the greater the extent of the separation between manage ment and
owners/members (or others with an economic interest in the entity) then the more likely it is that there
will be users who are dependent on financial reports for economic decision making.
2 Economic or political importance/influence. SAC 1 further argues that the greater the economic or political
importance of an entity, the more likely it is that there will be dependent external users (paragraph 21).
These types of entities are most likely to have dominant positions in markets, and those that are
concerned with balancing the interests of significant groups, such as employer/employee associations
and public sector entities which have regulatory powers.
3 Financial characteristics. SAC 1 argues that financial characteristics are also important.
These include an entity's size (e.g. sales turnover) or indebtedness. The larger the size or the greater the
indebtedness of an entity, the more likely it is that there will be external users dependent on GPFRs for
economic decision making (paragraph 22).
Some writers have argued that a major limitation of SAC 1 is that it does not provide sufficient guidelines
as to what constitutes a reporting entity. In particular, guidelines for identifying dependent users are
expressed in qualitative rather than quantitative terms. For example, what constitutes economic political
importance or what degree of size or indebtedness must exist before it can safely be assumed that
dependent users exist I Because these guidelines are generic and are expressed in qualitative terms,
determination of whether a reporting entity exists becomes a largely subjective exercise. A mote critical
assumption underlying SAC 1 concerns the existence of external users. The reporting entity concept as
enunciated in SAC 1 is underpinned by assumptions about the information needs of users. Some
commentators have been concerned about the degree of 'use' that needs to be established before it can be
concluded that users make economic decisions based on GPFRs.

Would an entity still qualify as a reporting entity if users only made very modest use of the financial reports'
Another potential weakness of SAC 1 is that there has been no attempt co rank users, for the purposes of
defining a reporting entity, in some order of priority. For example, if it is established that one entity has
investors as a major user, and another has employees as a major user, will the entity with employees as the
major user be more or less of a reporting entity'
It is clear that the introduction of SAC 1, despite potential limitations, will still have an impact on accounting
practice. For example, it will result in some partnerships, crusts, government departments and statutory
authorities currently not preparing GPFRs co do so, because they would qualify as reporting entities under SAC
1 (see paragraph 33).

This stage of the conceptual framework deals with the overall objective of GPFRs, the users of these reports
and their information needs. Statement of Accounting Concepts o. 2 (SAC 2), 'Objective of General Purpose
Financial Reporting' issued in August 1990, deals with this aspect of the framework. SAC 2 states:
General purpose financial reports focuses on providing information co meet the common information
needs of users who are unable co command the preparation of reports tailored co their particular
information needs. These users must rely on the information communicated co them by the reporting
SAC 2 acknowledges that some users have specialised needs and will possess the author ity co obtain the
information co meet those needs. Examples are taxation authorities, central banks and grants commissions. The
information they seek is called special purpose financial reports. Because these users are able co command the

preparation of this information, special purpose financial reports are excluded from general purpose financial
reporting, and hence will not become the subject of standard setting.
The grand vision behind SAC 2 is the belief that the provision of relevant financial information by
companies co external users will ultimately enhance the efficient allocation of scarce resources throughout the
entire economy, thus contributing co national economic growth. Relevant financial information will assist, for
example, investors co make informed portfolio decisions concerning the spread of risk and return, and creditors
co make informed lending decisions.
Because efficient resource allocation is the ideal, SAC 2 states that the primary objective of GPFRs is co
provide relevant information co various external users so that they can make and evaluate decisions about the
allocation of scarce resources. SAC 2 outlines a secondary objective of GPFRs. This is co demonstrate the
discharge of accountability. SAC 2 states:
Managements and governing bodies are accountable to those who provide resources co the entity for
planning and controlling the resources of the entity. In a broader sense, because of the influence reporting
entities exert on members of the community at both the microeconomic and macroeconomic levels, they
are accountable co the public at large. General purpose financial reporting provides a means by which
this responsibility can be discharged.
SAC 2 defines three classes of user: resource providers, recipients of goods and services, and parties performing a
review or oversight function (paragraphs 17-19). It also defines the types of information these user groups will need in
order co make informed and rational economic decisions. To this extent, SAC 2 stresses that user needs for information
will overlap because all users are fundamentally concerned with the ability of an entity co generate

favorable cash flows. SAC 2 provides a discursive breakdown of the information needed by users into four
different headings: performance, financial position, finance and investing, and compliance.
1 Performance. Performance implies how effective an entity has been in meeting its objectives, and how
efficiently and economically it has used resources in meeting those objectives. Aspects of performance can
be measured in both financial and non-financial terms. Included in the financial information needed to
assess performance is information typically found in company profit and loss accounts and balance sheets.
Disclosure of revenues and expenses, assets, liabilities and equity is envisaged by SAC 2 to be relevant to
assessing performance. With this information, users will be able to, inter alia, evaluate the changes in the
entity's control over resources by reference to the resources or funds employed in achieving the change.
Ostensibly, this information is relevant to users in predicting both the capacity of an entity to generate cash
from its existing resource base and the effectiveness by which it would employ additional resources.
2 Financial position. The financial position of an entity involves disclosure of information about its wealth or
control over economic resources, financial structure, capacity for adaptation and solvency. Most of the
information needed to make these assessments is contained in company balance sheers. Disclosure of
information about an entity's control over resources (its assets) is ultimately useful in predicting the ability
of an entity to continue to meets its objectives, whether these relate to generation of positive cash flows in
the future or the continued provision of goods and services. The financial struc ture of an entity, at any point
in time, is a specified relationship (both in terms of value and amount) between its assets, liabilities and
equity. Disclosure of relevant information about the financial structure of an entity relates to the sources,
types and time patterns of finance, whether debt or equity and the types of assets used by the entity. This
information is useful for predicting the future distribution of cash flows among providers of resources and
the ability of an entity to attract resources in the future.
Capacity for adaptation refers to the ability of an entity to change or modify its resource base, whether
this is necessitated by changes in economic conditions, new opportunities, or directives from controlling
bodies. SAC 2 states that information about the location, realisable value and current state of repair of an
entity's assets would be relevant to users in assessing capacity for adaptation.
Solvency concerns the ability of an entity to meet its debts as they fall due. According to SAC 2, relevant
information needed to assess solvency would include the liquidity of company's assets and the availability of
cash from external sources. This information will be useful for predicting the ability of the entity to meet its
obligations as they fall due and, therefore, in predicting the ability of the company to provide goods and
services into the future.
3 Financing and investing. Financing and investing relates to an entity's sources and application of funds during
the period. This information indicates the way in which an entity has financed its operations and invested its
resources during a period.
4 Compliance. SAC 2 states that information about non-compliance with externally imposed regulations is
relevant as an input into user assessments about an entity's performance, financial position, and financing
and investing. Examples of externally imposed requirements include: conditions imposed by borrowing
agreements; conditions imposed by licensing agreements and grant arrangements; spending mandates and
borrowing limits; occupational health and safety legislation; and environmental legislation.

Part 4. Fundamentals
This part of the framework, Level 4 of Exhibit 5.2, comprises two building blocks: qualitative characteristics of
financial information; and elements of financial statements.
Qualitative characteristics of financial information
SAC 3 'Qualitative Characteristics of Financial Information', issued in August 1990, considers this aspect of the
framework. The specification of the qualitative characteristics of financial information will provide criteria for
choosing between: (a) alternative accounting and reporting methods; and/or (b) disclosure requirements.
Basically, these criteria indicate which information is better (more useful) for decision-making purposes. The
characteristics may be viewed as a hierarchy as indicated in Exhibit 5.3.

Relevance and reliability are the two primary qualities, with related ingredients.
Comparability and consistency are presented as secondary and interactive qualities. Finally, the concepts
of cost-benefit considerations and materiality are recognised, respectively, as a pervasive constraint and
a threshold for recognition. Each of these qualitative characteristics of accounting information will now
be examined.

Relevance. Relevance is defined in SAC 3 to mean that quality of financial information that exists when
information influences the decisions of users about the allocation of scarce resources. Influencing
decisions could mean:

a helping users form predictions about the outcomes of past, present or future events; and/or
b confirming or correcting their past evaluations, which enables users to assess the rendering of accountability
by preparers.
Hence, information must materially affect, or have the potential to affect, the decisions of users. The
importance of relevance as a qualitative characteristic of financial information is central to financial
reporting and has been advocated widely in the accounting litetature. 18
I t is noted that SAC 3 emphasises that the predictive and confirmatory roles of financial information ate
not mutually exclusive. For example, information about the current level and structure of asset holdings will
be relevant to users in assessing (predicting) an entity's ability to take advantage of opportunities in the
marketplace. However, this same information can playa confirmatory role in respect of past predictions.
Furthermore, to have predictive value information does nor have to be in the form of an explicit forecast.
Users are interested in forming assessments (predictions) about the nature, timing and amounts of future cash
flows based on the information presented to them in GPFRs.
Financial information can also be judged as relevant by reference to its nature or mag nitude. For
example, an increase in directors' emoluments or a related party contract may be critical with respect to its
nature even though the absolute amounts may be insignificant compared to other costs.
Some authors have argued that a major weakness of the definition of relevance provided in SAC 3 is that
'nature' and 'magnitude' are not defined in operational or quantifiable terms, but in qualitative terms only.
This leaves the door open for professional accountants to have legitimate disagreements over whether any
particular transaction is significant by virtue of either its nature and/or magnitude to warrant disclosure in
GPFRs. Furthermore, it is possible that the predictive and confirmatory roles of financial information
emphasised by SAC 3 are too broadly based to provide definite guidelines on different measurement and
disclosure alternatives in accounting. For example, many researchers have disputed the relative merits of a
current cost accounting system versus a conventional historical cost accounting for economic decision
making by users. Because both systems would, in differing degrees and under differing circumstances, play a
predictive or confirmatory role in user decision making, the definition of relevance in SAC 3 might nor be
sufficiently detailed in testing or assessing whether one measure ment system would be more relevant to
users than the other.
2 Reliability. Reliability is defined in SAC 3 as 'that quality of financial information which exists when the
information can be depended upon to represent faithfully and without bias or undue error, the transactions or
events that it either purports to represent or could reasonably be expected to represent'. It is essential that
financial information be reliable. i9 If information is relevant, but not reliable, SAC 3 implies that it will not
qualify for inclusion in GPFRs. Unreliable information, while relevant, can lead to poor or less than optimal
decisions by users. SAC 3 (paragraphs 25-26) is careful to point Out that reliability should not be confused
with the accounting convention of conservatism or prudence. That is, accountants should not deliberately
understate net income on the basis or conservatism, 'thereby usurping the rights of users to make their own
decisions' (paragraph 21).
An important part of reliability is the avoidance of bias. For information to avoid bias, or be presented
neutrally, it should not be designed to lead users to the conclusions that

serve particular needs, desires or preconceptions of preparers. Bias can stem from deliberate
misstatement or even 'misguided' conservatism. This is not to imply that the preparers of information
do not have a purpose in mind when preparing the reports; it only means that the purpose should not
influence a predetermined result. SAC 3 (paragraphl9) draws a distinction between faithful
representation of transactions and the effective representation of those transactions. For example,
measuring an asset at historical cost may be reliable, but not effective in terms of providing relevant
information to users. In such situations, SAC 3 does not rank relevance over reliability or vice versa.
Both characteristics are seen as primary. In practice, however, there could arise a number of situations
where a trade-off between relevance and reliability could be a practical necessity. A major weakness of
SAC 3 is that it strongly associates the concept of reliability with minimum recognition criteria
(paragraph 18) covered in SAC 4 'Definition and Recognition of Elements of Financial Statements'.
However, SAC 4 states that reliable measurement is an essential criterion of recognition. Hence, the
definitions are circular.
3 Comparability. Comparability is defined in SAC 3 as:
that quality of financial information which exists when users of that information are able to evaluate similarities in
and differences between, the nature and effects of transactions and events, at one time and over time, either when
assessing aspects of a single reporting entity or a number of reporting entities ..

This implies that the measurement and display of accounting transactions and events need to be
carried out in a consistent manner through the entity and over time for the entity and that there is
consistency between entities. Comparability describes the use of the same method over time by a given
firm. The consistency principle does not, however, mean that a particular method of accounting cannot
be changed once it is adopted. Environmental circumstances may dictate a more desirable change in
accounting policy or technique if properly justified. Indeed, an important aspect of comparability is
that users need to be informed of the accounting policies employed in the preparation of financial
reports, the changes in those policies and the financial effects of those changes.
4 Understandability. Understandability means, not surprisingly, that quality of financial information that
exists when users of that information are able to comprehend its meaning. However, an interesting
development is that SAC 3 does not presume that financial reports should be prepared for the
layperson. Rather, financial reports should be constructed for users who are prepared to exercise
'diligence' in reviewing the accounts and who possess the necessary 'proficiency' to comprehend the
significance of contemporary accounting practices. SAC 3 advises that, if need be, interested users
should solicit the services of professionals to assist them in interpreting accounting information.
Furthermore, SAC 3 acknowledges that some transactions are too complex to simplify. This implies
that relevance and reliability should not be sacrificed in order to simplify the information produced in
5 Timeliness as a constraint on relevance. SAC 3 cautions that information will lose its relevance if there is
undue delay in the reporting of that information. SAC 3 therefore stipulates that information should be
prepared and disclosed to users on a timely basis. It is of interest that SAC 3 states that the application
of the accounting convention of periodicity can often lead to the need to report on transactions before
all aspects of a transaction or event are known. This can limit the availability of relevant information
and adversely affect reliability. A limitation of SAC 3 is that it makes no comment on the frequency
with which annual reports should be prepared by companies (e.g. annually versus quarterly).

6 Cost versus benefits as a constraint on relevance. Cost-benefit considerations ate recognised as another pervasive
constraint on relevance. Financial accounting information will be sought if the benefit to be derived from
the information exceeds its cost. Thus, before preparing and disseminating financial information, the
benefits and costs of providing the information must be compared. The FASB emphasises the importance of
cost-benefit considerations in the following statement:
Before a decision is made to develop a standard, the Board needs to satisfy itself that the matter to be
ruled on represents a significant problem, and that a standard that is promulgated will not impose
costs on the many for the benefit of the few. If the proposal passes that first test, a second test may
subsequently be useful. There are usually alternative ways of handling an issue. Is one of them less
costly and only slightly less effective? Even if absolute magnitudes cannot be attached to costs and
benefits, a comparison between alternatives may yet be possible and useful 50
SAC 3 mentions that as a general principle the benefits of providing financial information should exceed
the cost. The cost of information includes collection, storage, retrieval, presentation, analysis and
presentation. The benefits of information will come from the sound economic decisions made by the various
user groups. Again, much judgement will need to be made by preparers when evaluating the relevance of
information in a cost-benefit situation. There is also the possibility of a conflict or ethical dilemma between
user groups if anyone or more of the qualitative characteristics are compromised by decisions made in
respect of the economic consequences (costs/benefits) of information disclosure to some user groups over
others.5 I
7 Materiality. Finally, financial information must pass the materiality test before inclusion into GPFRs.
Materiality is defined in qualitative terms in SAC 3 as:
the extent to which relevant and reliable information may be omitted, misstated or not dis closed
separately without having the potential to adversely affect the decisions made about the allocation of
scarce resources made by users ...
Materiality is regarded as a threshold for recognition. Materiality is also a state of rel ative importance.
SAC 3 emphasises that consideration must be given to whether or not the information is likely to have a
significant, or material, impact on decisions. Of crucial importance is who should determine the materiality
rules, and how. (This question will be examined fully in Chapter 6.) The AASB's position on the subject is
consistent with the FASB's approach:
The Board's present position is that no general standards of materiality could be formulated to take
into account all the considerations that enter into an experienced human judgment. However, that
position is not intended to imply either that the Board may not in the future review that conclusion or
that quantitative guidance on materiality of specific items may not approximately be written into the
Board's standards from time to time. That has been done on occasion already (for example, in the
statement on financial reporting by segments of a business enterprise), and the Board recognizes that
quantitative materiality guidance is sometimes needed ... However, whenever the Board or any other
authoritative body imposes materiality rules, it is substituting generalized collective judgment for
specific individual judgments, and there is no reason to suppose that the collective judgments are
always superiors2

DeflnJllon and recognition of elements of financial statements

Level 4 and part of level 5 of Exhibit 5.2 deals with the definition and recognition of the ele ments of financial
statements. This is the subject of SAC 4. SAC 4 was initially released in 1992, but attracted much public
criticism and was consequently revised in March 1995. The

public concern with the 1992 version of SAC 4 and the specific amendments made to the document in 1995 are
discussed in the next section. This section briefly discusses the definition and recognition of assets, liabilities,
equity, revenues and expenses proposed by SAC 4.

Definition and recognition of assets. SAC 4 embraces the asset/liability view point and defines assets as future
economic benefits or controlled by the entity as a result of past transactions or other past events. 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. SAC 4 avoids a legally rigid definition. 'Future economic benefits' is considered by SAC 4 to be
the essence of assets. It constitutes the scarce capacity of assets to provide bene fits to an entity. The future
economic benefits are used to provide goods and services for exchange with the objective of generating
positive net cash inflows. SAC 4 states that other aspects of an asset are indicative but not essential
characteristics of assets. For example, consider the notion of exchangeability. This means that an asset is
separable from the entity and has a separate disposal value or selling price. SAC 4 does not consider this an
essential characteristic of assets because the future economic benefits are not precluded by the inability ro
sever an asset from the entity, nor are assets necessarily related to the existence of a disposal value.
SAC 4 further outlines recognition criteria for assets. SAC 4 stipulates that an asset should only be
recognised in the balance sheet when:
a it is probable that the future economic benefits embodied in the asset will eventuate; and
b the asset possesses a cost or other value that can be measured reliably.
As you will see in the next section, many companies have been concerned with the definition of
probability. For instance, 'probable' is defined rather vaguely in SAC 4 to mean 'more likely than less likely'
(more or less than 50%). SAC 4 argues that this can only be determined on the basis of available evidence
and logic. The SAC 4 probability test represents a departure from current practice, which usually specifies
probability in terms of 'beyond reasonable doubt' or 'virtually certain', which is usually the basis of the
realisation principle.
A more stringent approach to probability based on the realisation principle has been
adopted by the FASB. Furthermore, paragraph 47 of SFAC 6 states:
The degree of probability of a future economic benefit [is a] matter of recognition and measurement
that [is] beyond the scope of this Statement ... Matters involving ... effects of uncertainty ... may be
significant in applying a definition, but they are not part of the definition.
The more open-ended and relaxed definition of probability in SAC 4 has the potential to create
uncertainty in the minds and judgements of account preparers, auditors and, ultimately, users.
SAC 4 also states that the term 'reliability' is to be interpreted in the context of the definition provided in
SAC 3. SAC 4 is explicit in assuming that not all assets will have a cost or value that can reliably be
measured - for example, the discovery of gold by a mining company may not suggest its cost or value, even
though the future economic benefits of the resource are probable. In many such situations it will be readily
apparent that no accurate or reliable assessment of the cost or value of an asset can be formed with

available information at the time the assessment is needed to be made for reporting pur poses.
However, in less extreme cases, different people may have different views about what constitutes a
reliable measure for an asset. Some accountants argue that asset values, whatever the basis, are
inherently unreliable, and only the cost price should be used as a basis for recording assets in the
balance sheet. Others have argued that the selling or replacement price of an asset can be reliably
determined. S3
2 Definition and recognition of liabilities. In a similar vein to assets, liabilities are defined in paragraph 48 of
SAC 4 as 'future sacrifices of economic benefits that the entity is presently obliged to make to other
entities as a result of past transactions or other past events'. In this definition the operative word is the
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 - such as income taxes or employer
superannuation contributions. However, the definition of liabilities provided by SAC 4 extends beyond
the concept of legal enforceability to include equitable obligations (arising from moral or social
sanctions). Furthermore, the definition of liabilities provided by SAC 4 embraces constructed
obligations. These obligations can be created, inferred or construed from the facts of a particular
situation rather than contracted by agreement with another party or government. For example, a
constructive obligation exists where an entity adopts a practice of paying year-end bonuses to
employees even though the company is not contractually bound to do so. Hence, while legally
enforceable obligations are usually always liabilities, the definition provided by SAC 4 encompasses
the financial obligations imposed by equity or fairness, and by custom or usual business practices.
Recognition criteria for liabilities are also set out in a similar vein to the recognition criteria
established for assets. Paragraph 65 states that a liability should recognised on the balance sheet when:
a it is probable that the future sacrifice of economic benefits will be required; and b the amount of
the liability can be measured reliably.
Again, the major weakness of this definition is that the term 'probable' is defined in qualitative
terms as being 'more likely than less likely'. This can potentially leave a wide discretion for different
interpretations in practice. Hence, the definition has been argued by many to provide insufficient
guidance to practitioners.
Furthermore, as previously mentioned, the concept of reliable measurement appears to lack a clear
and precise meaning in SAC 4. In extreme cases, it may be readily apparent that the amount of an
impending liability cannot be ascertained. For example, an entity engaged in litigation might realise
that the loss of the case is imminent, but have no idea about what the extent of the loss will be. In less
extreme cases, the concept of reliable measurement can still pose problems. As SAC 4 observes, while
verifiability of the nominal amounts to be paid and the dates of payments are available for most liabil ities, some liabilities can potentially have a range of nominal values.

3 Definition and recognition of equity. SAC 4 defines equity as a residual interest in the assets of the
entity after the deduction of its liabilities. Equity is therefore determined by subtracting the total
assets from the total liabilities of an entity. This net amount constitutes a claim or right to the net
assets of an entity. It is important to note that the equity and liabilities of an entity are mutually
exclusive interests in the entity's assets by parties external to the company. Equity ranks after
liabilities as a claim to the assets of the entity. An entity's equity is increased by profitable
operations (revenues exceed expenses) and contributions by owners. Conversely, equity is
diminished by distributions to owners and unprofitable operations

(expenses exceed revenues). Because SAC 4 defines equity as a residual, the recognition of equity will
be consequential to procedures used to recognise assets and liabilities.
4 Definition and recognition of revenues. Consistent with the asset/liability view, SAC 4 defines revenues as
'inflows or other enhancements, or savings in outflows, of future economic benefits in the form of
increases in assets or reductions in liabilities of the entity, other than those relating to contributions by
owners, that result in an increase in equity during the reporting period'.
The definition of revenues is driven by the definition of assets and liabilities. The logical
application of this definition in practice could result in important items not previously treated as
revenues (under conventional accounting) being treated as revenues. For example, incremental
increases in the value of non-current assets above book value could justifiably be treated as revenues
under SAC 4.
Recognition criteria for revenues is defined in a similar fashion to assets and liabili ties and, it has
been argued, suffer from the same limitations. A revenue should be recognised in the profit and loss
account when:
a it is probable that the revenue has occurred; and
b the revenue can be measured reliably.
5 Definition and recognition of expenses. In a similar vein to revenues, SAC 4 defines an expense as
'consumptions or losses of future economic benefits in the form of reductions in assets or increases in
liabilities of the enitity, other than those relating to distributions to own ers, that result in a decrease in
equity during the reporting period'. Likewise the recognition criteria for expenses is the same for
revenues. An expense would be brought to account only when:
a it is probable the expense has been incurred; and
b the amount of the expense can be reliably measured.

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. For example, how should assets and
liabilities be valued given the objective of financial reporting, and the qualitative characteristics of
financial information? Should assets and liabilities be measured at some market-determined value or at
historical cost This area of the framework is undoubtedly the most contentious. Measurement of assets,
liabilities, equity, revenues and expenses is nor explicitly dealt with in SAC 4. SAC 4 merely describes
some of the implications and procedures of different measurement possibilities. For instance, SAC 4
outlines recognition criteria for the elements of the financial statements under the conventional historical
cost model, and alternative current value models. The failure of the conceptual framework to cackle the
difficult and controversial issue of measurement has been a further criticism levelled at the project These
criticisms have grown lately because the AARF has been taking an increasingly proactive position on
current-value accounting in some of its more recent accounting standards. However, these initiatives have
been dubbed by some as 'ad hocery'. In other words, recent current-value regulations have been intro duced on a piecemeal basis and have not been explored in the context of a broader and more public
debate on measurement alternatives in accounting. The AARF now seems aware of
'While not explicitly dealt With, the definitions of the elements of the financial statements adopted in SAC 4 carry implications to different measurement choices. For example.
assets are defined in terms of their economic substance - that is, in terms of future economic benefits or service potential. This is ultimately determined by the future net cash
inflows generated by assets. II is well established in the accounting literature that the historical cost model would not adequately reflect the economic substance of this definition
of assets." The definition, by implication, leans heavily towards a current value measurement model

the need to publicly address the critical issue of measurement in the financial statements. In mid-1994 the
AARF released a public Invitation to Comment on a 'Proposed Program for the Development of Concepts
on Measurement of the Elements of Financial Statements', with a response deadline set for November
1994. The purpose of the Invitation to Comment was to inform interested parties of, and seek comment
on, the AASB's suggested timetable and policy position for developing SAC 5 on the measurement of
accounting elements. The Invitation to Comment acknowledged that measurement is one of the most
significant contemporary issues in financial reporting because of:
1 the frequently significant impact of measurement choices on reported results;
2 the existence of widely divergent views among practitioners, users and other parties about the relevance
of historical cost accounting;
3 widely divergent measurement practices under the present system of modified historical cost accounting
in Australia (revaluation practices);
4 the voluntary adoption of current market value measurements industries such as life insurance, banking
and funds managements; and
5 the range of existing accounting standards which specify current-value accounting approaches (see
paragraph 27).
While these issues will be explored further in Chapters 12-14, it is noteworthy that at the time this
book was completed (late 2000) the AARF still has not released the longanticipated SAC 5 on
Part 6. Display of financial information
The final level of the main body of the framework is the display level. This level considers in detail
the nature of the information to be displayed in financial reports. As Exhibit 5.2 indicates, this involves
identifying the appropriate information groupings (financial position, performance, investing, and
financing and compliance) and analysing the components of those selected groupings. This is envisaged
to provide a rational basis for disclosures required by Australian Accounting Standards. The display level
of the conceptual framework is naturally closely related to the objective of general purpose financial
reporting, concerning as it does the information to be displayed and the format of the disclosure.

Part 7. Standard-setting policy and enforcement

The lowest levels of the conceptual framework considers policy issues - that is, issues such as the audit
status, applicability and timing of financial reporting, and, lastly, enforcement of policy. Clearly, different
levels of the framework will be to a large extent interdependent and interrelated. For example, the
objectives of financial reports will have a bearing on the definition of the scope of financial reporting.
Another example is that the qualitative characteristics of financial information will influence various
measurement alternatives, and measurement alternatives will impinge on auditor verification and policy
enforcement issues. Hence, it will be essential for decisions made at one level of the framework to be
reviewed for consistency and applicability with other levels.
It can be concluded that the Australian conceptual framework is developing. Most areas of the
conceptual framework structure outlined in Exhibit 5.2 are not covered by existing SACs. So far, only
four SACs have been issued by the AARF on behalf of the AASB and PSASB. The two most important
contemporary issues that need to be addressed by the AARF are measurement and the scope of financial


e Australian conceptual framework

The only aspect, albeit a crucial one, of the Australian conceptual framework to attract significant
corporate concern was SAC 4. The corporate backlash against SAC 4 took the AARF and its
Boards by surprise, as earlier exposure drafts had nor attracted significant commercial opposition.
The commercial backlash to the requirements of SAC 4 only became evident when the Statement
was officially released by the AARF in August 1992. 55 There were 108 public submissions relating
to SAC 4 during 1993. The submissions contained a variety of criticisms from a number of leading
accounting firms, companies, local and federal government agencies and departments, including
interest groups and representative bodies such as the Australian Institute of Directors, the Group of
100, the Government Accountants Group Committee and the Australian Merchant Bankers
Association. Furthermore, the AARF received considerable feedback from a number of workshops
and seminars it conducted on SAC 4 in all the major States and Territories throughout Australia in
1993. Many concerns with SAC 4 were captured in a statement from a submission by Caltex Oil
Australia: '[SAC 4} is a laudable aim but I contend it does not address commercial reality, or focus
on that very important issue of the credibility of the accounting profession in Australia'.
This section II outlines a number of specific corporate concerns with SAC 4 as they appeared in
the submissions of 1993. It should be noted that a number of these issues are interrelated.
Balance sheet versus profit and loss account orientation. A number of submissions expressed

explicit or implicit concern that SAC 4 was balance sheet oriented. For example, the def initions
of revenues and expenses in SAC 4 are derived or driven from the definitions provided for
assets and liabilities56 This implies a concept of profit based on the comparison of two balance
sheets at the beginning and end of the reporting period. These concerns were compounded by
the absence of any specific mention of the matching principle in SAC 4. A balance sheet view of
profit does not appear to be generally accepted in Australian business or accounting practice. 57
Many viewed the conventional accounting emphasis on profit measurement through nominal
revenue and expense accounts as both pragmatic and appropriate. For example, in rejecting the
balance sheet emphasis of SAC 4, the Australian Institute of Directors noted that profit
determination and disclosure is the 'key factor on which the credibility of financial reports and
the boards of directors are judged'.
2 Definition of elements too prescriptive and uncertain. Numerous submissions indicated that the
definitions of assets and liabilities adopted in SAC 4 were too vague, uncertain and contentious.
Furthermore, there was much doubt whether the definitions could be applied logically to all
situations in respect of a given transaction, and the concept of 'control' was not considered
appropriate in all situations. There were also concerns that the SAC 4 definition of revenue
departed too much from accepted commercial practice because it failed to separate revenue
attributable to an entity's core operations and revenues derived from other activities.
Furthermore, there were fears that SAC 4 could result
This section is based on material compiled by Despina Makrakis in her honors thesis entitled 'A Case Study on the Ill-fated Statement of Accounting Concept SAC 4 "Definition
and Recognition or Elements in the Financial Statements"', unpublished honors thesis, Syme Department of Accounting, Monash University, t994.

and proportionately un-performed meet the definition criteria of assets and liabilities, and therefore
should be recognised on the face of the balance sheer.58 Recognition of these contracts, however,
in some

would result in a significant departure from existing accounting praerice 59 As the Commonwealth


Bank of Australia stated in its submission, 'no other international equivalent concept statement

appears to have extended the recognition of assets and liabilities co this level'. Respondents argued


that the mere existence of a signed contract does not guarantee the receipt of an asset. It was noted by


respondents that commercial contracts are regularly revised, revoked, avoided or negotiated away due


co uncertainties in the economic environment and the inherent lack of control over other parries


involved in the contract. It was also emphasised that such contracts can easily be manipulated by less


scrupulous managers. Furthermore, there were fears that recognition of these contracts would distort


the debt/equity ratio and provide misleading information about an entity's liquidity. Some of these


concerns were raised by SAGASCO Holding Limited, a major Australian gas company. SAGASCO


was particularly concerned about its long-term gas purchase contracts. If SAC 4 was followed, the


company would have co recognise a liability having no corresponding asset, because the company


had no offsetting long-term contract with its customers. Hence, in the first year after the contract is

nts that

signed, massive losses would have co be recorded, which would eventually be 'clawed back' as the


gas was sold. ~

b Accounting for leases. The definitions of SAC 4 do not provide for a differentiation between finance


and operating leases. Under SAC 4 operating leases and leaseback transactions would be reported in


the balance sheer.6o However, a number of submissions indicated that this procedure was not

ersy in

appropriate because operating leases are, in substance, rental in nature. The asset remains the property


of the lessor during the term of the lease and beyond. There was concern that capitalising these lease


contracts could provide misleading information to users because there is essentially no additional


security or asset cover provided to creditors or investors. Furthermore, there was particular concern


that the recognition of operating leases as assets and liabilities would adversely affect an entity's rate

d the

of return and debt/equity ratio.61


Treatment of debt/equity items. A concern to standard-setters in recent years has been the growing
practice of companies disclosing certain types of hybrid securities as equity items when they possess
all the essential characteristics of liabilities (for example, redeemable preference shares, convertible


debt). A potential motivation for such practices is improvement in the debt/equity ratio and the rate of
return on assets. To some extent SAC 4 has tried


tackle this problem. For instance, equity is

defined in SAC 4 as a residual. Hence, the test for classification of equity items is based on whether
or not they meet the definition of liabilities. SAC 4 also suggests that a security could be classified as
either debt or equity during the lifetime of those securities. Many commentators were concerned with
SAC 4's handling of the debt/equity classification controversy. Submissions remarked that
reclassification could occur as the likelihood of redemption or conversion changes with stock market
conditions, or with the circumstances of the entity or management intent, at a future time. Many of
these events

are outside an entity's control and are difficult to anticipate. As such,

commentators noted, reclassification can be extremely subjective. A number of respondents
stated that not only does reclassification run counter to the consistency doctrine, but it opens
the door to potential creative accounting and managerial manipulation.
d Revaluation practices. There were concerns from companies that SAC 4 provides insufficient
guidance on selective asset revaluation practices, now widely adopted by Australian
companies. In particular, SAC 4 was not considered useful in resolving the issue of what
valuation model should be used as the basis for revaluation, nor was it clear under SAC 4
whether revaluation increments/decrements should be treated as revenues or as equity
e Financial instruments. The concerns from respondents that SAC 4 was unable to resolve
controversial accounting issues were highlighted with respect to some recent expo sure
drafts issued by the AARF. Some respondents were dismayed that the provisions of ED 59
(issued in 1994), which sets our measurement and disclosure rules for finan cial
instruments, were not consistent with SAC 4. For example, ED 59 specifically states that
forward exchange contracts are to be set off - in other words, they shall not be grossed up
in the balance sheet as suggested by SAC 4. Furthermore, ED 59 treats preference shares
as equity rather than liabilities (even when it is probable that such shares will be
redeemed). As the Commonwealth Bank of Australia stated in its sub mission, 'it is not
credible to put out a statement of concepts only to vary them with the next exposure draft
3 Recognition criteria - the probability test. As was expected, many submissions were concerned with
SAC 4's permissive recognition criteria, particularly the probability test or the 'more likely than
less likely' (50% or more) rule62 This test relaxes current practice which usually requires
probability to be interpreted as 'beyond reasonable doubt' or 'virtually certain'. Under SAC 4
revenues and expenses will not necessarily be recorded when they are realised (or realisable),
but when the inflows or outflows are probable. As one submission noted, the SAC 4 probability
test 'will undoubtedly be subjected to abuse and exploitation by the less scrupulous operators'.
There are a number of other pragmatic concerns. For example, how will auditors estimate and
distinguish probability levels at, say, 40%,67% or 90%' Furthermore, because different
individuals may have different procedures and perceptions for interpreting 'probable' ,6) the test
could undermine the comparability of company financial reports. The SAC 4 probability test
was also seen to undermine the principle of prudence or conservatism, which dictates that more
stringent criteria be applied in respect of the recognition of revenues and assets than for
expenses and liabilities. As noted by the FASB SFAC No 5:
... as a reaction to uncertainty, more stringent requirements historically have been
imposed for recognising revenues and gains than for recognising expenses and losses,
and those conservative reactions influence the guidance for applying the recognition
criteria to components of earnings. (paragraph 81)
4 Inconsistency with existing accounting standards. Following the release of the SACs, the AARF
stated that inevitable clashes would arise between certain accounting standards and the concept
statemems.64 Because many of our accounting standards are based on the historical cost model
and associated principles of matching, realisation and conservatism (none of which are referred
to in the 1992 version of SAC 4), the relevance and commercial reality of SAC 4 has been
seriously questioned by Australian companies. The inconsistencies between the SACs and
accounting standards are bound to lead to

Boards. Several submissions indicated that the mandatory status of SAC 4 should be
removed on the basis of these points alone.
er, 5 Departure from international accounting standards and practices. There were also concerns from
respondents that SAC 4, if it remained mandatory, would result in significant
departures from accepted international accounting practices (e.g. contracts equally
and proportionately unperformed, accounting for operating leases). The problem of
international comparability raised fears that foreign investors, rating agencies and
analysts may not readily comprehend Australian financial statements. The
competitive advantage of Australian companies could be adversely affected, for
example, by foreign investors raising the cost of capital requirements for Australian
nflict, 5.5.1
The AARFs backdown on SAC 4 (March 1995)
The barrage of criticism from commercial interests could not be ignored by the
profession. In late 1993, a Joint Standing Committee of the ASCPA and ICAA
considered these submissions and decided that, as of 31 December 1993, SACs should
no longer have mandatory status for members of the accounting profession.
Furthermore, to quell industry discontent with the AARF's conceptual framework
efforts, the AASB and PSASB decided to amend SAC 4. Work on these revisions
progressed through most of 1994 and involved an extensive consultative process
e. 65
between the AARF, its Boards, representatives of the Big Six accounting firms, the
Group of 100 and the Australian Securities Commission. An amended SAC 4 was
released by the AARF in March 1995. These amendments were accompanied by an
AARF release entitled 'SAC 4: Definition and Recognition of the Elements of Financial
Statement - Background and Basis for Conclusions' (March 1995). This document set
our specific changes to SAC 4 and provided discussion on why the Boards had arrived
at particular conclusions. Some of the changes made to SAC 4 were substantive, others
cosmetic. However, the overall change to SAC 4 was the AARF's endorsement of a
more descriptive and internationally compatible Statement. The substantive changes' to
SAC 467 included the following:
ed the
1 The mandatory status and transitional provisions were removed.
2 The operative date was removed (it was no longer appropriate to a document that did nor have
mandatory status).
submi 3 The detailed appendix attached to the 1992 version of SAC 4 was removed. This appen dix
provided guidance on the interpretation and application of SAC 4 concepts to a
is that
number of specific accounting transactions. These detailed interpretations were no
longer considered appropriate to a Statement designed to set out broad concepts. It
was concluded that interpretations of SAC 4 to specific accounting issues is better
reserved for Accounting Standards and other AARF releases.
not be
easy 4 There were certain changes to the commentary sections, including a tightening up in the
classification of liabilities, greater discussion on the nature of reciprocal and
non-reciprocal transfers and greater discussion on circumstances under which
an increase in asset value would constitute an item of revenue or an equity
adjustment (such as additions to revaluation reserve).
ut the
r issue
ed by
and its


g of relevant and reliable information about the profitability of a profit-seeking entity will typically
involve the matching of revenues and expenses:
(a) matching of expenses with revenues where those items result directly and jointly from the same
transactions or other events; for example, simultaneous recognition of sales and cost of
goods sold, and recognition of project revenues arising from performance under
construction contracts simultaneously with recognition of project expenses;
(b) matching of revenues with progressive performance by an entity over a period; for example, recognition
of interest revenues by lenders over the period of credit, and recognition of insurance
premiums by insurers over the period of risk; and
(c) matching of expenses with the entity's productive operations; for example, the systematic recognition of
depreciation over the periods which the entity consumes the future economic benefits
embodied in its long-lived assets. Where expenses are not related directly to particular
revenues, their recognition will largely be independent of the recognition of revenues.
However, a matching of those expenses will occur in the sense that they will be
recognised concurrently with revenues generated by the entity's operations in the
reporting period.
It is noteworthy that the Australian conceptual framework for financial accounting and reporting explicitly


frowns on income smoothing tecniques. SAC 4 'Definition and Recognition of Elements of Financial


Statements' (March 1995) states:

. This


Some matching techniques smooth the effects of events of different reporting periods in a man ner that
reflects the preparer's view of the long-term performance of the entity and reduces the volatility of
reported results, but which involves recognition in the statement of financial position of items which
satisfy neither the definition of assets nor the definition of liabilities. These techniques are not consistent
with this Statement'.
These allocations would include deferred exchange losses, provisions for uninsured future losses and
provisions for expected future losses on unprofitable business segments.
Implicit in this notion of matching is a view that the operating statement should not have primacy over the
statement of financial position. Furthermore, according to the AARF and its Boards, these allocations do not
foster reliable reporting and confidence in the quality of financial reports, because:
they cause operating statements to reflect the expectations of preparers rather than economic phenomena,
and are inherently unverifiable;
2 anticipated long-term trends in profitability or in other measures of performance can only be confirmed after
a substantial period has elapsed and resource allocation decisions have already been made; and


3 they may obscure the relative riskiness of different businesses (paragraph A44).


With respect to the more controversial issue of recognition criteria and the probability test, the AARF and


its Boards made no alterations to SAC 4 other than to provide additional explanation for their particular policy

r. In

stances. As explained by the amended SAC 4 (paragraph A24):


Although virtually all of the overseas frameworks adopt probability as a general criterion for the
recognition of an element, most of those frameworks include a more stringent requirement or more
stringent guidance that would be applied in practice to the recognition of revenues or their equivalent.
This is because of views that the recognition criteria need to be applied prudently, especially in respect
of revenues; and because some of those Concepts Statements attempt to establish the implicit links
between the concepts specified therein and historical practices.

ch requires inter alia that financial information is neutral. Accordingly, it would conflict with the
qualitative characteristics set our in SAC 3.
2 It would conflict with the Boards' goal of a balance between the quality of information reported in the

statement of financial position and in the operating statement.

er, the

3 It would specify two-tier criteria for the recognition of assets and liabilities instead of the


general criterion of probability. That is, the criteria for the recognition and dere cognition


of assets and liabilities would differ according to whether a revenue or expense is



at the
n of a
h in the
tion of

A number of other concerns raised by the public submissions of 1993 did not result in any change to
SAC 4. For example, in contrast to the FASB's position, the Boards of the AARF decided against
providing separate definitions for gains and losses from the general definition of revenues and expenses.
This was mainly because 'of the difficulties of consistently distinguishing inflows and outflows from
"ordinary" or "central" operations .. .from inflows and outflows ... which are not "central" bur
nevertheless are essential to the operations of the entity' (paragraph Al 5). The Boards concluded that the
presentation of revenues and expenses jointly as 'gains' and 'losses' is really only a matter of display
anyway. Another example is that the Boards kept to their guns in requiring recognition of agreements
equally proportionately unperformed in the statement of financial position.
In conclusion, Australia's experimentation with a mandatory and prescriptive framework provides
insights into the many difficulties facing standard-setters in achieving the implementation of a generally
accepted conceptual framework. The amended SAC 4 will undoubtedly quell widespread concerns and
disgruntlement with the Australian conceptual framework project. While the Boards have only met the


industry half-way on these amendments, the real substantive change to SAC 4 is the removal of its

s, for

mandatory status and its relegation to a mere 'general guide'. With the removal of the mandatory status of


the SACs from APS 1, the accounting bodies have effectively dismantled the conceptual framework.


The future of the SACs is now uncertain, although it is clear that they will play less of a role in


guiding company financial reporting and disclosure practices. However, it is widely understood that the


AASB and PSASB will continue to develop SACs and continue to use them in the standard-setting




c of

5.6 Other conceptual framework projects and

This section briefly outlines conceptual framework projects in the United States, the United Kingdom
and Canada.


Development of the US conceptual framework

In response to the criticism of corporate financial reporting and the realisation that a conceptual
framework of accounting is urgently needed, the Board of Directors of the American Institute of
Certified Public Accountants announced the formation of two study groups in April 1971. The study
group on the establishment of accounting principles, known as the

'Wheat Committee', was charged with the task of improving the standard-setting process. Its report resulted in the
formation of the Financial Accounting Standards Board (FASB). A second study group, known as the 'Trueblood
Committee', was charged with the development of the objectives of financial statements - that is, with determining:
1 who needs financial statements;
2 what information they need;
3 how much of the needed information can be provided through accounting; and 4 what framework is
required to provide the needed information.
The Trueblood Committee consisted of nine members, representing the accounting pro fession, the academic
world, industry and the Financial Analysts Federation. A team of academics, practitioners and consultants served as
advisers. The Committee conducted meetings and interviews to assess the informational needs of various interested
groups from all sectors of government and the business and professional communities. Relevant literature in
accounting, economics and finance provided the basic conceptual foundations. On the basis of the empirical and
conceptual data gathered, the study group issued two reports. The first and more important, Report of the Study Group

on the Objectives of Financial Statements, contains the principal conclusions and the stated objectives of financial
statements. The second report contains a selection of articles by the team of advisers that the study group considered
when forming the conclusions and objectives in the first reporr 69

The objectives of financial statements as expressed in the TruebLood

Although the twelve objectives in the study group's report were intended to be equal, there is a justifiable tendency
to distinguish a definite hierarchical structure to the objectives 70 Differences in emphasis and the relative
dependency among the objectives justify such a hierarchy. The following six objective levels may be derived from
the Trueblood Report:
1 the basic objective (no. 1);
2 four objectives (nos 2, 3, 11 and 12) that specify the diverse users and uses of accounting information;
3 two objectives (nos 4 and 5) that specify enterprise earning power and management ability (accountability) as the
type of information needed;
4 one objective (no. 6) that specifies the nature of the needed information as factual and Interpretive;
5 four objectives (nos 7,8,9 and 10) that describe the financial statements required to meet objective no.

6; and

6 a number of specific recommendations for the financial statements made in order to meet each of the preceding
objectives (nos 7, 8, 9 and 10).
These objectives are stated in the Trueblood Report as follows:
NO.1: The basic objective of financial statements is to provide information on which to base economic
NO.2: An objective of financial statements is to serve primarily those users who have limited authority,
ability, or resources to obtain information and who rely on financial statements as their principal source of
information about an enterprise's activity.
No.3: An objective of financial statements is to provide information useful to investors and creditors for
predicting, comparing and evaluating potential cash flows to them in terms of amount, timing and related

No.4: An objective of financial statements is to provide users with information for predicting, comparing and
evaluating enterprise earning power.
No.5: An objective of financial statements is to supply information useful in judging managements ability to
utilize enterprise resources effectively in achieving the primary enterprise goal.
No.6: An objective of financial statements is to provide factual and interpretive information about transactions
and other events that is useful for predicting, comparing and evaluating enterprise earning power. Basic
underlying assumptions with respect to matters subject to interpretation, evaluation, prediction, or estimation
should be disclosed.
No.7: An objective is to provide a statement of financial position that is useful for predicting, comparing and
evaluating enterprise earning power. This statement should provide information concerning enterprise
transactions and other events that are part of incomplete earnings cycles. Current values should also be reported
when they differ significantly from historical cost. Assets and liabilities should be grouped or segregated by the
relative uncertainty of the amount and timing of prospective realization or liquidation.
No.8: An objective is to provide a statement of periodic earnings useful for predicting, comparing and evaluating
enterprise earning power. The net result of completed earnings cycles and enterprise activities resulting in
recognizable progress toward completion of incomplete cycles should be reported. Changes in the values
reflected in successive statements of financial position should also be reported, but separately, since they differ in
terms of their certainty of realization.
No.9: An objective is to provide a statement of financial activities useful for predicting, comparing and
evaluating enterprise earning power. This statement should report mainly on factual aspects of enterprise
transactions having or expected to have significant cash consequences. This statement should report data that
require minimal judgment and interpretation by the preparer.
No.1 0: An objective of financial statements is to provide information useful for the predic tive process. Financial
forecasts should be provided when they will enhance the reliability of users' predictions.
No. 11: An objective of a financial statement for governmental and not-for-profit organiza tions is to provide
information useful for evaluating the effectiveness of the management of resources in achieving the
organization's goals. Performance measures should be quantified in terms of identified goals.
No. 12: An objective of financial statements is to report on those activities of the enterprise affecting society
which can be determined and described or measured and which are important to the enterprise in its social

To satisfy users' needs, information contained in financial statements must possess certain characteristics. The Trueblood
Report mentions seven qualitative characteristics of reporting:
1 relevance and materiality
2 form and substance
3 reliability
4 freedom from bias
5 comparability
6 consistency
7 understandability.

In the Reports works:

The qualitative characteristics of financial statements should be based largely on the needs of users of the statements.
Information should be free as possible from any bias of the preparer. In making decisions, users should not only
understand the information presented, but also should be able to assess its reliability and compare it with information
about alternative opportunities and previous experience. In all cases, information is more useful if it stresses
economic substance rather than technical form."
The recommendations of the Trueblood Report found their way into the six Statements of Financial Accounting
Concepts, which together comprise the present conceptual framework in the United States. The six statements cover the
following areas:
1 the objectives of financial reporting by business undertakings (SFAC 1); 2 qualitative characteristics of
accounting financial information (SFAC 2); 3 elements of the financial statements (SFAC 3);
4 objectives of financial reporting by non-business entities (SFAC 4);
5 recognition and measurement in financial statements of business undertakings (SFAC 5); and
6 a statement of amendments to previous concepts statements (SFAC 6).
In substance, the SFACs have the same conceptual foundations as the SACs. 72 The major differences between the SFACs
and the SACs is that the former are more detailed, more explicitly stated and less prescriptive than the SACs. As examples,
the SFACs: (a) recommend more conservative recognition criteria for the elements of financial statements; (b) differentiate
between revenues, expenses, gains and losses in manner consistent with conventional practice; and (c) make greater
reference to conventional accounting principles.
The differences in approaches can be highlighted by comparing SAC 2 with SFAC 1. Both concept statements enunciate
the objectives of financial reporting by reporting entities. However, SFAC 1 is more detailed and descriptive in both
approach and terminology.
The objectives of financial reporting are summarised in the following excerpts from SFAC 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
with reasonable diligence. (paragraph 34)
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 interests and the
proceeds from the sale, redemption, or maturity of securities or loan. The prospects for those cash receipts are affected
by an enterprise's 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 enterprise's securities. Thus, financial reporting should
provide information to help investors, creditors and others assess the amount, timing and uncertainty of prospective
net cash inflows to the related enterprise. (paragraph 37)
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. (paragraph 40)

Financial reporting should provide information about an enterprise's 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 the future enterprise performance, those expectations
are commonly based at least partly on evaluations of past enterprise performance. (paragraph 42)
The primary focus of financial reporting is information about an enterprise's performance provided by measures of earnings
and its components. (paragraph 43)
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
resource to owners, and about other factors that may affect an enterprise's liquidity or solvency. (paragraph 49)
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. (paragraph 50)
Financial reporting should provide information that is useful to managers and directors in making decisions in the interests
of owners'. (paragraph 52)
The Statement also makes the following points:

t Financial reporting is not an end in itself, but is intended to provide information that is useful in making business
and economic decisions.
t The objectives of financial reporting are not immutable - they are affected by the economic, legal, political and
social environment in which financial reporting takes place.
t The objectives are also affected by the characteristics and limitations of the kind of information that financial
reporting can provide.

The objectives in this statement are those of general-purpose external

financial reporting by business enterprises.
t The terms 'investor' and 'creditor' are used broadly, and apply not only to those who have or contemplate having a
claim to enterprise resources, but also those who advise or represent them.

t Although investment and credit decisions reflect investors' and creditors' expectations about future enterprise
performance, such expectations are commonly based, at least partly, on evaluations of past enterprise
t The primary focus of financial reporting is information about earnings and its components.
t Information about enterprise earnings based on accrual accounting generally provides a better indication of an
enterprise's present and continuing ability to generate favorable cash flows than information limited to the financial
effects of cash receipts and payments.
t Financial reporting is expected to provide information about an enterprise's financial performance during a period and about how management of an enterprise has discharged its stewardship responsibility to

t Financial accounting is not designed to measure directly the value of a business enterprise, but the information it
provides may be helpful to those who wish to estimate its value.

Investors, creditors and others may use reported earnings and information
about the elements of financial statements in various ways to assess the
prospects for cash flows.

t They may wish, for example, to evaluate management's performance, estimate earning power, predict future
earnings, assess risk, or confirm, change or reject earlier predictions or assessments. Although financial reporting
should provide basic information to aid them, users do their own evaluating, estimating, predicting, assessing,
confirming, changing and rejecting.
t Management knows more about the enterprise and its affairs than investors, creditors, or other 'outsiders' and,
accordingly, may often increase the usefulness of financial information by identifying certain events and
circumstances and explaining their financial effects on the enterprise.

5.6.2 The Corporate Report

In July 1976, the Accounting Standards Steering Committee of the Institute of Chartered Accountants in
England and Wales published The Corporate Report, a discussion paper intended as a first step toward a
major review of users, purposes and methods of modern financial reporting in the United Kingdom. The
report presented the efforts of an eleven member party, working within the following frame of reference:
The purpose of this study is to reexamine the scope and aims of published financial reports in the light of modern
needs and conditions.
It will be concerned with the public accountability of economic entities of all kinds, but especially of business
It will seek to establish a set of working concepts as a basis for financial reporting. Its aims will be to identity the
persons or groups for whom published financial reports should be prepared, and the information appropriate to
their interests.
It will consider the most suitable means of measuring and reporting the economic position, performance and
prospects of undertakings for the purposes and persons identified above'?}

How well the report lives up to its stated aims is evidenced by its major findings and recommendations.
First, the basic philosophy and starting point of the report is that financial statements should be appropriate
to their expected use by potential users. In other words, financial statements should attempt to satisfy the
informational needs of their users.
Second, the report assigns responsibility for reporting to the 'economic entity' having an impact on
society through its activities. The economic entities are itemised as limited companies, listed and unlisted;
pension schemes, charitable and other trusts, and not-for-profit organisations; non-commercially oriented
central government departments and agencies; partnerships and other forms of unincorporated business
enterprises; trade unions and trade and professional associations; local authorities; and nationalised
industries and other commercially oriented public sector bodies74
Third, the report defined users as those having a reasonable right to information and whose information
needs should be recognised by corporate reports. The users are identified as the equity investor group, the
loan creditor group, the employee group, the analyst-advisor group, the business contract group, the
government and the public75
Fourth, to satisfy the fundamental objectives of annual reports established by the basic philosophy, seven
desirable characteristics are cited - namely, that the corporate report be relevant, understandable, reliable,
complete, objective, timely and comparable.
Fifth, after documenting the limitations of current reporting practices, the report suggests the need for the
following additional statements:
a statement of value added, showing how the benefits of the efforts of an enterprise are shared among
employees, providers of capital, the state and reinvestment. Exhibit 5.4 is an example of a statement of value added.
2 an employment report, showing the size and composition of the work force relying on the enterprise for its
livelihood, the work contribution of employees and the benefits earned;
3 a statement of money exchange with government, showing the financial relationship between the enterprise and
the state;

4 a statement of transactions in foreign currency, showing the direct cash dealings between Great Britain and
other countries;
5 a statement of future prospects, showing likely future profit, employment and investment levels; and
6 a statement of corporate objectives, showing management policy and medium-term strategic targets.

Finally, after assessing SIX measurement bases (historical cost, purchasing power, replacement
cost, net realisable value, value to the firm and net present value) against three criteria (theoretical
acceptability, utility and practicality), the report rejected the use of historical cost in favor of
current values accompanied by the use of general index adjustment.
In conclusion, a comparison of the principal findings and recommendations of the Corporate
Report, the Australian SACs and the Trueblood Report cannot be made without considering
underlying differences in cultural, economic and political environments in the United Kingdom,
Australia and the United States. In general, the Corporate Report expresses a more pronounced
concern for statements that can be used to improve the social and economic welfare of society.


The Stamp Report

The Canadian Institute of Chartered Accountants (CICA) published a research study in June 1980
entitled 'Corporate Reporting: Its Future Evolution', written by Professor Edward Stamp and
hereafter referred to as the Stamp Report. 76 The main motivations behind this effort were that, first,
the FASB conceptual framework was not suitable for Canada, given the environmental, historical,
political and legal differences between the United States and

Canada and, second, the framework would provide a Canadian solution to the problem of improving the quality of
corporate financial accounting standards.
The approach advocated in the Stamp Report is evolutionary. It identifies problems and conceptual issues and
provides solutions in terms of the identification of the objectives of corporate financial reporting, the users of
corporate reports, the nature of the users' needs and the criteria for the assessment of the quality of standards and of
corporate accountability as the possible components of a Canadian conceptual framework. Each of these components
will be examined later.

The Stamp Report begins with an examination of some of the problems accounting standard-setters face:
t How is economic reality to be measured in an unambiguous manner)
t What is the nature of accounting, since the question of how best to develop accounting standards rests on it
t Are there permanent and universal concepts on which financial reporting and accounting standards rest
t Who are the users, what kind of decisions are they apt to make as the result of reading an annual report, and what
kind of information will they be looking for in the report on which to base these decisions?
t What criteria do standard-setters, preparers and users need to judge the quality of account ing standards, to choose
between the possible alternative standards on any given subject, and to assess the utility of published accounting
t How can the costs and benefits be estimated when deciding what action to take in the area of standard setting!
t Can standards resolve the conflicts of interests between preparers and users and between different users by
achieving neutrality!
t How useful is a published accounting report in the light of the 'efficient marker' evidence! Is the report predictive Is
it too concise! Does it include too much information
t Should there be extensions to disclosure! Should these extensions include disclosure?
t Given that the process of accounting srandardisation is to narrow the areas of difference, is the resulting increase in
uniformity possible? How can stifling the process of legitimate innovation in accounting measurement be avoided
and the trend toward the 'book of rules' be accelerated?
t Should information be made available regarding the size of the margins of error in preparing accounts, or should
the illusion of precision be presented?
t Are general-purpose reports enough? If not, should additional information be published in the form of
supplementary statements or by adding further columns to the present financial reports)
t How should standards be enforced) (It is noted, however, that since 1975 the Canada Business Corporation Ace has
specified that the operational definition of generally accepted accounting principles is the set of accounting
pronouncements in the Canadian Institute of Chartered Accountants Handbook.)

Conceptual issues in standard setting

In addition co the problems just outlined, Scamp identified some complex conceptual issues that accountants
must face in formulating their standards:
t Allocation problems: accountants must make periodic measurements of the financial position and performance



of an emerprise and, in the process, develop systematic and rational methods of allocation. Unfortunately,
these allocations are generally arbitrary and incorrigible.
Income problems: should income be regarded and defined as the result of matching cases against revenues, or
as the change in the net assets of the entity during a period'
Reporting focus: should the proprietary concept (which looks at the financial affairs of an enterprise through
the eyes of its owners) or the entity concept (which looks at the financial affairs of the enterprise from
within, as it were) be used?
Capital-maintenance concepts: which capital-maintenance concept is most suitable'
Asset-valuation base: which asset-valuation base is co be used - historical cost, replacement cost, net realisable
value, or value co the firm'
Economic reality: what is economic reality? Can the balance sheet measure the current worth of an enterprise?
As an example, the goodwill problem is presented as insolvable. As Stamp states:
The problem of how to account for goodwill, especially internally generated goodwill, is probably the most
perplexing problem in accounting, and one that is almost certainly irresolvable. Human talent, technical and other
know-how, and many other largely unquantifiable assets are involved, making the measurement task virtually
insoluble ... many of the perplexing problems of accounting are indeed irresolvable in the sense that a unique
solution is neither possible nor necessary?77

The objectives of corporate financial reporting

Now that we have outlined the problems and conceptual issues of - and the need for accounting standards,

we will examine the objectives of financial reporting. These objectives are assumed
legitimate users of published corporate financial reports.
The first major objective concerns accountability:


apply co all

One of the primary objectives of published corporate financial reports is to provide an accounting by management
exercise of its stewardship function but also of its success (or otherwise) in achieving the goal of producing a
satisfactory economic performance by the enterprise and maintaining it in a strong and healthy financial position. 78

In short, an important objective of financial reporting is the provision of useful information to all of the potential
users of such information in a form and in a time frame that is relevant to their various needs.79

The second major objective concerns uncertainty and risk. Although it is impossible to eliminate
uncertainty and risk:
... it is an objective of good financial reporting to provide such information in such a form as to minimize uncertainty
about the validity of the information, and to enable the user to make his or her own assessment of the risks associated
with the enterprise80

It is therefore necessary that the standards governing financial reporting should have ample scope for innovation and
evolution as improvements become feasible81

The fourth major objective concerns complexity and the unsophisticated user. The objectives of financial
... should be taken to be directed towards the needs of users who are capable of comprehending a complete (and
necessarily sophisticated) set of financial statements or, alternatively, to the needs of experts who will be called on by
unsophisticated users to advise thema2

Users of corporate reports

Users demand accountability, but a major issue must be resolved to strike the right bal ance between
accountability and the right to privacy. Because accountability is a broader concept in Canada than it is in the
United States and Australia, the range of users is broader in Canada than the range of users considered by the
AABSs and FASBs conceptual-framework projects. The range of Canadian users includes the following
fifteen categories:
1 shareholders (present and potential);
2 long-term creditors (present and potential);
3 short-term creditors (present and potential);
4 analysts and advisers serving the above (present);
5 employees (past, present and potential);
6 non-executive directors (present and potential);
7 customers (past, present and potential);
8 suppliers (present and potential);
9 industry groups (present);
10 labor unions (present);
11 governmental departments and ministers (present);
12 the public (present);
13 regulatory agencies (present);
14 other companies, both domestic and foreign (present); and
15 standard-setters and academic researchers (present).83

After the types of users are determined, the next step is to determine their informational needs. This task is
complicated by the difficulties of determining the users' decision models. The Stamp Report emphasised that
'one of the most difficult problems in developing accounting standards arises from our ignorance about the
nature of users' decision-making processes' and 'about the rational (and often irrational) mental processes that
users go through in reaching their decisions' .84 In any case, the following thirteen categories of user needs are
1 assessing performance;
2 assessing management quality;
3 estimating future prospects;
4 assessing financial strength and stability;
5 assessing solvency;
6 assessing liquidity;
7 assessing risk and uncertainty;
8 aiding resource allocation;
9 making comparisons;

10 making valuation decisions;

11 assessing adaptability;

12 determining compliance with the law or regulations; and

13 assessing contributions to society.

Criteria for assessment of the quality of standards and of corporate

The next step is to define the criteria for assessment that are 'the yardsticks whereby stan dard-setters, as well as
preparers and users of published financial statements, can decide whether...published financial statements are indeed
meeting the needs of users and the objectives of financial reporting,S5 These criteria are to be used to decide which
information can and ought to be excluded from financial statements. They included objectivity, compara bility, full
disclosure, freedom from bias, uniformity, materiality and cost-benefit effectiveness, flexibility, consistency and

Toward a Canadian conceptual framework

A conceptual framework project for Canada (and elsewhere), based on an evolutionary approach and resting on the
concepts (objectives and criteria for assessment), is offered at the end of the Stamp Report. Unlike the AASB's and
the FASB's conceptual framework, which it deemed too normative (if not axiomatic) and, in the case of the FASB,
too narrow in its scope (its primary concern is with the investors), the Canadian conceptual framework is based on an
evolutionary (rather than revolutionary) approach and would be less narrow in its scope (its primary concern is with
the reasonable needs of the legitimate users of published financial reports). Furthermore, a public justification and
explanation of the standards is suggested, to win general acceptance of the Canadian conceptual framework.
It is now up to the Canadian Institute of Chartered Accountants to evaluate the rec ommendations of the Stamp
Report and to develop a truly Canadian conceptual framework. The report is successful in listing the major
conceptual problems encountered in developing any framework and also provides a basis or background so that more
research can be conducted.
Reactions to the Stamp Report have been mixed. It has been rightfully perceived as an opinion document:
In the final analysis, Corporate Reporting is an opinion document. It is not, nor do I believe it attempts to be, a
classic inquiry-type research study. Rather, it is based on the informed opinion of a group of experienced and
capable accounrants86
The report has also been characterised as confusing, before it finally opts for a socioeconomic-political world
We might conclude that the Stamp Report, though arriving at many blind alleys, going through several iterations
and making several detours, does arrive at a position on a world view that might prove to be very fruitful in the
development of public accounting theory and standards - the socioeconomic-political world view. 87
Finally, practitioners found the report's recommendations either far from practical,88 or too costly to implement.

Discussion and conclusions

Logically, the formulation of an accounting theory entails a sequential process that begins with the development of the
objectives of financial statements and ends with the derivation of a conceptual framework or constitution to be used as a
guide to accounting techniques. Such a process was initiated and is manifested by:
the SACs and the conceptual framework project of the AARF and its Boards

APB Statement No.4

the Trueblood Report and the FASB's conceptual-framework project
the Corporate Report
the Stamp Report.

The major benefit of the Australian and other conceptual frameworks is that it will facilitate the resolution of
conceptual disputes in the standard-setting process. As we have seen in the case of SAC 4, to be effective this
framework or constitution must gain general acceptance, represent collective behavior and protect the public interest in
areas in which it is affected by financial reporting. Can this be achieved? The capacity of the conceptual framework to
achieve general acceptance is probably the most critical factor facing its future. Many problems confronting gen eral
acceptance of a conceptual framework relate to the social-choice aspect of accounting standard setting and the realities
of political processes.
One prevailing idea is that it is impossible to develop a set of accounting standards that can be applied to accounting
alternatives in a way that will satisfy everybody.9o In fact, many authors have expressed pessimism about the Iikelihood
of a conceptual framework ever achieving general acceptance. The problem of achieving consensus was crystallised by
the setting of accounting standards is as much a product of political action as of flawless logic or empirical
findings. Why? Because the setting of standards is a social decision. Standards place restriction on behav ior,
therefore they must be accepted by the affected parties. Acceptance may be forced or voluntary or some of both. In
a democratic society, getting acceptance is an exceedingly complicated process that requires skil ful marketing in a
political arena. 91
Accounting standards are set in a political environment of conflicting economic interests.
Political processes (such as lobbying) by interest groups, and the need by regulators to consider the diverse interests of
many affected parties, often result in the development of ad hoc and some times inconsistent standards. This process can
hamper general acceptance of a theoretical framework which can guide standard setting. For instance, Watts and
Zimmerman have been doubtful of whether a conceptual framework project can succeed in a political environment. They
We view accounting theory as an economic good and examine the nature of the demand for and the sup ply of that
good ... Understanding why accounting theories are as they are requires a theory of the political process. We model
that process as competition among individuals for the use of the coercive power of government to achieve wealth
transfers. Because accounting procedures are one means of effecting such transfers, individuals competing in the
political process demand theories which prescribe the accounting procedures conducive to their desired wealth
transfers. Further, because individual interests differ, a variety of accounting prescriptions, hence a variety of
accounting theories is demanded on anyone issue. We argue that it is this diversity of interests which prevents
general agreement on accounting theory,.92 tt

Another aspect of the social-choice problem was developed by Demski97 Demski provided mathematical evidence that
indicates the general impossibility of developing normative accounting standards, and consequently a prescriptive
conceptual framework. He argued that no set of extant accounting standards can identify the most preferred accounting
alternative without reference to diverse individual utilities or preferences. However, in the evaluation of individual
preferences the impasse of' Arrow's paradox' is confronted. That is, the sum of all individual pref erences cannot lead to a
collective social welfare. In other words, it is mathematically impossible to sum or add together a number of individual
preferences or utilities to form a collective decision that can satisfy all parties.
In response to these more pessimistic views Cushing suggests that those who reject the possibility of finding an
unobjectionable social-welfare function (that is, social goals that everyone is bound to accept) may be overstating the
problem.98 In practice, argues Cushing, society is able to reach decisions about the provision of , collective' goods (which
include financial statements) by a partial, piecemeal approach. Cushing recommends this approach for tackling accounting
problems. Bromwich, however, feels that the conditions for successful use of the partial approach are fairly restrictive. 99 His
analysis indicates that:
Cushing's approach of seeking the best out of a set of mutually exclusive standards for a given accounting problem,
while holding all other standards constant, will be successful only where interdependence of the utility, attached to the
outcomes addressed by that standard, from all the outcomes affected by other standards can be assumed. 100
In addition to social-choice problems and political realities, the acceptance or workability of a conceptual framework
may also be hampered by the level of abstractness in definition and recognition criteria for elements of financial statements
and in other framework recommendations and conclusions, as we have seen in the case of SAC 4. The ultimate test of the
conceptual framework is its implementation and survival. In substance, the framework should exist in more than form. A
view that the conceptual framework may be forgotten presents the following argument:
Our initial guess is that the objectives selected by the board will be ignored in future rule-making activities, just as
were those from previous authoritative attempts. Following the publication of these objectives, the Board will
probably feel obligated to pay lip service to them in future pronouncements, but these pronouncements will not be
affected in any substantive way by what is contained in the present documents.
In order for the conceptual framework to guide the AASB in resolving controversial account ing issues, it must have the
technical substance and clarity to achieve this. Dopuch and Sunder make a strong argument that the FASB framework is
unlikely to help resolve major accounting issues or to set standards. ,o2 They illustrate their point by analysing three muchdebated accounting techniques, which are equally applicable to the AASB framework:
The FASB's definition of liabilities is so general that at this stage we cannot predict the Board's position on deferred
taxes. However, those who favor the recognition of deferred taxes can adopt a somewhat broad interpretation of the
FASB's definition of liabilities to justify the inclusion of deferred taxes as an element of financial statements,
particularly at the individual asset level. In contrast, those who do could take the FASB's statements literally and just
as easily argue against the inclusion of deferred taxes.'03
The conceptual framework is also shown to support either a full-cost or a successful-efforts method for the extractive
industries. The only explicit statement bearing on this problem is that 'information about enterprise earnings and its
components measured by accrual accounting

generally provides a better indication of enterprise performance than information about current cash receipts and
payments'. However, both full-cost and successful-efforts accounting are forms of accrual accounting, so that
proponents of the former (for example, the Federal Trade Commission of the United States) have the same support for
their position as do the proponents of the latter (for example, the FASB).104
Finally, with regard to the asset-valuation debate, Dopuch and Sunder conclude that:
no conceptual framework, however logically conceived, can counter practical issues regarding the reliability of
estimates of, say, replacement costs. So the issue is not whether costs are useful in making economic decisions;
rather, the issue is what criteria may be used to determine alternative estimates of unknown
In addition to the above examples, some specific concerns with the Australian framework relate to its inability to
provide clear-cut technical and conceptual guidance to resolve issues relating to the financial reporting of financial
instruments, debt and equity classifications, accounting for revaluations and revaluation reserves, and the treatment for
contracts equally and proportionately unperformed.
Three other issues concern the conceptual framework. First, the conceptual framework has often been referred to as a
kind of constitution. Yet there may be great differences that make the analogy an imperfect one, and at the same time a
strong case for the conceptual framework. Solomons, for example, cites the following three differences:
1 A constitution has the force of law. A conceptual framework has no authority except that which flows from its

intellectual pervasiveness.
2 Constitutions contain many arbitrary elements - for example, the number of senators each State is to have, the length of
the interval between elections and so forth. There is no room for arbitrariness in a conceptual framework.
3 There are significant differences among the nations of the world in their constitutional arrangements. There could be
important national differences among conceptual frameworks - this is mere speculation because no country other than
the United States has yet made any attempt 106
Second, Miller points to eight myths about the FASB conceptual framework. Many of these myths are equally
applicable to the AASB framework:
t The Accounting Principles Board failed because it did not have a conceptual framework.
t The FASB (or AASB) cannot succeed unless it has a conceptual framework.
t A conceptual framework will lead to consistent standards.
t A conceptual framework will eliminate the problem of standard overload.
t The FASB's (or AASB's) conceptual framework captures only the status quo of accounting practice.
t The conceptual framework project has cost more than it should have.
t The FASB (or AASB) will revise the existing standards to make them consistent with the conceptual framework.
t The FASB has abandoned the conceptual framework project. 10?

The reality is that the framework is a political document that is not the ultimate authority for resolving issues; it is
neither a complete description of existing practice nor a blueprint for the future. It is a point of departure for future
Third, the conceptual framework is not going to provide all the answers, but at least it will provide a direction for
setting standards and reduce the influence of personal biases and political pressures in making accounting j

Various scenarios await the conceptual framework project. Sterling offers the following view of the future:
The most pessimistic one is that the Board meets so much resistance that it fails to complete the task and reverts to 'ad
hocery'. The most optimistic scenario, indeed widely optimistic, is that I can convince everyone that it is possible for
accounting to become a scientific discipline and thereby rely more on the method of science - empirical and logical
testing - and less on the method of authority. The most likely scenario is that the Board will complete this task, albeit
faced with increasing resistance, and will therefore be forced to slow it down or water it down or both. Thus, the most
likely scenario is that the Board will continue to make progress, continue to improve accounting, but that this will
occur by inching along and not by quantum leap.110
It is very hard not to agree with the most likely scenario as described, as the AASB and PSASB continue to improve
gradually through a 'muddling through' process created by the political quagmire that characterises the accounting
environment and its interests groups. The Boards of the AARF and elsewhere, however, ought to consider the useful
suggestions offered in the literature. The best suggestions for improvement, offered by Agrawal, are as follows:
The need to make an explicit distinction between what the FASB (or AASB) considers to be the basic concepts and
policy issues. Only the basic concepts should be the subject matter of the conceptual framework. Policy issues are
those that depend upon the particular circumstance of each case and may need to be changed with changes in
circumstances over time. These issues should be addressed by FASB's standard-setting function. The primary
accounting model will be the connecting link between the two categories. This, in turn, would involve specification
(a) the attribute to be measured;
(b) the capital maintenance concept;
(c) timing of recognition (particularly of revenues/gains and expenses/losses);
(d) relative importance to be placed on the Income Statement and Balance Sheet; and (e) the
unit of measurement.
FASB should indicate the primary model it implies in its standards currently, with a proviso that exceptions may be
made for dominant, but specific, reasons. The justification must be based upon the objectives of financial reporting,
qualitative characteristics of information, definitions of elements and the recognition criteria. FASB should also state
that it might experiment with other models under appropriate circumstances and that a different model might be
adopted as the primary model when considered appropriate.
The need to specify a temporal hierarchy of objectives and needs. The first tier should consist of those the fulfilment
of which is sought currently (or in the near future). Subsequent tiers should be aimed for achieve ment in a more
distant future when:
(a) there is a better understanding of information needed, and (b)
means are available to provide such information.
The ideas of ' freedom from error' and 'precision' that have been used rather ambiguously should be integrated
properly in the qualitative characteristics. This will require consideration of several related concepts that have been
considered only briefly in the network, including:
(a) accuracy;
(b) truth or truthfulness; and (c)
evenhandedness or fairness.
The need to provide criteria for the disclosure of items that are not formally 'recognized'. These criteria may be the
same as for formal recognition but might also provide for:
(a) disclosure of attribute(s) in addition to those under the primary accounting model; and (b)
explanation or further details of items that are formally recognized.'"

5.1 Why is it important to know the objectives of accounting in order to construct an accounting theory?
5.2 List the various attempts to develop the objectives of accounting in Australia, the United
States, Canada and the United Kingdom.
5.3 List and discuss the functions and goals of a conceptual framework.
5.4 What economic entities are identified in The Corporate Report?
5.5 List and explain the different financial statements advocated by The Corporate Report.
5.6 What is meant by an 'accounting constitution'?
5.7 In 'Opportunities and Implications of the Report on Objectives of Financial Statements' (in Studies
on Financial Accounting Objectives, supplement to Vol. 12,Journal of Accounting Research, 1974,
pp. 1-2), G.H. Sorter and M.S. Gans made the following statement concerning the importance of
the Trueblood Report and the objectives suggested:
The Report's mere existence and acknowledgement can have profound implications for the
development of accounting standards and the resolution of accounting problems. No longer
should it be possible to legislate accounting standards by fiat; no longer should it be possible
to thunder 'Thou shalt' without continuing with 'because'. If the existence of explicit
objectives is acknowledged, then each proposed accounting standard should be evaluated in
terms of how the standard relates to and furthers the objectives. Disagreement relating to
alternative standards should be analyzed and resolved in terms of what standard relates to and
furthers the objectives. In other words, for something to be a part of the recognized body of
generally accepted accounting principles, it should be demonstrated to be right because it is
the best available means for executing the objectives.
In your opinion, how valid is this implication?
5.8 Define, in your own words, a prescriptive and descriptive conceptual framework. On what premises is a
prescriptive framework founded? Which is more preferable for the Australian reporting
5.9 Why is it important to define the scope of financial reporting? How would you define the scope of
financial reporting?
5.10 Who are the major beneficiaries of a conceptual framework project? Why? Explain your answer.
5.11 What are the limitations of the Australian conceptual framework? Which limitations do you consider
more serious for the implementation of the framework? Will these limitations doom the framework
to failure?
5.12 What assumptions and implications are present in the definitions of the elements of financial statements
adopted in SAC 4? Do they differ from generally accepted accounting principles?
5.13 Is the conceptual framework consistent with Australian accounting standards? Provide illustrations of
specific standards to support your argument.
5.14 On what criteria, theoretical or otherwise, would you justify the inclusion of management forecasts (e.g.
cash flow, profitability, EPS) in the scope of financial reporting?
5.15 Why do you think the business world was so opposed to SAC 4?
5.16 What is meant by earning power?

5.17 Explain the differences between the two distinct views of measuring income: the asset/liability
view, and the revenue/expense view.
5.18 Should the asset/liability view or the revenue/expense view be adopted as the basis for a
conceptual framework for financial accounting and reporting? Discuss your answer.
5.19 Explain the differences between the definitions of assets, liabilities, revenues, expenses, gains
and losses according to the asset/liability view and the revenue/expense view. Which
alternative definition should make up the substance of a definition of assets, liabilities, rev enues, expenses, gains and losses for a conceptual framework for financial accounting and
5.20 Evaluate the three different formulations of the relationship between income and its
5.21 List the different concepts of capital maintenance. How do they differ?
5.22 Discuss the nature and purpose of the qualitative criteria for selecting and evaluating
financial accounting and reporting policies.

5.23 In 'Recommendations and Accounting Theory' (in Studies in Accounting Theory, eds

Baxter and Sidney Davidson, London, Sweet and Maxwell, 1962 p. 427), Baxter makes the following
Recommendations by authority on matters of accounting theory may in the short run seem
unmixed blessings. In the end, however, they will probably do harm. They are likely to yield little
fresh knowledge ... They are likely to weaken the education of accountants: the conversion of the
subject into cut-and-dried rules, approved by authority and not to be lightly questioned, threatens
to reduce its value as a subject of liberal education almost to nil. They are likely to narrow the
scope of individual thought and judgment: and a group of men who resign their hard problems to
others must eventually give up all claim to be a learned profession.
Does this statement apply to the MSB's effort to develop a conceptual framework? Explain your answer.
5.24 Standard-setting When the Accounting Principles Board was founded in 1959, it planned to
establish financial accounting standards using empirical research and logical reasoning only;
the role of political action was little recognised at this time. Today, there is wide accept ance of the view
that political action is as much an ingredient of the standard-setting process as is research evidence.
Considerable political and social influence is wielded by user groups, those parties who are most
interested in or affected by accounting standards.
Two basic premises of the AASB are that:
1 it should be responsive to the needs and viewpoints of the entire economic community; and
2 it should operate in the public arena, affording interested parties ample opportunity to make their views
known. The extensive procedural steps employed by the AASB in the standard-setting process
support these premises.
Describe why financial accounting standards inspire or encourage political action and social
involvement during the standard-setting process. (CMA adapted)
5.25 Objectives, users and stewardship The owners of CSC Inc., a privately held company, are
considering a public offering of the company's ordinary shares as a means of acquiring
additional funding. Preparatory to making a decision about a public offering, the owners had
a lengthy conversation with John Duncan, CSC's Chief Financial Officer. Duncan informed
the owners of the reporting requirements of the Australian Securities Commission,

including the necessity for audited financial statements. At the request of the owners, Duncan also discussed
the objects of financial reporting, the sophistication of users of financial information, and the stewardship
responsibilities of management, all of which are addressed in SAC 1, Objectives of General Purpose Financial

1 Discuss the primary objectives of financial reporting.
2 Describe the level of sophistication that can be expected of the users of financial information.
3 Explain the stewardship responsibilities of management.