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The Conceptual Framework

The Financial Reporting environment

1. What is Conceptual Framework
The Conceptual Framework
AASB is responsible for the development of a conceptual framework of
accounting, with the framework seeking to define the nature,
subject, purpose and board content of general-purpose
financial reporting.
Not alone Australia, other countries and IASB have also been involved
in the development of a conceptual framework.
No absolute definition. But FASB of USA has defined Conceptual
Conceptual Framework is a coherent system of interrelated objectives
and fundamentals that is expected to lead to consistent standards.
A central goal in establishing a conceptual framework will be general
consensus such as:

The scope and objectives of financial reporting;

The qualitative characteristics that financial information

should possess (Relevance etc);

The elements of financial reporting, including agreement on the

characteristics and recognition criteria for assets and liabilities;

2. Why Conceptual Framework is required ?

It is generally accepted that it is UNWISE, and perhaps ILLOGICAL,
to develop accounting standards unless there is firstly some
agreement about key issues, such as

What are the objectives of general purpose financial reporting,

What qualitative characteristics financial information should


How and when transactions should be recognized;

Who is the audience of general-purpose financial reports

Therefore: Conceptual Framework is developed to provide guidance

on key issues

The Conceptual Framework

such as objectives, qualitative characteristics, definitions, and
recognition criteria.
However, the accounting standard setters do not hold the same point
that we need a conceptual framework before we start developing
accounting standards. Within Australia, Policy statement No.5 defines
the Conceptual Framework as a series of statement of accounting
concepts finally in 1990.
The paragraph 3 of Policy statement 5 set out the concepts already
adopted by the AASB relating to the nature, subject, purpose and
broad content of general-purpose conceptual framework, the contents
of the various accounting standard should be logically consistent.
3. Benefits of a Conceptual Framework
Policy Statement 5 Para #7 explicitly highlights the benefits having a
conceptual framework:

Accounting standard are developed in the context of an orderly

set of concept could make it more consistent and logical;


Increased international compatibility of accounting standards

should occur, because they are based on a conceptual framework
that is similar to the explicit conceptual frameworks used by other
overseas and IASB standard setters.


AASB should be more accountable for its decision; because the

thinking behind specific requirements should be more explicit


The process of communication between the Boards and their

constituents should be enhanced;


Development of accounting should be more economical.

The conceptual Framework itself will ultimately comprise a set of

statements of accounting concepts (SAC).
Para #6 further notes:
Knowledge of the concepts the Boards use in developing accounting
standards should assist prepares, auditors and other parties with an
interest in accounting standards to UNDERSTAND better the general
nature and purpose of information reported in General-purpose
Financial Reports.

The Conceptual Framework

4. Statement of Accounting Concept

A. SAC 1 Definition of the Reporting Entity
According to SAC1, general-purpose financial report (GPFRs) should be
prepared by all entities. General-purpose financial reports are
reports that comply with statements of accounting concepts and
accounting standards.
Definition: Reporting entity is determined by the information needs
of the users, and relies on professional judgement.
When information relevant to decision making is not accessible to
users who are judged to be dependent upon general-purpose
financial reports to make and evaluate resource reallocation decision,
the entity is deemed to be a Reporting Entity.
AASB 125 Para# 27 fpr the definition of a reporting entity means
An entity in respect of which it is reasonable to expect the existence
of users dependent on general purpose financial reports for
information which will be useful to them for making and evaluating
decision about the allocation of scarce resources, and includes but is
not limited to the following:

A listed company;


A borrowing corporation and


A subsidiary of a foreign company that is itself isted on an

Australian stock exchange

Parag. 6 of SAC1 further states that general-purpose financial reports

intended to meet the information needs common to users who
are unable to command the preparation of reports tailored so as to
satisfy, specifically, all of their information needs.
It also states that GRRPs should be prepared when there are users
whose information needs have common elements, and those
users cannot command the preparation of the information to

The Conceptual Framework

satisfy their individual information needs.
Point to note: If an entity is not deemed to be a reporting entity, it will
not be required to produce GPERs- it will not necessarily be required
to comply with all accounting standards.
B. SAC2 Objective of General-purpose Financial Reporting

It states that an objective of general-purpose financial reporting

is to provide relevant (para.11) information to assist report
users to make and evaluate decision about the allocation of
scarce resources (para 26) and to enable management and
governing bodies to discharge their accountability (para. 14).
Financial reports and ser of the financial information
Financial report provides a means for the controllers of the
resources of the company (management and the Board of
directors) to report about their role as stewards of those
resources. This part of the reporting process is known as
User requires information to help them assess:
a. Whether the reporting entity is achieving its objectives and is
operating economically
and efficiently in the process;
b. The ability (i.e. entity) to continue to provide goods and
services in the future;
c. Whether resources have been used for the purposes
General-purpose financial report (GPFR)
The reports intended to meet the information needs common
to users who are unable to command
the preparation of reports tailored so as to satisfy, specifically,
all of their information needs.
GPFR is not an end in itself, but is a means of communicating
relevant and reliable information about
a reporting entity to users.
The objective specified in this Statement derives from the
information needs of those identified

The Conceptual Framework

as the user of GPFR. Those needs depend, in turn, on the
activities of reporting entities and
the decisions users make about them.
The focus on providing information about an entitys economic
or financial performance, rather than about its social
performance is vital as it is Relevant in resource allocation and
B. SAC2 Objective of General-purpose Financial Reporting

Relevant and reliable

It states that an objective of GPFR is to provide relevant and
reliable information (Para # 11)
to assist report users to make and evaluate decisions about the
allocation of scarce resources (Para #26)
and to enable management and governing bodies to discharge
their accountability (Para #14).
Disclosure and Compliance
Statement of Accounting Concept SAC 2 requires that GPRF
disclose information relevant to
the assessment of performance, financial position and financing
and investing, including information
about compliance.
Additioan Readings:
User related Studies (M1/4 The usefulness of financial
a. a.
Who the users are and their diverse needs;
b. b.
How financial report are used; and
c. c.
What information users want from financial reports
1. The users and their diverse needs
Revsine (1970) explained the decision models of users variation
Demski (1973) contended no one theory and theorized that
there is a trade-off of some benefits
to certain users against potential benefits to other users.
Cushing (1977) disagreed with Demski and he came into three
conclusions different from Demski.
2. Is the financial report useful?
Understandability and readability of financial report are the
major concern in accessing the
usefulness of financial report to the user.
Research studies found out that understandability, (i.e. the
level of user knowledge of accounting)

The Conceptual Framework

is considered by many as the ultimate quality for financial
Research of usage of published financial report conducted by
Goldberg and Clift (1968) and
Lee and Tweedie (1974) support the point of FASB in the USA in
Decision Makers and
their characteristic as the survey found that the directors
report was the most commonly
read section of the annual report.
4. Statement of Accounting Concept
C. The AASB Framework ((formerly known as SAC 3
Qualitative Characteristic of Financial Information))
The AASB Framework seeks to identify the characteristics of financial
information necessary if it is to allow users to make and evaluate
decisions about the allocation of scarce resources the objective
identified in SAC 2.
Within Australia this issue was formerly covered by SAC3. The four
principal characteristics of financial reporting are identified in the
AASB Framework as : Understandability, relevant, reliability and
The primary qualitative characteristics of financial reporting are
identified as Relevance and Reliability.
Information is considered to be reliable if it is faithfully represents
the entitys transactions and events (Para #16). For information to be
reliable, it should be free from bias (Para #21) and from undue error
Information is considered to be relevant if it influences decision
relating to the allocation of scarce resources.
AASB Framework also states that general-purpose financial reports
shall include all financial information which satisfies the concepts of
relevant and reliability to the extent that such information is material.
Material is further defined in the AASB Framework (Para #30)
AASB Framework notes that the inclusion of immaterial information in
financial reports may well impair the understandability of those
The framework also states that information should be comparable,
be understandable and be produced in a timely manner.
Considerations of cost versus benefits are also required in determining
whether particular information should be disclosed.
When considering the Qualitative characteristics of financial

The Conceptual Framework

information, and particularly the issue of understandability, some
assumptions must be made about the knowledge-base of readers is
stipulated in paragraph 25 of AASB and it provides that:
users are assumed to have a reasonable knowledge of business and
economic activites and accounting and a willingness to study the
information with reasonable diligence.