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Chapter one

A conceptual framework can be defined as an attempt to codify existing generally accepted
accounting practice (GAAP) in order to reappraise current accounting standards and to produce
new standards.
Framework has been developed as a constitution, a coherent system of interrelated objectives
and fundamentals which can lead to consistent standards and which prescribe the nature,
function and limits of financial accounting and financial statements.

The international Accounting Standards Board (IASB) is working on a joint project with FASB to revisit
its conceptual framework for financial accounting and reporting. The goals of the project are to build on
the existing frameworks and converge them into a common framework. The first phase has now been
published as the Conceptual Framework for Financial Reporting.
(a) Discuss why there is a need to develop an agreed international conceptual frame work and the
extent to which an agreed international conceptual framework can be used to resolve practical
accounting issues.
(13 marks)
(b) Discuss the key issues which will need to be addressed in determining the basic components of an
internationally agreed conceptual framework.
(10 marks)
Appropriateness and quality of discussion

( 2 marks)
(Total = 25 marks)

(a) The need for a conceptual framework
The financial reporting process is concerned with providing information that is useful in the
business and economic decision making. Therefore a conceptual framework will form the
theoretical basis for determining which events should be accounted for, how they should be
measured and how they should be communicated to the user.
Although it is theoretical in nature, a conceptual framework for financial reporting has highly
practical aims.
The danger of not having a conceptual framework is demonstrated in the way some
countries standards have developed over recent years; standards tend to be produced in a
haphazard and fire fighting approach. Where an agreed framework exists, the standard
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setting body acts as an architect or designer, rather than a fire fighter, building accounting rules
on the foundation of sound, agreed basic principles
The lack of a conceptual framework also means that fundamental principles are tackled more
than once in different standards, thereby producing contradictions and inconsistencies in basic
concepts, such as those of prudence and matching. This leads to ambiguity and it affects the
true and fair concept of financial reporting.
Another problem with the lack of a full conceptual framework has become apparent in the USA.
The large number of highly detailed standards produced by the Financial Accounting Standards
Board (FASB) has created a financial reporting environment governed by specific rules rather
than general principles. FASB has concept statements but a full conceptual framework would
be better.
A conceptual framework can also bolster standard setters against political pressure from various
lobby groups and interested groups and interested parties. Such pressure would only prevail if it
was acceptable under the conceptual framework.

Advantages and disadvantages of a conceptual framework

(a) The situation is avoided where standards are developed on a patchwork basis, where a
particular accounting problem is recognized as having emerged, and resources were
then channeled into standardizing accounting practice in that area, without regard to
whether that particular issue was necessarily the most important issue remaining at that
time without standardization.
(b) As stated above, the development of certain standards (particularly national standards)
have been subject to considerable political interference from interested parties. Where
there is a conflict of interest between user groups on which policies to choose, policies
deriving from framework will be less open to criticism that the standard-setter buckled to
external pressure.
(c) Some standards may concentrate on the SOCI whereas some may concentrate on the
valuation of net assets (SOFP).
Can it solve practical accounting issues?
A framework cannot provide all the answers for standard setters. It can provide basic
principles which can be used when deciding between alternatives, and can narrow the range of
alternatives that can be considered. In the UK, the Statement of Principles has provided
definitions that have formed the basis of definitions in accounting standards, as has the
IASBs conceptual framework in areas such financial instruments and provisions. A framework
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can also provide guidance in the absence of an accounting standard. For example, there is no
IFRS dealing specifically with off balance sheet finance, so the IASB Conceptual Framework
must form the basis for decisions.
However, a conceptual framework is unlikely, on past form, to provide all the answers to
practical accounting problems. There are a number of reasons for this:
(a) Financial statements are intended for a variety of users, and it is not certain that a
single conceptual framework can be devised which will suit all users.
(b) Given the diversity of user requirements, there may be a need for a variety of accounting
standards, each produced for a different purpose (and with different concepts as a
(c) It is not clear that a conceptual framework makes the task of preparing and then
implementing standards any easier than without a frame work.
The IASBs Conceptual Framework for Financial Reporting has been criticized by the UK
Accounting Standards Board at least partly on grounds of practical utility - it is thought to be too
theoretical, and also for focusing on some users (decision makers) at the expense of others
(shareholders). Perhaps it is not possible to satisfy all users.

Generally Accepted Accounting Practice (GAAP)

GAAP signifies all the rules, from whatever source, which govern accounting.
In individual countries this is seen primarily as a combination of:

National company law

National accounting standards

Local stock exchange requirements

GAAP does not have any statutory authority. It changes and evolves with changing
The IASBs Framework
The introduction to the Framework lays out the purpose, status and scope of the document. It
then looks at different users of financial statements and their information needs.
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Purpose of the Framework defined as assisting:

IASC in development of new standards

Review of existing standards

Harmonisation of standards and procedures

Reduction of penumbral areas of divergent possibilities

Development of new standards by national accounting bodies

Preparers of financial statements

Auditors in forming audit opinions.

Users in their interpretation of financial statements

Provide those who are interested in the work of IASB with information about its approach
to the formulation of IASs (now IFRSs).

(b) Key issues in determining the basic components of an internationally agreed

conceptual framework.
Framework contents

Objectives of financial statements

The Framework states that:

The objective of financial statements is to provide information about the financial
position, performance, and changes in the financial position of an entity that is useful to
a wide range of users in making economic decisions.

Basis of accounting-accrual

Underlying assumption(going concern)

Qualitative characteristics

The framework states that qualitative characteristics are the attributes that make the
information provided in the financial statements useful to users

Fundamental qualitative characteristics are relevancy and faithful representation

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Relevance: relevant information is capable of making a difference in the decisions made

by users. It should have both predictive and confirmatory value.
The relevance of information is affected by nature and materiality.

Faithful representation: data must be complete, neutral and free from error
Substance over form: this is not a separate qualitative characteristic under the conceptual
framework. The IASB says that to do so would be redundant because it is implied in
faithful representation. Faithful representation of a transaction is only possible if it is
accounted for according to its substance and economic reality

Enhancing qualitative characteristics include:

Comparability(including consistency)
Verifiability(meaning the different observers could agree that a particular depiction is a
faithful representation)

Timeliness(information provided in time to influence decisions)

Understandability(information must be classified, characterized and presented clearly and


Elements of financial statements (assets, liabilities, equity, expenses and incomes)

The financial position of an enterprise is primarily provided in the Statement of Financial

Position. The elements include:
o Asset: An asset is a resource controlled by the enterprise as a result of past events
from which future economic benefits are expected to flow to the enterprise.
o Liability: A liability is a present obligation of the enterprise arising from the past
events, the settlement of which is expected to result in an outflow from the
enterprise' resources,
o Equity: Equity is the residual interest in the assets of the enterprise after
deducting all the liabilities under the Historical Cost Accounting model. Equity is
also known as owner's equity. Under the units of constant purchasing power
model equity is the constant real value of shareholders equity.
The financial performance of an enterprise is primarily provided in the Statement of
Comprehensive Income (income statement or profit and loss account). The elements of an
income statement or the elements that measure the financial performance are as follows:
o Revenues: increases in economic benefit during an accounting period in the form
of inflows or enhancements of assets, or decrease of liabilities that result in
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increases in equity. However, it does not include the contributions made by the
equity participants, i.e., proprietor, partners and shareholders.
o Expenses: decreases in economic benefits during an accounting period in the
form of outflows, or depletions of assets or incurrences of liabilities that result in
decreases in equity.

Revenues and expenses are measured in nominal monetary units under the Historical
Cost Accounting model and in units of constant purchasing power (inflation-adjusted)
under the Units of Constant Purchasing Power model.

An item is recognized in the financial statements when:

it is probable future economic benefit will flow to or from an entity.

the resource can be reliably measured otherwise the stable measuring unit assumption is
applied under the Historical Cost Accounting model: i.e. it is assumed that the monetary
unit of account (the functional currency) is perfectly stable (zero inflation or deflation); it
is simply assumed that there is no inflation or deflation ever, and items are stated at their
original nominal Historical Cost from any prior date: 1 month, 1 year, 10 or 100 or 200 or
more years before; i.e. the stable measuring unit assumption is applied to items such as
issued share capital, retained earnings, capital reserves, all other items in shareholders
equity, all items in the Statement of Comprehensive Income (except salaries, wages,
rentals, etc., which are inflation-adjusted annually), etc.

Under the Capital Maintenance in Units of Constant Purchasing Power (CMUCPP) model, all
constant real value non-monetary items are measured in units of constant purchasing power in
terms of a daily index at all levels of inflation and deflation; i.e. all items in the Statement of
Comprehensive Income, all items in shareholders equity, Accounts Receivables, Accounts
Payables, all non-monetary payables, all non-monetary receivables, provisions, etc.


Concept of capital and capital maintenance

The Framework is not an IAS and so does not overrule any individual IAS. In the rare (cases) of
conflict between an IAS and the Framework, the IAS will prevail. These cases will diminish
over time as the frame work will be used as a guide in the production of future IASs. The frame
work itself will be revised occasionally depending on experience of the IASB in using it.
The need for regulatory framework
The regulatory framework is the most important element in ensuring relevant and reliable
financial reporting and thus meeting the needs of shareholders and other users.
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Without a single body overall responsible for producing financial reporting standards(the IASB)
and a framework of general principles within which they can be produced( the Framework),
there would be no means of enforcing compliance with GAAP. Also GAAP would be unable to
evolve in any structured way in response to changes in economic conditions.

The International Accounting Standards Board (IASB)

The IASB is an independent Board is an independent, privately-funded accounting standard
setter based in London.
In March 2001 the IASC Foundation was formed as a not-for-profit corporation incorporated in
the USA. The IASC Foundation is the parent entity of the IASB.
From April 2001 the IASB assumed accounting standard setting responsibilities from its
predecessor body, the IASC. This restructuring was based upon the recommendations made in
the Recommendations on Shaping IASC for the future.
How the IASB is made up
The 14 member of IASB come from 9 countries and have a variety of backgrounds with a mix of
auditors, preparers of financial statements, users of financial statements and an academic. The
board consists of 12 full-time members and two part-time members.
In accounting terms what do you think are
(a) The advantages to international harmonization?
(b) The barriers to international harmonization?
a) Advantages of global harmonization
The advantages of harmonization will be based on the benefits to users and preparers of
accounts as follows.

Investors, both individual and corporate, would like to be able to compare the
financial results of different companies internationally as well as nationally in
making investment decisions.

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Multinational companies would benefit from harmonisation for many reasons

(1) Better access would be gained to foreign investor funds.
(2) Management control would be improved, because harmonization would aid
internal communication of financial information.
(3) Appraisal of foreign entities for take-overs and mergers would be more
(4) It would be easier to comply with the reporting requirements of overseas
stock exchanges.
(5) Preparation of group accounts would be easier.
(6) A reduction in audit costs might be achieved.
(7) Transfer of accounting staff across national borders would be easier.

Governments of developing countries would save time and money if the could adopt
international standards and, if there were used internally, governments of developing
countries could attempt to control the activities of foreign multinational companies in their
own country. These companies could not hide foreign accounting practices which are
difficult to understand.

Tax authorities. It will be easier to calculate the tax liability of investors, including
multinationals who receive income from overseas sources.

Regional economic groups usually promote trade within a specific geographical region.
This would be aided by common accounting practices within the region.

Large international accounting firms would benefit as accounting and auditing would be
much easier if similar accounting practices existed through out the world.

Barriers to harmonization
Different purposes of financial reporting. In some countries the purpose is solely for tax
assessments, while in others it is for investor decision-making.
Different legal systems. These prevent the development of certain accounting practices
and restrict the options available.
Different user groups. Countries have different ideas about who the relevant user groups
are and their respective importance. In the USA investor and creditor groups are given
prominence, while in Europe employees enjoy a higher profile.

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Needs of developing countries. Developing countries are obviously behind in the
standard setting process and they need to develop the basic standards and principles
already in place in most developed countries
Nationalism is demonstrated in an unwillingness to accept another countrys standard.
Cultural differences result in objectives for accounting systems differing from country to
Unique circumstances. Some countries may be experiencing unusual circumstances
which affect all aspects of everyday life and impinge on the ability of companies to
produce proper reports, for example hyperinflation, civil war, currency restriction and so
The lack of strong accountancy bodies. Many countries do not have strong independent
accountancy or business bodies which would press for better standards an greater

Setting of International Financial Reporting Standards

Due Process
The overall agenda of the IASB will initially be set by discussion with the Standards Advisory
Council. The process for developing an individual standard would involve the following
Step 1

During the early stages of project, IASB may establish an Advisory Committee to
give advice on issues arising in the project. Consultation with the Advisory
committee and the Standards Advisory Council occurs throughout the project.

Step 2

IASB may develop and publish Discussion Documents for public comment.

Step 3

Following the receipt and review of comments, the IASB would develop and
publish and an exposure Draft for public comment.

Step 4

Following the receipt and review of comments, the IASB would issue a final

The period of exposure for public comment is normally 90days.However, in exceptional

circumstances; proposals may be issued with a comment period of 60days. Draft IFRIC
interpretations are exposed for a 60day comment period.

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