Topic 4

1. How do conceptual frameworks of accounting attempt to create a theory of accounting? Describe

the components of the IASB Framework and how they contribute to a theory of accounting.

Conceptual frameworks (such as those developed in the United States, Australia and at the IASC/IASB)
do not employ the term ‘theory’ because of the difficulty of demonstrating logical consistency and in
gathering empirical evidence to corroborate the theory. However, by following a structured program of
inter-related concepts, accounting regulators aim to use the conceptual framework to achieve
consistent accounting standards that will replace ad hoc solutions to specific problems. In this context,
the components of the conceptual framework can be viewed as the building blocks of a theory of
accounting.

The components of the IASB/Australian Framework are: objectives of financial statements; qualitative
characteristics of financial information (such as relevance, reliability, comparability, timeliness and
understandability); and definitions of the basic elements of accounting reports (such as assets, liabilities,
equity, revenue, expenses and profit) and principles and rules of recognition and measurement of the
basic elements, and the nature of the information to be displayed in financial reports.

7. Can accounting ever provide an unbiased map of economic reality? Why or why not?

Yes. Criticisms of neutrality or freedom from bias take two forms. First, some argue it is a state of mind
that is not attainable, because all of us are affected by personal values that have been shaped by our
particular beliefs, traditions, environment, background and personality. Granted that this is true, it is still
meaningful to speak of neutrality or freedom from bias. We recognise the existence of these influences
on our perceptions. The idea is to control them within an acceptable range.

Second, some contend that neutrality or freedom from bias is not operational, because we cannot be
expected to read other people’s minds. However, it is possible to translate neutrality or freedom from
bias into operational terms by establishing specific control devices that are external and subject to
examination.

Control devices are the means by which the notion of objectivity receives operational meaning. Control
devices have to do with making public or external what is essentially internal or introspective. Rules and
procedures under the heading of disclosure, consistency, comparability, and materiality as well as GAAP
are practical control devices.

In the accounting literature, practical control devices under the heading of objectivity have taken the
following three forms:

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 to make specific and precise the concepts and procedures of accounting, and to obtain general
agreement on them
 to determine a consensus of the measure among a number of experts
 to improve the standards of competence and ethics of the profession.

Accountants must construct unbiased or neutral financial maps of economic reality. Otherwise, as
Solomons warns, ‘If it ever became accepted that accounting might be used to achieve other than purely
measurement ends, faith in it would be destroyed’.

12. Give reasons for your answers to the following questions.

(a) How important is it that standard setters agree on objectives, concepts and
definitions before they develop a conceptual framework of accounting?
(b) How important is it that the conceptual framework is generally accepted by the business
community before it is applied to develop accounting standards?

Although it is important that prior agreement be reached on concepts and definitions in the conceptual
framework programs so that there is no confusion in understanding the subject matter, one must
remember that substantive knowledge comes from investigation of the subject matter, not from prior
agreement on definitions. We should take care that statements we make should never depend on the
meaning of our terms. Unfortunately, this is not the approach of the conceptual framework projects. For
example, when the standard setters define ‘assets’, ‘liabilities’ and so on, they intend that the valuation
decisions should depend on the definitions. Similarly, prior agreement on the objective of financial
reporting may be biased towards a particular valuation system.

(c) Why do the FASB and IASB require a common conceptual framework.

See discussion in the chapter. The FASB and IASB have embarked on a convergence project, to remove
differences between their respective standards and to align their work agendas. The standards produced
by both bodies should reflect the underlying principles contained in their conceptual frameworks. For
example, the financial statements elements (assets, liabilities, equity, income and expenses) are defined
in conceptual framework and these definitions are used in standards. If the IASB and FASB have
differences in their frameworks, they could flow through to differences in their standards. Thus,
agreement about fundamental matters such as definitions and recognition criteria can help the boards
to produce harmonised standards.

Deegan Textbook:

Chapter 6: Questions 6.19, 6.23, 6.26, 6.32

6.19 The basis of Hines’ argument is that conceptual frameworks promote certain qualities
that are considered as central to a ‘legitimate’ profession. Such qualities include
objectivity, neutrality, representational faithfulness and reliability. An absence of a

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 ‘formal body of knowledge’ can be detrimental to the integrity of a profession. If a group
of professionals that seek to self-regulate can demonstrate that they adopt standards
that are beyond reproach then this should act as a defence against outside
interventions.

The history of conceptual frameworks does appear to provide some support for Hines’
perspective. She advances the case of the Canadian Institute of Chartered Accountants’
work in 1980 and 1986 as cases to support the view that the work only commenced when
the body was under threat. The fact that standard-setters have also not provided
definitive guidance in relation to measurement issues could also provide support for
Hines’ position. If a standard-setter embraced one method in preference to another then
this would conceivably generate criticism from many members of the community which
might undermine the standard-setters’ position. According to Horngren (1981), it is more
important for survival that a standard-setting body resolves conflicts of opinion, rather
than creating them.

6.23 If newly developed accounting proposals represent a major departure from existing
practices then history indicates that the degree of opposition to the requirements could
be quite significant. There are a number of reasons for this. Firstly, accountants will be
familiar with existing generally accepted accounting principles and will potentially be
sceptical about whether the benefits associated with new approaches will outweigh the
costs associated with learning the new approaches. Secondly, it could be quite costly to
implement changes to existing recording systems to collect the new information
potentially required by the new accounting approaches. There might also be a view that
financial statement readers are familiar with existing rules, and that changing them
might lead to confusion for the users. Managers might also consider that the rules they
currently use provide the best reflection of the entity’s economic performance and that
to change them will lead to inefficiencies in the ability of external parties to assess the
performance of the entity.

It is also possible that new accounting rules could lead to significant economic
consequences for some sectors of the community. For example, if a new rule comes in
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that requires certain assets to be measured on a new basis then this might deflate the
assets of some entities and this could be deemed, in turn, to affect community
confidence in an organisation. Also, some companies might be put into technical default
on certain borrowing agreements as a result of the newly proposed rules. Hence,
potential economic consequences might impact support for newly developed
requirements. Accounting standard-setters are quite open in stating that they consider
the economic consequences of new rules before implementing them. This has obvious
implications for the neutrality and objectivity of the new rules.

The newly proposed rules might also eliminate some discretion that the firm previously had
in relation to choosing the methods of accounting it would apply in given circumstances.
This discretion might have been used to smooth accounting earnings in periods which
would otherwise show great volatility in earnings.

Lack of support for particular proposals has been shown in the past to lead to standard-
setters removing particular issues from their agenda. Standard-setting is a political
process, and the continuity of the standard-setter (and the employment of the people
working therein) can be very much dependent upon constituency support.

An interesting and recent case of a new accounting standard being developed that
represents a significant change to pre-existing practice is the case of the new accounting
standard being developed in relation to accounting for leases. It has been proposed by
the IASB and FASB that under a new accounting standard many more leased assets (and
therefore lease liabilities) will be recognised in the balance sheet. The perception was
that the pre-existing accounting standard for leasing failed to recognise many of the
liabilities associated with leases because of its reliance on the somewhat out-dated use
of the operating versus financial classification of leases.

The new proposals for accounting for leases will have major implications in terms of
increasing the apparent debt (and ratios such as debt to asset ratios and debt equity
rations – ratios that are frequently used in debt covenants negotiated between
organisations and their lenders) of reporting entities. Because of potentially adverse

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 effects on balance sheets (and also on the statement of comprehensive income, as the
new standard would also tend to increase costs in the early years of the lease) and the
related economic effects this might create, the development of the new accounting
standard has attracted much interest – much of which was in the form of heated
opposition. The result has been that the accounting standard has taken many years to
be completed and a number of exposure drafts have been released. Whilst a new
accounting standard was initially expected to be released in 2011 yet another exposure
draft was released for comment in mid-2013. Arguably, had the proposals for change
not been so ‘radical’, a new accounting standard might have already been released.

6.26 If we consider the objective of general purpose financial reporting then we can see that
there is clearly a bias towards considering users that have an economic interest in the
reporting entity. Other members of the community that do not have a direct economic
interest are effectively excluded from specific consideration.
General purpose financial reports do not provide useful information to people trying to
assess a reporting entity’s social and environmental performance. Such people need to
look elsewhere, such as in corporate sustainability reports, or corporate social
responsibility reports. The focus of general purpose financial reports is on the financial
performance of an organisation and not on its social and environmental performance.
Indeed, the way assets are defined (with reliance on considerations such as ‘control’)
means that many social and environmental impacts are ignored by general purpose
financial reporting.

6.32 Hines' arguments are informed from a ‘critical perspective’ of accounting. Rather than
necessarily seeing the role of conceptual frameworks as being part of a process to
improve the process of general purpose financial reporting, she sees conceptual
frameworks as a process to provide benefits to those parties that are responsible for
developing the frameworks. The view is that there are certain attributes that society
expects a profession to exhibit (such as objectivity, neutrality, reliability, etc) and
therefore, if a profession wants to be seen as being legitimate, then a profession should
release documents which associates them with these legitimising characteristics. Hines

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further promotes a view that if professions are able to establish a perspective that they
are objective and professional then this assists their quests for autonomy and enhances
their ability to self-regulate without the unwanted intervention of government.

Whether we agree with Hines’ perspective is matter of opinion and tied to our own
values and beliefs. There does seem to be some logic to what Hines is arguing but there
is also some grounds to believe that many people (but perhaps not all) involved in the
development of conceptual frameworks have a ‘public interest’ in improving the process
of general purpose financial reporting (in accordance with the public interest theory of
regulation discussed in Chapter 3). Perhaps, rather than believing Hines is either right or
wrong, we might adopt a position that her view of the world provides some insights into
what might have motivated some individuals involved in developing conceptual
frameworks, but perhaps not all people.