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Learning objectives
Chapter 10
Regulation and the
Conceptual Framework
©2020 John Wiley & Sons Australia Ltd
Learning objectives
10.4 describe the objectives of general purpose
financial reporting under the Conceptual
Framework
10.5 identify the qualitative characteristics for the
selection and presentation of financial
information
10.6 define assets, liabilities, equity, income and
expenses, as established under the Conceptual
Framework
Regulation and development of accounting
standards
• Brief history of regulation:
– As new types of transactions evolved in business,
accountants developed rules and practices for
recording them.
– These accounting practices came to be known as
generally accepted accounting principles (GAAP).
– GAAP consist of rules, practices and procedures,
the authority of which stems from their general
acceptance and use by the accounting profession
and the business community.
After studying this presentation you should be able to:
10.1 describe the development of accounting
regulation in Australia resulting in the issue of
accounting standards
10.2 explain the nature of the Conceptual Framework
for Financial Reporting, and the history of the
development of the framework
10.3 describe the nature of a reporting entity under
the Conceptual Framework
Learning objectives
10.7 describe the recognition criteria, established in
the Conceptual Framework, for assets,
liabilities, income and expenses
10.8 explain the importance of measurement in the
preparation of financial statements.
Regulation and development of accounting
standards
• International Accounting Standards Board (IASB):
– The IASC issued accounting standards over a
27‐year period until it was replaced in 2001 by the
IASB.
– The main reason for replacement was that the
IASC’s standards allowed too many alternatives
and it was felt that international accounting
standards should be of a higher quality if they
were to be accepted and used for the purpose of
listing a company’s shares on securities exchanges
around the world.
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Regulation and development of accounting
standards
• The IFRS Interpretations Committee:
– The mandate of the committee is to ‘review on a
timely basis widespread accounting issues that
have arisen within the context of current IFRS and
to provide authoritative guidance on those issues’.
– The interpretations cover:
• Newly identified financial reporting issues not
specifically covered by international financial
reporting standards (IFRS) issued by the IASB.
Regulation and development of accounting
standards
• Financial Accounting Standards Board (FASB):
– The aim was to agree on high‐quality solutions to
existing and future accounting issues and to
converge their existing standards as soon as was
practicable.
– The FASB is also subject to the directions of the
SEC in the United States.
The Conceptual Framework
• The effectiveness of decision makers is enhanced if
they have information that has several important
characteristics.
• Accounting standards are continually being reviewed
and revised to keep up with the increasing
complexity of economic activity, both in Australia and
at international level.
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Regulation and development of accounting
standards
• The IFRS Interpretations Committee:
– Issues where unsatisfactory or conflicting
interpretations have developed, or are likely to
develop in the absence of authoritative guidance,
to try to reach consensus on the appropriate
treatment.
Regulation and development of accounting
standards
• Financial Accounting Standards Board (FASB):
– The FASB and IASB had reaffirmed in June 2010
(see the FASB and IASB websites) their
commitment to improving and converging their
respective accounting standards.
The Conceptual Framework
• It was hoped that development of a conceptual
framework for financial reporting would enable
regulators to:
– Develop standards that were consistent and
logically formulated.
– Provide guidance to accountants in areas where
no standards existed.
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The Conceptual Framework
• It was hoped that development of a conceptual
framework for financial reporting would enable
regulators to:
– Enable users of financial reports to understand
better the standards developed.
– These aims of the Conceptual Framework are
similar to those outlined by the IFRS as part of the
Conceptual Framework project.
The Conceptual Framework
• Background to the development of the Conceptual
Framework:
– Step 2:
• Define the reporting entity.
• This second step established the criteria by
which a reporting entity is recognised to exist,
in order to determine which entities should
prepare general purpose financial reports.
The Conceptual Framework
• Background to the development of the Conceptual
Framework:
– Step 4:
• Used the broad framework established in the
first three steps to develop the qualitative
characteristics of financial information the
elements of the reporting processes and
recognition and measurement of those
elements.
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The Conceptual Framework
• Background to the development of the Conceptual
Framework:
– Step 1:
• Define the boundaries of financial reporting in
that the conceptual framework was to deal
only with general purpose financial reporting.
The Conceptual Framework
• Background to the development of the Conceptual
Framework:
– Step 3:
• Establish the objectives of general purpose
financial reporting. This step also identified the
users of financial reports, their information
needs, and the types of reports which best
meet those needs.
The reporting entity
• The purpose of SAC 1 Definition of the Reporting
Entity is to define and explain the concept of a
reporting entity, and to establish a benchmark for
the minimum required quality for financial reporting
by such an entity.
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The reporting entity The reporting entity

• SAC 1 suggests a number of indicators to help assess • Tiers 1 and 2 differential reporting requirements:
when dependent users exist and hence when an
entity is a reporting entity.
– Separation of management from economic
interest.
– Economic or political importance/influence.
– Financial characteristics.

Objectives of general-purpose financial Qualitative characteristics of financial

reporting information

• The IASB’s Conceptual Framework points out that • The IASB’s Conceptual Framework asserts that there
general purpose financial reports do not, and cannot, are six main qualitative characteristics that financial
provide all of the information needs of users. information should have in order to be the subject
• Users must consider pertinent information from matter of general purpose financial reports.
other sources.
– For example, general economic conditions and
expectations, political events and political climate,
and industry and company outlooks.
• Information about a reporting entity’s financial
performance is also useful.

Qualitative characteristics of financial Qualitative characteristics of financial

information information

• The six main qualitative characteristics: • Fundamental characteristics:

– relevance – Relevance:
– faithful representation • Financial information must have a quality that
– comparability makes a difference in a decision of an economic
– verifiability nature made by users.
– timeliness and understandability. – Faithful representation:
• For a complete faithful representation,
information must be complete, neutral and free
from material error.

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Qualitative characteristics of financial
information
• Enhancing qualitative characteristics:
– Comparability:
• Comparability is the qualitative characteristic
that enables users to identify and understand
similarities in, and differences among, items.
Qualitative characteristics of financial
information
• Enhancing qualitative characteristics:
– Timeliness:
• Timeliness simply means having information
available to decision makers in time to be
capable of influencing their decisions.
– Understandability:
• Understandability, however, does not
necessarily imply simplicity.
Definition of elements in financial
statements
• The Conceptual Framework provides definitions of
important elements underlying general purpose
financial reports, namely:
– assets
– liabilities
– equity
– income
– expenses.
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Qualitative characteristics of financial
information
• Enhancing qualitative characteristics:
– Verifiability:
• It means that different knowledgeable and
independent observers could reach consensus,
although not necessarily complete agreement,
that a particular piece of information is a
faithful representation of the economic
phenomena.
Qualitative characteristics of financial
information
• The cost constraints on relevant, faithfully
representative information:
– Reporting financial information imposes costs, and
it is important that those costs are justified by the
benefits of reporting that information.
– Costs could include those of collection, storage,
retrieval, presentation, analysis and
interpretation, and loss of competitive position,
most of which are incurred by the reporting entity.
Definition of elements in financial
statements
• Assets in the conceptual framework:
• An asset is a present economic resource
controlled by the entity as a result of past
events.
– Further, an economic resource is defined as:
• An economic resource is a right that has the
potential to produce economic benefits.
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Definition of elements in financial
statements
• Liabilities in the conceptual framework:
• A liability is a present obligation of the entity to
transfer an economic resource as a result of
past events.
Definition of elements in financial
statements
• Income in the Conceptual Framework:
– The Conceptual Framework defines income as:
• Increases in assets, or decreases in liabilities,
that result in increases in equity, other than
those relating to contributions from holders of
equity claims.
Definition of elements in financial
statements: summary
• Elements discussed in Chapter 1 Conceptual
framework
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Definition of elements in financial
statements
• Equity in the Conceptual Framework:
– The Conceptual Framework defines equity as ‘the
residual interest in the assets of the entity after
deducting all its liabilities’.
• Equity = Assets − Liabilities
Definition of elements in financial
statements
• Expenses in the Conceptual Framework:
– The definition of expenses in the Conceptual
Framework is as follows:
• Decreases in assets, or increases in liabilities,
that result in decreases in equity, other than
those relating to distributions to holders of
equity claims.
Recognition of the elements
• Recognition means the process of incorporating in
the statement of financial position or statement of
financial performance an item that meets the
definition of an element.
• It involves the inclusion of dollar amounts in the
entity’s accounting system.
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Recognition of the elements
• Asset and liability recognition in conceptual
framework:
– An entity recognises an asset or a liability (and any
related income, expenses or changes in equity) if
such recognition provides users of financial
statements with:
• Relevant information about the asset or the
liability and about any income, expenses or
changes in equity.
Recognition of the elements
• Recognition criteria based on assets and liabilities
because the other elements defined in terms of
changes in assets and liabilities or the difference
between them.
• Items not recognised may still need inclusion in
notes.
Recognition of the elements
– Faithful representation: recognition depends on
both relevance and faithful representation
estimates acceptable but may depend on
measurement certainty
– If Measurement uncertainty is high, asset or
liability not recognised: examples
• the range of possible outcomes is exceptionally
wide and the probability of each outcome is
exceptionally difficult to estimate
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Recognition of the elements
• Asset and liability recognition in the conceptual
framework:
– An entity recognises an asset or a liability (and any
related income, expenses or changes in equity) if
such recognition provides users of financial
statements with:
• A faithful representation of the asset or the
liability and of any income, expenses or
changes in equity.
Recognition of the elements
– Elements must be relevant to be recognised.
– Including elements in the financial statements
sometimes may not provide relevant information
to decision makers because of
• uncertainty re existence or
• asset or liability exists but probability of inflow
or outflow is low
Recognition of the elements
– Measurement uncertainty high if
• the measure is extremely sensitive to small
changes in estimates of the probability of
different outcomes — for example, if the
probability of future cash inflows or
outflows occurring is exceptionally low, but
the magnitude of those cash inflows or
outflows will be exceptionally high if they
occur
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Recognition of the elements
– Measurement uncertainty high if
• measuring the asset or liability requires
exceptionally difficult or exceptionally
subjective allocations of cash flows that do
not relate solely to the asset or liability
being measured (Conceptual Framework,
para. 5.20)
– With such high measurement, uncertainty , no
useful information can be provided about the
element
Recognition of the elements
• Revenue from contracts with customers (AASB 15)
• Revenue recognised if:
• the parties to the contract have approved the
contract (in writing, orally or in accordance with
other customary business practices) and are
committed to perform their respective obligations;
• the entity can identify each party’s rights regarding
the goods or services to be transferred;
Recognition of the elements
• Expense recognition in the Conceptual Framework:
– The Conceptual Framework views expenses in
terms of decreases in equity in the form of
reductions in assets or increases in liabilities
– Expenses recognised simultaneously with
decreases in assets or increases in liabilities
– Matching with revenue no longer the expense
recognition criteria
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Recognition of the elements
• Asset and liability recognition in the conceptual
framework:
– An entity recognises an asset or a liability (and any
related income, expenses or changes in equity) if
such recognition provides users of financial
statements with:
• Information that results in benefits exceeding
the cost of providing that information.
Recognition of the elements
• Revenue from contracts with customers (AASB 15)
• the entity can identify the payment terms for the
goods or services to be transferred;
• the contract has commercial substance (i.e. the risk,
timing or amount of the entity’s future cash flows is
expected to change as a result of the contract); and
• it is probable that the entity will collect the
consideration to which it will be entitled in exchange
for the goods or services that will be transferred to
the customer
Recognition of the elements
• Expense recognition in the Conceptual Framework:
– An expense is also recognised in the income
statement when the entity incurs a liability
without the recognition of any asset.
• For example wages payable.
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Measurement Measurement

• Measurement is very important in accounting in that • Different measurement bases include the following:
it is the process by which valuations are placed on all – historical cost
elements reported in financial statements. – Fair value
• Measurement of equity, income highly dependent on – Value in use
the concepts of assets and liabilities
– current cost

Measurement Summary

• Concepts of capital: • The development of accounting regulation in

– Two main concepts of capital are discussed in the Australia resulting in the issue of accounting
Conceptual Framework: standards.
• Financial capital: • The nature of the Conceptual Framework for
–Capital is synonymous with the net assets or Financial Reporting.
equity of the entity • The history of the development of the framework.
• Physical capital:
• The nature of a reporting entity under the
–Capital is seen not so much as the equity Conceptual Framework.
recorded by the entity but as the operating
capability of the assets

Summary Summary

• The objectives of general purpose financial reporting • The importance of measurement in the preparation
under the Conceptual Framework. of financial statements.
• The qualitative characteristics for the selection and
presentation of financial information.
• Assets, liabilities, equity, income and expenses, as
established under the Conceptual Framework.
• The recognition criteria, established in the
Conceptual Framework, for assets, liabilities, income
and expenses.

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Concepts of Capital

• Financial capital
– Capital is synonymous with the net assets (equity) of the
entity
– Profit exists only after the entity has maintained its capital,
measured as the dollar value (or purchasing power) of
equity at the beginning of the period

• Physical capital
– Capital is viewed as the operating capability of the entity’s
assets
– Profit exists only after the entity has set aside enough
capital to maintain the operating capability of its assets

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