GODFREY

HODGSON
HOLMES
TARCA

CHAPTER 4
A CONCEPTUAL FRAMEWORK
 The role of a conceptual
framework
• A structured theory of accounting
• States the scope and objective of financial
reporting
• Identifies and defines qualitative
characteristics of financial information and the
basic elements of accounting
• Deals with principles and rules of recognition
and measurement, and report disclosures

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 The role of a conceptual
framework

… a coherent system of interrelated objectives

and fundamentals that is expected to lead to
consistent standards and that prescribes the
nature, function and limits of financial
accounting and reporting.
FASB

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 The role of a conceptual
framework
Issues:
– Do we need a general theory of accounting?
– Is current accounting too permissive?
– Are current accounting practices too inconsistent?
– Is there too much political interference in the
neutrality of accounting reports?

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 The role of a conceptual
framework
Benefits:
– consistent, logical reporting requirements
– greater compliance
– enhanced accountability
– fewer specific standards
– enhanced understanding of reporting
requirements
– more economical standard setting

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 Objectives of conceptual
frameworks

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.
FASB

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 Objectives of conceptual
frameworks
• Information should be
– useful in making economic decisions
– useful in assessing cash flow prospects
– about enterprise resources, claims to those
resources and changes in them

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 Objectives of conceptual
frameworks

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 Developing a conceptual
framework
• The development of conceptual frameworks is
influenced by two key issues:
– principles versus rules-based approaches to
standard setting
– information for decision making and the decision-
theory approach

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Principles-based and rule-based
standard setting
• IASB mostly produces consistent, coherent
principles-based standards
• Rule-based standards may increase
comparability and verifiability and may reduce
earnings management

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Principles-based and rule-based
standard setting
• The standards of the FASB have traditionally
been rule-based
• Emphasis now being given to principles
• Timely given the IASB/FASB convergence
program

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 Information for decision making
and the decision-theory approach
• Accounting data are required for decision
making or accountability purposes
– stewardship
– decision making
• users

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 Information for decision making
and the decision-theory approach
• The decision-theory approach maps the
process by which the outputs of the
accounting system provide inputs to the
decision model of a user

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 Information for decision making
and the decision-theory approach
Decision-theory process
Overall theory
of accounting

Individual Prediction Decision

accounting model of model of
system user user

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International developments: the IASB
and FASB Conceptual Framework
• In 2004 the FASB and IASB agree to undertake a
joint project to:
– develop an improved, common conceptual
framework
– goal of developing standards that are principles-
based, internally consistent and internationally
converged
– an Exposure Draft was produced - June 2009
– deferred consideration of not-for-profit sector issues

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International developments: the IASB
and FASB Conceptual Framework
• ED has several contentious areas:
– entity vs proprietorship perspective
– primary user group
– decision usefulness and stewardship
– qualitative characteristics

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International developments: the IASB
and FASB Conceptual Framework
• Australia follows an approach whereby issues
for both the not-for-profit and for-profit
sectors are considered together
• Standards are intended to apply to both
sectors
• IFAC’s International Public Sector Accounting
Standards Board has begun a project to
develop a public sector CF

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 A critique of conceptual
framework projects
• Approaches to developing a CF:
– scientific
• recourse to logic and empiricism or both
– professional
• prescribes the best course of action by recourse to
professional values

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 A critique of conceptual
framework projects
Scientific criticisms:
• prescriptive
• unspecified rules and conventions
• do not resolve contemporary disclosure issues
• vague definitions
• do not address measurement issues
• risk of mechanical decision making
• framework may become an end in itself
• overreliance on definitions

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Ontological and epistemological
assumptions
• Freedom from bias (neutrality)
– an information quality that avoids leading users to
conclusions that secure the particular needs, desires or
preconceptions of the preparers
• Solomons: freedom from bias as ‘financial
mapmaking’
• Feyerabend: scientific truth is not absolute
• Hines claims mainstream accounting is ‘taken-for-
granted’

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Circularity of reasoning
• Objective of a conceptual framework: guide the
everyday practice of accountants
• A superficial view
– deducing principles from generalised theory

• Existing frameworks typified by internal circularity:

– e.g. FASB Statement No. 2
– qualitative characteristics are often stated in terms of
other qualities which are non-operationalised

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An unscientific discipline
• Is accounting a science?
– prescriptive by nature and value laden
• Stamp
Until we are sure in our minds about the nature of
accounting, it is fruitless for the profession to
invest large resources in developing a conceptual
framework to support accounting standards.

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Positive research
• Conceptual framework projects ignore the empirical
findings of positive accounting research
– in conflict with each other
• Mounting evidence that capital markets are not
efficient
• If the conceptual framework could ensure users
receive useful information this would serve a useful
purpose

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The conceptual framework as a
policy document
– As a generalised body of knowledge, conceptual
frameworks fail a number of ‘scientific’ tests
– The distinction between theories and policies is
important
– CFs not produced in a political vacuum
– CFs may just be a reflection of the dominant
group’s will

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 Professional values and self-
preservation
• ‘Self-preservation’
– implies the pursuit of self-interest
• ‘Professional values’
– suggests idealism and altruism
• Gerboth
– sense of personal responsibility
• Hines
– professional legitimacy

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 Conceptual framework for
auditing standards
• Auditing is a discipline based in logic
• The traditional verification role has evolved
into business risk auditing

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Summary
• The conceptual framework is intended to provide a coherent
and prescriptive guide to accounting practice
• If effective it should result in the communication of more
useful financial information to users
• Developing a conceptual framework has been a long and
complicated process
• Criticisms of conceptual framework projects exist
• Others debate the importance of these criticisms
• In auditing there has been a shift away from substantive
testing toward the role of client business risk
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Key terms and concepts

• Conceptual frameworks for accounting and

auditing
• Statement of accounting concepts
• FASB and IASB
• Principles-based and rule-based standards
• Decision making and decision-theory
• Professional values and self-preservation
• Business risk auditing
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