Professional Documents
Culture Documents
Objectives
To explain what a conceptual framework of financial accounting is To discuss the accounting principles set out in the accounting framework To explain the benefits and criticisms of the conceptual framework in accounting To comment critically on rule-based and principles-based approaches
An accounting conceptual is a set of guiding principles used to plan and decide financial accounting standards. Those guidelines/principles are designed to provide guidance and help make decisions relating to the financial accounting treatments. Those guidelines/principles can be used as a basis for forming the accounting standards and interpretations used for financial reporting. A conceptual framework differs from an accounting standard. Accounting standards state specific requirements for a particular area of financial reporting.
From 1920s and 1930s, there were attempts to draft statements of principles to guide accounting in response to reporting failure. Principles suggested in this period focused on the area of accounting measurement.
In 1936, the American Accounting Association issued a Statement of accounting principles. In 1959, a set of basic principles for accounting standards was established by the American Institute of Certified Public Accountants. In 1962, A tentative set of broad accounting principles of business enterprises published by Sprouse and Moonitz.
The development of more comprehensive and formal conceptual frameworks begins in the 1970s in response to corporate failure the 1960s.
The Financial Accounting Standards Board (FASB) established 6 concept statements between 1978 and 1989 in the US. During this period the UK, Canada and Australia were also developing their own conceptual frameworks. The Framework for the preparation and presentation of financial statement issued by the IASC (now IASB) is developed directly from those previous conceptual framework projects.
Overview of the IASC Framework Questions that the Framework answers: 2. Who are the financial statements for? There is a very wide range of users. Investors Employees Lenders Suppliers and trade creditors Customers Governments and their agencies The public
Overview of the IASC Framework Questions that the Framework answers: 3. What is the purpose of financial statement? Stewardship or accountability =>managers are required to report to the providers of the resources in order to explain how well they have managed the companies. Decision usefulness =>the financial statements should provide information about the financial position, performance, generation and use of cash, and financial adaptability of an enterprise that is useful to users in making decisions.
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4. What are the assumptions to be made when preparing financial statements? The accrual basis.
The effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate (para. 23).
5. What type of information should be included? Ans: Useful information But what makes financial information useful???? Four main elements (qualitative characteristics) Information Content Relevance Reliability Information Presentation Comparability Understandability Additionally, information need to be material.
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Relevance: This characteristic ensures that the information included in the financial statement has the ability to influence the economic decisions of users. It must have: predictive value, i.e. help users to evaluate past and present event, or predict future event. confirmatory value, i.e. help users to confirm or correct their past evaluation.
Reliability: This characteristic ensures that users have confidence in the information stated in the financial statements/reports. Five components affect the reliability of accounting information: Faithful representation: this requires making sure that ensure that what is shown in the financial statement corresponds to the actual events and transactions that are being represented. Free from material error: transactions have been accurately recorded and reported. Substance over form: this requires item to be accounted for and presented in accordance with their substance and economic reality and not merely their legal form.
5. What type of information should be included? Neutrality: this aims to ensure that there is no attempt to promote and particular view; the financial statements provide an impartial description of the events and transactions. Prudence: The inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. Completeness: Users require all relevant information to be included in the financial statements, if there are to be useful for decision making.
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Comparability: The accounting information needs to be comparable over time and between companies. Therefore, the similarities and differences can be determined and evaluated. Comparability would be achieved with: Consistent measurement Disclosure of accounting policy used in preparing financial statements.
Understandability: Users abilities: the information is capable of being understood by a user with a reasonable knowledge of business activities and accounting. Aggregation and classification
Threshold quality - Materiality: no information can be useful if it is not material. An item of information is material to the financial statements if its misstatement or omission might reasonably be expected to influence the economic decisions of users of those financial statements, including their assessment of management s stewardship. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Avoid unnecessary costs on preparers Impede decision makers by obscuring material information with excessive detail
Therefore, the Framework proposes that when the conflict occurs, the qualitative characteristics of relevance and reliability should override understandability and comparability (In theory, it is still an unresolved question).
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Constraints on information Two constraints may limit the ability to provide information that is relevant and reliable.
Timeliness: Accounting information needs to be provided on a timely basis. Delaying the issue of the financial statements is likelihood to reduce its usefulness to users. Benefits versus costs: The benefits to users from better decisions should outweigh the costs in preparing the statements.
*The definitions of those elements do not refer to legal form but to economic benefits. This reflects the substance over form approach required by the Framework.
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Recognition criteria Recognition is the process of recording an item in the balance sheet or income statement. An item should be recognised if it meets two criteria:
Probability: There is always some uncertainty as to when to recognise an event or transaction. It is necessary to take into account there being some uncertainty about many items in the financial statements. Sufficient evidence to support the existence of the new asset or liability. Reliable measurement: the item has a cost or value (monetary amount) that can be measured with reliability. In many cases, the use of estimates in the accounting information does not mean that a measure is unreliable.
Items that do not meet both of recognition criteria cannot be recognised, although information may be disclosed in notes to the statements where this is useful to users.
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Disadvantage:
Can be very complex => allow confusion and even manipulation. Detailed rules => Companies are able to structure their transaction in order to circumvent unfavourable reporting mask unfavourable financial position. Detailed standards are likely to be incomplete or out of date. Manipulated compliance with rules makes auditing more difficult.
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The incentive, ability and judgment of managers, audit committee members and auditors may affect the quality of the accounting statements. Managers are able to select treatments both that reflect the underlying economic substance of a transaction and that do not. Rely on the incentive and ability of managers, audit committee members and auditors: managers, audit committee and auditors must have the desire for unbiased reporting and expertise to achieve treatments that reflect the underlying economic substance. The judgement and choice of the treatment may reduce comparability.
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