Contemporary Issues in Accounting

Chapter 2 THE CONCEPTUAL FRAMEWORK OF FINANCIAL REPORTING

Notes and Highlights

What is a conceptual framework?

A conceptual framework is a set of broad principles that provide the basis for guiding actions or
decisions. The IASB’s conceptual framework sets out the concepts that underlie the preparation
and presentation of financial statements for external users.

Explain the difference between general purpose financial reports and special purpose financial
reports? What kind of reports is the conceptual framework concerned with

General purpose financial reports: financial reports intended to meet the needs of users who
are not in a position to require an entity to prepare reports tailored to their particular
information needs.

Special purpose reports: are reports prepared to meet the needs of particular users. These
normally contain specialized information designed for users who have the power to ask for the
information they need. These normally contain specialized information designed for users who
have the power to ask for the information they need.

 Some lenders can require, as part of the terms for granting a loan that reports be
prepared with specific information.
 Taxation authorities can require specific reports.
 Management would require, and be able to obtain, more detailed reports.

The Conceptual Framework states that it is concerned with general purpose financial reports,
and does not need to be applied in the preparation of special purpose financial reports.

What is the objective of financial reports according to the Conceptual Framework?

The objective of general purpose financial reporting Is to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders and other creditors in
making decisions about providing resources to the entity. Those decisions involve buying, selling
or holding equity and debt instruments, and providing or settling loans and other forms of
credit.
What is the underlying assumption to be applied in preparing financial reports according to
the Conceptual Framework? How does this assumption affect the financial report items?The
Conceptual Framework requires the financial reports to be based on one underlying
assumption, being the going concern basis. It states that ‘the financial statements are normally
prepared on the assumption that an entity is a going concern and will continue in operation for
the foreseeable future’.

The going concern assumption has a direct impact on both the recognition and measurement of
items in the financial statements. If the entity is not expected to continue in business, then the
economic benefits in particular items, such as prepaid insurance, would no longer be expected
to be received, so they could not be recognized as assets. The reported values of assets would
also need to be reconsidered. For example, if the business is to close, inventory may not realize
its ‘normal’ selling price. Where the assumption that the entity is a going concern is
inappropriate, this basis should not be used and this would need to be disclosed.

The Conceptual Framework identifies a limited range of primary users of financial statements.
List them

 existing and potential investors

 lenders
 other creditors.

Identify and briefly explain the fundamental and enhancing qualitative characteristics of
financial information in the Conceptual Framework. Page 35-37

List and define the elements of financial statements

Assets: An asset is a resource controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity.

Liabilities: A liability is a present obligation of the entity arising from past events, the settlement
of which is expected to result in an outflow from the entity of resources embodying economic
benefits.

Equity: is the residual interest in the assets of the entity after deducting all its liabilities.

Income: Income is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in increases in equity,
other than those relating to contributions from equity participants.

Expenses: are decreases in economic benefits during the accounting period in the form of
outflows or depletions of assets or incurrences of liabilities that result in decreases in equity,
other than those relating to distributions to equity participants.
When should an item be recognized in the financial reports?

For an item to be recognized in the financial statements it should

1. Meet the definition of a financial statement element

2. It is probable that any future economic benefit associated with the item will flow to or
from the entity (Probability test).
3. The item has a cost or value that can be measured with reliability (Reliable
measurement).

Outline the technical benefits of a conceptual framework.

1. to assist the Board in the development of future IFRSs and in its review of existing IFRSs
2. to assist preparers of financial statements in applying IFRSs and in dealing with topics
that have yet to form the subject of an IFRS
3. to assist auditors in forming an opinion on whether financial statements comply with
IFRSs
4. to assist users of financial statements in interpreting the information contained in
financial statements prepared in compliance with IFRSs

Why is accounting said to be ‘political’ in nature? How can a conceptual framework help in the
setting of accounting standards in a political environment?

The political nature of accounting is due to the fact that accounting information is used in, and
influences, decisions. Thus, the accounting ‘rules’ determine what information is provided and
therefore what information is used in decisions. Recall that the objective of financial reporting is
to provide information useful to users in making economic decisions. If economic decisions
change and are influenced by accounting then this means that accounting information has
economic consequences (i.e. can result in transfers of wealth). Thus, people will try to influence
the accounting rules (the accounting standard) to try to ensure that their own interests are met.

List some of the problems and criticisms of the conceptual framework

1. It is ambiguous
2. The principles are too vague
3. Too much room for alternative interpretations.
4. It is descriptive not prescriptive; The Conceptual Framework simply describes current
accounting practice.
5. The concept of faithful representation is inappropriate