7.1 What is a conceptual framework for financial reporting?

A conceptual framework of accounting can be considered to be a normative theory of accounting. A

conceptual framework makes prescriptions in regards to what the objectives of accounting are, what
qualitative characteristics general-purpose financial information should possess, how the elements of
accounting should be defined and when they should be recognised and how the elements of accounting
should be measured.

Within the United States, the conceptual framework has been defined as ‘a coherent system of interrelated
objectives and fundamentals that is expected to lead to consistent standards’. It is further stated that the
conceptual framework ‘prescribes the nature, function and limits of financial accounting and reporting’
(Statement of Financial Accounting Concepts No. 1: Objectives of Financial Reporting by Business
Enterprises, 1978).

In May 2008, an exposure draft entitled Exposure Draft of an Improved Conceptual Framework for
Financial Reporting was released jointly by the IASB and FASB and, according to the exposure draft, the
conceptual framework is:

a coherent system of concepts that flow from an objective. The objective of financial reporting is the foundation of
the framework. The other concepts provide guidance on identifying the boundaries of financial reporting; selecting
the transactions, other events and circumstances to be represented; how they should be recognised and measured (or
disclosed); and how they should be summarised and communicated in financial reports.

As this definition indicates, the objective of financial reporting is the fundamental building block for the
conceptual framework being developed by the IASB and the FASB. Hence, if particular individuals or
parties disagreed with the objective identified by the IASB and the FASB, they would most likely
disagree with the various prescriptions provided within the revised conceptual framework.

7.2 Do you think we need conceptual frameworks? Explain your answer.

The view often promoted by various advocates of conceptual framework projects is that it is difficult and
perhaps illogical to develop systems of financial accounting if we do not initially agree on important
issues such as what general purpose financial reporting is, what the objective of a general purpose
financial reporting system is and in relation to this, what the qualitative characteristics of the information
generated from that system should be. Further, to make the system consistent we need to agree on how we
define, recognise and measure the elements of that system. The view taken is that there are a number of
building blocks involved in developing a logical system of accounting and that a conceptual framework
develops such building blocks in a logical order. For example, we initially need some consensus on the
definition of general purpose financial reporting and of a reporting entity, before we can consider the
objective of financial reporting. Once we have considered the objective of financial reporting we can then
consider defining the qualitative characteristics of financial reporting, as well as how to define the
elements of financial reporting and so forth.

Without some consensus on issues such as those mentioned above, it is likely that the development of
rules of accounting (assuming that we need rules) will be undertaken in a rather piecemeal manner with
limited consistency between the various rules (which raises another issue: do we need consistency?). This
inconsistency appeared to be the case in many countries prior to the development of conceptual
frameworks. There was a great deal of inconsistency between the various standards in terms of definitions
(often implied) of the elements of accounting, as well as inconsistencies in determining when the
elements should be recognised and how they should be measured. With a conceptual framework, the
accounting standards are expected to be more consistent.

Across time, the accounting profession attracted a great deal of criticism for the lack of agreement on key
issues - so from a ‘legitimacy’ perspective, the profession probably needed a conceptual framework.

7.13 The two main qualitative characteristics that financial information should possess have been
identified as relevance and representational faithfulness. Is one more important than the other or
are they equally important?
Both relevance and faithful representation are considered in the IASB Conceptual Framework as
‘fundamental qualitative characteristics’ that financial information should possess. If something is not
considered to be relevant (that is, if it is not likely to influence decisions about the allocation of scarce
resources) then one view is that the item does not really need to be disclosed, perhaps regardless of
whether it is representationally faithful or not.

However, if something is considered to be relevant to financial statement readers, which obviously is a

matter of judgement, then people are considered likely to act on the information. It would be important
that the information faithfully represents the underlying transaction or event to which it relates (which
implies it is free from bias and undue error).
Hence, we could perhaps argue that representational faithfulness is particularly important if an item is
considered relevant, however, if it is not considered to be relevant then it probably does not matter
whether the item is representationally faithful or not given that people might not be expected to act on it
in either case. Therefore, logically, we might argue that the initial characteristic to consider is whether the
information is likely to be relevant. Does this sound logical? By contrast to this argument, it would appear
that the IASB proposes that both attributes must be considered at the same time. As Paragraph QC17 of
the IASB Conceptual Framework states:

Information must be both relevant and faithfully represented if it is to be useful. Neither a faithful representation of
an irrelevant phenomenon nor an unfaithful representation of a relevant phenomenon helps users make good
decisions.

7.24 The Corporate Report (UK) referred to the ‘public’s right to information’. How does this differ
from the perspectives adopted in other conceptual framework projects?
The Corporate Report embraced a broader notion of accountability, rather than a notion of decision
usefulness. The view of the authors of The Corporate Report was for organisations to not have any
absolute right to exist within the community and that those organisations that are given ‘permission to
operate’ have a related obligation, or responsibility, to provide information about their financial
performance to members of the community in which they operate. This notion of who was deemed to be
the target of the disclosures was wider than that adopted within other attempts to develop a conceptual
framework. Most other frameworks emphasise the information needs of parties with a direct financial
interest. For example the FASB framework emphasised the information needs of ‘present and potential
investors and creditors and other users in making rational investment, credit and similar decisions’. This
is similar to the position taken within the IASB Conceptual Framework.

The former Australian Conceptual Framework - which was superseded by the IASB Framework -
emphasised the needs of ‘resource providers, recipients of goods and services, and parties performing a
review or oversight function’. While the Australian definition of ‘users’ was broader than the United
States’ position, it was narrower than the position proposed in the United Kingdom by The Corporate
Report.

7.37 Do you agree with a ‘one-size-fits-all’ approach to international financial accounting - that is,
that all countries should adopt the same accounting standards and conceptual framework? Explain
your answer.
Moves towards standardisation of accounting standards and also conceptual frameworks imply a one-
size-fits-all approach. As we know, this is a goal of the IASB. Chapter 4 referred to the work of different
researchers who have shown that previous international differences in accounting standards (prior to the
efforts for international standardisation) can potentially be explained by international differences in
culture, religion and business ownership and financing systems. The view provided by a good deal of the
research indicates that underlying differences in how people think and how they conduct their business in
turn impacts the information they require (which seems a reasonable proposition). A number of
researchers have explicitly questioned the relevance of ‘Western-style’ accounting standards to the needs
of people within developing countries, or the relevance of ‘Anglo-American’ standards in ‘continental
European’ countries.

As we know, the standard-setting process in many countries is a political process (or perhaps ‘was’, given
that domestic standard-setters are increasingly being replaced by the IASB) in which the standard-setters
invite submissions from constituents as part of the due process of developing accounting standards. The
submissions are considered to influence the contents of the final standards. When developed in this
manner, accounting standards developed in one country tended to be different to standards developed in
other countries. For many years such differences were accepted as being reasonable however, such
differences no longer appear to be considered as ‘reasonable’ (particularly to parties such as the IASB).

If we accept that people in different countries have different values and consequently different
information needs, then it is perhaps somewhat naïve to expect that one system of accounting will meet
the needs of all people within all countries. Nevertheless, work towards international standardisation is
ongoing. Obviously, those organisations that are pushing for standardisation in accounting across the
world (for example the IASB) do not consider that different people, of different cultures and religions,
require different information.