2 Corporate governance
3.10 Exposure Draft: Conceptual Framework for Financial Reporting
In May 2015, the IASB issued an exposure draft: The Conceptual Framework for Financial Reporting. The exposure draft is the latest document in a project that has been ongoing since 2004, although interrupted in 2010. The ED proposes comprehensive changes to the Conceptual Framework, notably:
Revisions to the definitions of elements in the financial statements
Guidance on derecognition
Discussions on measurement bases
Principles for including items in other comprehensive income
High-level concepts for presentation and disclosure
The ED follows a 2013 discussion paper covering all aspects of the framework project, and was published at the same time as another ED covering references to the Conceptual Framework in other IASB
pronouncements (not on your examinable documents list).
3.10.1 Background and approach
While the existing Conceptual Framework was found to be useful in helping the IASB with its stated mission to ‘develop Standards that bring transparency, accountability and efficiency to financial markets around the world’, it was also found to be lacking in the following respects.
Problem Solution
Gaps in the current Conceptual Framework, such as insufficient guidance on
presentation and disclosure. Fill gaps
Parts of the existing Conceptual Framework are out of date. An example is the
guidance on when assets and liabilities should be recognised. Update Some of the guidance is unclear, for example regarding the role of measurement
uncertainty in deciding how to measure assets, liabilities, income or expenses. Clarify
3.10.2 Structure
The ED is structured as follows:
Chapter Topic
Introduction
1 The objective of general purpose financial reporting 2 Qualitative characteristics of useful financial information 3 Financial statements and the reporting entity
4 The elements of financial statements 5 Recognition and derecognition
6 Measurement
7 Presentation and disclosure
8 Concepts of capital and capital maintenance Appendix A Cash-flow-based measurement techniques Appendix B Glossary
3.10.3 Introduction
The ED’s introduction to the Conceptual Framework states that its purpose is:
(a) To assist the International Accounting Standards Board (IASB) to develop Standards that are based on consistent concepts
(b) To assist preparers to develop consistent accounting policies when no Standard applies to a particular transaction or event, or when a Standard allows a choice of accounting policy, and (c) To assist all parties to understand and interpret the Standards
The Conceptual Framework is not an IFRS, nor does it override any specific IFRS. If the IASB decides to issue a new or revised pronouncement that is in conflict with the framework, the IASB will highlight the fact and explain the reasons for the departure.
3.10.4 Chapter 1: The Objective of General Purpose Financial Reporting
This Chapter, together with Chapter 2, was finalised in the 2010 version of the Conceptual Framework, and so there are only limited changes from that version.
The main change is that more emphasis is placed on the importance of providing information needed to assess management’s stewardship of an entity’s resources.
3.10.5 Chapter 2: Qualitative characteristics of useful financial information
This Chapter, together with Chapter 1, was finalised in the 2010 version of the Conceptual Framework, and so there are generally only limited changes from that version. However, one change that could be regarded as important is the introduction of an explicit reference to the idea of prudence. Prudence is described as the exercise of caution when making judgements under conditions of uncertainty. It is explicitly stated that prudence is important in achieving neutrality, and therefore in achieving faithful
representation. Prudence had been removed from the Conceptual Framework in 2010.
The IASB has further clarified that prudence works both ways: assets and liabilities should be neither overstated nor understated.
Another key change is to the explanation of faithful representation. The chapter contains a proposed addition that would clarify that faithful representation means representation of the substance of an economic phenomenon instead of representation of merely its legal form.
3.10.6 Chapter 3: Financial Statements and the reporting entity
This Chapter is not in the current version of the Conceptual Framework, and is based on the feedback received on a 2010 Exposure Draft on the topic.
The ED states the objective of financial statements as being to provide information about an entity's assets, liabilities, equity, income and expenses that is useful to financial statements users in assessing the prospects for future net cash inflows to the entity and in assessing management's stewardship of the entity's resources. It then sets out the going concern assumption, which is unchanged from the current version.
Definition of the reporting entity
A reporting entity is an entity that chooses, or is required, to present general purpose financial statements.
It does not need to be a legal entity and can comprise only a portion of an entity or two or more entities.
Boundary of the reporting entity
The Exposure Draft proposes to determine the boundary of a reporting entity that has one or more subsidiaries on the basis of control. The boundary can be determined by either direct control, which results in unconsolidated or individual financial statements or by direct and indirect control, which results in consolidated financial statements.
The following diagram, taken from the IASB’s ‘Snapshot’, provides a summary of the approach:
Reporting entity Parent
Subsidiary
direct control
unconsolidated financial statements consolidated financial statements
direct and indirect control
Consolidated financial statements, according to the ED, are generally more likely to provide useful information to users than unconsolidated financial statements. If an entity prepares both, the unconsolidated financial statements must disclose how users may obtain the consolidated financial statements.
3.10.7 Chapter 4: The elements of financial statements
The elements of financial statements are, as in the existing Conceptual Framework, assets, liabilities, equity, income and expense. However, the definitions have been modified
The current definitions of assets and liabilities require a probable expectation of future economic benefits or resource outflow. The IASB argues that the definitions of assets and liabilities should not require an expected or probable inflow or outflow as it should be sufficient that a resource or obligation can produce or result in a transfer of economic benefits. While the IASB believes that the current definitions have worked well in the past, it wishes to refine them in order to place more emphasis on the fact that an asset is a resource and a liability is an obligation. In addition, the notion of probability will be removed from the definitions. The proposed definitions are:
(a) An asset is a present economic resource controlled by the entity because of past events.
(b) A liability is a present obligation of the entity to transfer an economic resource because of past events.
An economic resource is a right that has the potential to produce economic benefits.
A present obligation is an obligation to transfer economic resources that:
(a) The entity has no practical ability to avoid, and
(b) Has arisen from a past event (ie economic benefits already received or activities already conducted).
For the definitions of both assets and liabilities, the IASB decided not to retain the notion of an ‘expected inflow or outflow of resources’ in acknowledgement of concerns about varied interpretations of the term
‘expected’ and the notion of a threshold level of probability.
Equity continues to be defined as ‘the residual interest in the assets of the entity after deducting all its liabilities’. It should be noted that while the 2013 Discussion Paper addressed problems that arise in classifying instruments with characteristics of both liabilities and equity, the ED does not do so.
Exploring those problems has been transferred to the IASB's research project on financial instruments with the characteristics of equity.
Income is increases in assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from holders of equity claims.
Expenses are decreases in assets or increases in liabilities that result in decreases in equity, other than those relating to distributions to holders of equity claims.
3.10.8 Chapter 5: Recognition and derecognition
Recognition
Recognition is the process of capturing an asset or a liability for inclusion in the statement of financial position. The ED states that only items that meet the definition of an asset, a liability or equity are recognised in the statement of financial position, and only items that meet the definition of income or expenses are to be recognised in the statement(s) of financial performance.
The ED requires that recognition criteria, based on the qualitative characteristics of useful financial information, must be met. An entity recognises an asset or liability if such recognition provides users of the financial statements with:
(a) Relevant information about the asset or liability
(b) A faithful representation of the asset or liability and of any resulting income and expenses, and (c) Information that results in benefits exceeding the cost of providing that information
Those criteria may not always be met in the following cases:
(a) It is uncertain whether an asset or liability exists.
(b) There is only a low probability of future inflows (outflows) of economic benefits from the asset (liability).
(c) The level of measurement uncertainty is so high that the resulting information has little relevance.
Whether the information provided is useful to users depends on the item and the specific facts and circumstances. Entities may also be required to exercise judgement, and recognition may vary, depending on the IFRS being applied.
Derecognition
Guidance on derecognition is new to this proposed version of the Conceptual Framework. The guidance is driven by the requirement of faithful representation. A faithful representation must be provided of:
(a) The assets and liabilities retained after a transaction or other event that led to derecognition, and (b) The change in the entity’s assets and liabilities as a result of that transaction or other event.
Decisions about derecognition are generally straightforward. However, in some cases the two aims described above conflict with each other, making the decisions more difficult. The discussion in the Exposure Draft focuses on these cases.
3.10.9 Chapter 6: Measurement
The guidance on measurement is an example of filling in gaps present in the existing Conceptual Framework. While developing the ED, the IASB considered whether the Conceptual Framework should advocate the use of a single measurement basis. Considering the different assets and liabilities being measured, relevance and the cost constraint, the Board eventually concluded that a multiple
measurement approach is more appropriate.
The ED covers the following:
(a) A description of various measurement bases, the information that these measurement bases provide and their advantages and disadvantages. The measurement bases are historical cost and current value measures (fair value and value in use/fulfilment value)
(b) Factors to consider when selecting a measurement basis (relevance, faithful representation, enhancing qualitative characteristics, and factors specific to initial measurement)
(c) Situations when more than one measurement basis provides relevant information. Consideration of the objective of financial reporting, the qualitative characteristics of useful financial information and the cost constraint are likely to result in the selection of different measurement bases for different assets, liabilities and items of income and expense
(d) Measurement of equity
Appendix A of the ED supplements this Chapter, and describes cash-flow-based measurement techniques for cases when a measure determined using a measurement basis cannot be observed.
3.10.10 Chapter 7: Presentation and disclosure
This Chapter discusses concepts that determine what information is included in the financial statements and how that information should be presented and disclosed. These concepts are intended to guide the IASB in setting presentation and disclosure requirements in individual standards and to guide entities in providing information in financial statements.
Disclosure initiative
The IASB is also undertaking a Disclosure Initiative, a collection of implementation and research projects aimed at improving disclosure in IFRS financial reporting. In the Disclosure Initiative, the IASB will seek to provide additional specific guidance to support the application of the concepts. This is discussed in more detail in Chapter 19.
Concepts and principles discussed in the ED The ED discusses the following issues:
(a) The balance between entities’ flexibility to provide relevant information that faithfully represents the entity’s assets and liabilities and the transactions and other events of the period, and comparability among entities and across reporting periods.
(b) Entity-specific information is more useful than boilerplate language for efficient and effective communication.
(c) Duplication of information in various sections of the financial statements is unnecessary and makes financial statements less understandable.
Profit or loss and other comprehensive income
This part of the ED discusses presentation disclosure in the statement of financial performance, and provides conceptual guidance on whether to present income and expenses in profit or loss or in other comprehensive income.
Both profit or loss and other comprehensive income would be retained and marked by subtotals or totals.
The purpose of the statement of profit or loss is to depict the return an entity has made on its economic resources during the period and to provide information that is helpful in assessing future cash flows and management’s stewardship of the entity’s resources. By default, therefore, all income and expense will be shown in profit or loss unless relating to the remeasurement of assets and liabilities - these would normally be shown in other comprehensive income. However, for an item recognised in other
comprehensive income in one period, there is a presumption that it will be included in the statement of profit or loss in a future period, unless there is no clear basis for identifying the period in which reclassification would enhance the relevance of the information in the statement of profit or loss.
3.10.11 Chapter 8: Concepts of capital and capital maintenance
This Chapter comprises material carried forward from Chapter 4 of the existing Conceptual Framework with minor changes for consistency of terminology