Marks
(a) Subjective 14
(b) Up to 3 marks per key issue 9
(i) Recognition and de-recognition
(ii) Equity v liabilities
(iii) P/L v OCI
Appropriateness and quality of discussion 2
Maximum 25
(a) The need for a conceptual framework
The financial reporting process is concerned with providing information that is useful in the business and economic decision-making process. Therefore a conceptual framework will form the theoretical basis for determining which events should be accounted for, how they should be measured and how they should be communicated to the user.
Although it is theoretical in nature, a conceptual framework for financial reporting has highly practical final aims.
The danger of not having a conceptual framework is demonstrated in the way some countries'
standards have developed over recent years; standards tend to be produced in a haphazard and fire- fighting approach. Where an agreed framework exists, the standard-setting body act as an architect
or designer, rather than a fire-fighter, building accounting rules on the foundation of sound, agreed basic principles.
The lack of a conceptual framework also means that fundamental principles are tackled more than once in different standards, thereby producing contradictions and inconsistencies in basic concepts, such as those of prudence and matching. This leads to ambiguity and it affects the true and fair concept of financial reporting.
Another problem with the lack of a full conceptual framework has become apparent in the USA. The large number of highly detailed standards produced by the Financial Accounting Standards Board (FASB) has created a financial reporting environment governed by specific rules rather than general principles. FASB has 'concept statements' but a full conceptual framework would be better.
A conceptual framework can also bolster standard setters against political pressure from various 'lobby groups' and interested parties. Such pressure would only prevail if it was acceptable under the conceptual framework.
Can it resolve practical accounting issues?
A framework cannot provide all the answers for standard setters. It can provide basic principles
which can be used when deciding between alternatives, and can narrow the range of alternatives that can be considered. In the UK, the Statement of Principles has provided definitions that have formed the basis of definitions in accounting standards, as has the IASB's conceptual framework in areas
such as financial instruments and provisions. A framework can also provide guidance in the absence of an accounting standard. For example, there is no IFRS dealing specifically with off balance sheet finance, so the IASB Conceptual Framework must form the basis for decisions.
However, a conceptual framework is unlikely, on past form, to provide all the answers to practical accounting problems. There are a number of reasons for this:
(i) Financial statements are intended for a variety of users, and it is not certain that a single conceptual framework can be devised which will suit all users.
(ii) Given the diversity of user requirements, there may be a need for a variety of accounting standards, each produced for a different purpose (and with different concepts as a basis). (iii) It is not clear that a conceptual framework makes the task of preparing and then implementing
standards any easier than without a framework.
The IASB's Conceptual Framework for Financial Reporting was criticised by the UK Accounting Standards Board at least partly on grounds of practical utility – it is thought to be too theoretical,
and also for focusing on some users (decision makers) at the expense of others (shareholders).
Perhaps it is not possible to satisfy all users.
(b) Discussion paper
(i) Recognition and derecognition of assets and liabilities
Generally all assets and liabilities are to be recognised unless recognising an asset or a liability is considered irrelevant or not sufficiently relevant to justify the costs for doing so or no measurement of the item would lead to a sufficiently faithful representation. For the first time, the Conceptual Framework will give guidance on derecognition. Generally entities should derecognise an asset or liability, or part of an asset or liability, when it no longer meets the recognition criteria.
(ii) Equity versus liabilities
The distinction between equity and liabilities is clarified through focus on the definition of a liability. The paper identifies two types of approach: narrow equity and strict obligation.
(1) Narrow equity approach. Equity is treated as being only the residual class issued, with
changes in the measurement of other equity claims recognised in profit or loss. (2) Strict obligation approach. All equity claims are classified as equity with obligations to
deliver cash or assets being classified as liabilities. Any changes in the measurement of equity claims would be shown in the statement of changes in equity.
Under the strict obligation approach, certain transactions now classified as liabilities would now be classified as equity because they do not involve an obligation to transfer cash or assets. An example of this is an issue of shares for a fixed monetary amount.
(iii) Profit or loss versus other comprehensive income
Currently, the Conceptual Framework does not contain principles to determine: (1) What items are recognised in profit or loss
(3) Whether, and when, items can be recycled from other comprehensive income to profit
or loss.
In response, the Discussion Paper proposes that the Conceptual Framework should: (1) Require a profit or loss total or subtotal that also results, or could result, in some
items of income or expense being recycled
(2) Limit the use of OCI (only to income and expenses resulting from remeasurements of
assets and liabilities).
The Discussion Paper proposes a narrow and broad approach to what should be included in
other comprehensive income, but the IASB has not yet decided which approach it will use. Under the narrow approach. Other comprehensive income would include bridging items and mismatched remeasurements. In addition to the narrow approach, the broad approach
would also include transitory remeasurements.
Bridging items are items of income or expense which represent the difference between measurement used in determining profit or loss and remeasurement used in the statement of financial position. An example would be investments in equity instruments with changes in fair value recorded in other comprehensive income. Such items would have to be recycled as a consequence of the measurement basis presented in profit or loss.
Mismatched remeasurements represent the effects of part of a linked set of assets, liabilities
or past or planned transactions. It represents their effect so incompletely that, in the opinion of the IASB, the item provides little relevant information about the return that the entity has made on its economic resources in the period. An example would be a cash flow hedge, where fair value gains and losses are accumulated in other comprehensive income until the hedged transaction affects profit or loss. These amounts should be recycled when the item can be presented with the matched item.