THE REGULATORY FRAMEWORK
KEY TERM
PART A REGULATION AND ETHICS OF FINANCIAL REPORTING 1: The regulatory framework
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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.
5.2 Advantages and disadvantages of a conceptual framework
5.2.1 Advantages
(a) The situation is avoided whereby standards are developed on a patchwork basis, where a
particular accounting problem is recognised as having emerged, and resources are then channelled into standardising accounting practice in that area, without regard to whether that particular issue was necessarily the most important issue remaining at that time without standardisation.
(b) As stated above, the development of certain standards (particularly national standards) have been subject to considerable political interference from interested parties. Where there is a conflict of interest between user groups on which policies to choose, policies deriving from a conceptual framework will be less open to criticism that the standard-setter buckled to external pressure. (c) Some standards may concentrate on the statement of profit or loss and other comprehensive income
whereas some may concentrate on the valuation of net assets (statement of financial position).
5.2.2 Disadvantages
(a) 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.
(b) 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). (c) It is not clear that a conceptual framework makes the task of preparing and then implementing
standards any easier than without a framework.
Before we look at the IASB's attempt to produce a conceptual framework, we need to consider another term of importance to this debate: generally accepted accounting practice; or GAAP.
5.3 Generally Accepted Accounting Practice (GAAP)
GAAPsignifies all the rules, from whatever source, which govern accounting. In individual countries this is seen primarily as a combination of:
National company law
National accounting standards Local stock exchange requirements
Although those sources are the basis for the GAAP of individual countries, the concept also includes the effects of non-mandatory sources such as IFRS or statutory requirements in other countries.
In many countries, like the UK, GAAP does not have any statutory or regulatory authority or definition, unlike other countries, such as the USA. The term is mentioned rarely in legislation, and only then in fairly limited terms.
There are different views of GAAP in different countries. The IASB convergence programme seeks to reduce these differences.
5.3.1 Rules based versus principles based GAAP
5/11
GAAP can be based on legislation and accounting standards that are either: (a) Rules based, or
(b) Principles based KEY TERM
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1: The regulatory framework PART A REGULATION AND ETHICS OF FINANCIAL REPORTINGThe USA operates a rules based system, where standards are very detailed, attempting to cover all eventualities. Accounts which do not comply in all details are presumed to be misleading. This has the advantage of clear requirements which can be generally understood and it removes any element of judgement. Other advantages of a prescriptive system are that it can be taught and learnt more easily, therefore it should ensure that similar items are treated in a similar way and it should be more obvious if a entity does not follow GAAP.
The IASB’s Conceptual Framework is a principles based system which does not specify all the details but seeks to obtain adherence to the 'spirit' of the regulations. This does leave room for some element of professional judgement, but it also makes it harder for entities to avoid applying a standard as the terms of reference are broader.
Other advantages of having a principles based system include the following.
(a) Standards based on principles don’t go out of date in the same way as those based on rules. For example if a prescriptive standard includes a list of common items that would qualify for specific treatment, the list may go out of date as economies progress and develop.
(b) It is more difficult for a company to manipulate information to avoid applying a standard based on principles than it is for a prescriptive standard.
(c) Standards based on principles are less likely to contradict each other than those based on rules as they are all based on the same basic principles.
(d) Standards based on rules require that many detailed standards covering all possible situations have to be produced. This can result in complexity in financial reporting as there are a considerable number of standards to be followed. Having standards based on principles avoids this.
5.3.2 GAAP and a conceptual framework
A conceptual framework for financial reporting can be defined as an attempt to codify existing GAAP in order to reappraise current accounting standards and to produce new standards.
Section summary
A conceptual framework provides the basis for the formulation of accounting standards.
6 The IASB Conceptual Framework 5/10, 11/10, 5/11, 5/13,
9/13, 11/13, 3/14
Introduction
This section explains the Conceptual Framework developed by the IASB.
6.1 A conceptual framework
5/10, 11/10
In July 1989 the old IASC produced a document called Framework for the preparation and presentation of financial statements. In 2010 this was updated to ‘The Conceptual Framework for Financial
Reporting. The Conceptual Framework is the basis upon which all IASs and IFRSs are developed and it therefore determines how financial statements are prepared and the information they contain.
The Conceptual Framework consists of four chapters, following on after a foreword and introduction. These chapters are as follows.
PART A REGULATION AND ETHICS OF FINANCIAL REPORTING 1: The regulatory framework
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Chapter 1 The objective of general purpose financial reporting Chapter 2 The reporting entity (to be added at a later date) Chapter 3 Qualitative characteristics of useful financial information Chapter 4 The remaining text from the 1989 Framework
Underlying assumption
The elements of financial statements
Recognition of the elements of financial statements Measurement of the elements of financial statements Concepts of capital and capital maintenance
6.2 Preface
The preface to the Conceptual Framework points out the fundamental reason why financial statements are produced worldwide, ie to satisfy the requirements of external users, but that practice varies due to the individual pressures in each country.
These pressures may be social, political, economic or legal, but they result in variations in practice from country to country, including the form of statements, the definition of their component parts (assets, liabilities etc), the criteria for recognition of items and both the scope and disclosure of financial statements.
6.3 Introduction
The introduction to the Conceptual Framework lays out the purpose, status and scope of the document. It then looks at different users of financial statements and their information needs.
6.3.1 Purpose and status
The introduction gives a list of the purposes of the Conceptual Framework.
(a) to assist the Board in the development of future IFRSs and in its review of existing IFRSs. (b) to assist the Board in promoting harmonisation of regulations, accounting standards and
procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative accounting treatments permitted by IFRSs.
(c) to assist national standard-setting bodies in developing national standards.
(d) to assist preparers of financial statements in applying IFRSs and in dealing with topics that have yet to form the subject of an IFRS.
(e) to assist auditors in forming an opinion as to whether financial statements conform with IFRSs. (f) to assist users of financial statements in interpreting the information contained in financial
statements prepared in conformity with IFRSs.
(g) to provide those who are interested in the work of IASB with information about its approach to the formulation of IFRSs.
The Conceptual Framework is not an IFRS and hence does not define standards for any particular measurement or disclosure issue. Nothing in this Conceptual Framework overrides any specific IFRS. In the (rare) cases of conflict between an IFRS and the Conceptual Framework, the IFRS will prevail. These cases will diminish over time as the Conceptual Framework will be used as a guide in the production of future IFRS. The Conceptual Framework itself will be revised occasionally depending on the experience of the IASB in using it.
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1: The regulatory framework PART A REGULATION AND ETHICS OF FINANCIAL REPORTING6.3.2 Scope
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The Conceptual Framework deals with: (a) The objective of financial reporting
(b) The qualitative characteristics of useful financial information
(c) The definition, recognition and measurement of the elements from which financial statements are constructed
(d) Concepts of capital and capital maintenance
The Conceptual Framework is concerned with 'general purpose' financial statements (ie a normal set of annual statements), but it can be applied to other types of accounts. A complete set of financial statements includes:
(a) A statement of financial position
(b) A statement of profit or loss and other comprehensive income
(c) A statement of changes in financial position (eg a statement of cash flows) (d) Notes, other statements and explanatory material
Supplementary information may be included, but some items are not included, namely commentaries and reports by the directors, the chairman, management etc.
All types of financial reporting entities are included (commercial, industrial, business; public or private sector). A REPORTING ENTITY is an entity for which there are users who rely on the financial statements as their
major source of financial information about the entity. (Framework)
6.3.3 Users and their information needs
Users of accounting information consist of investors, employees, lenders, suppliers and other trade creditors, customers, government and their agencies and the public. You should be able to remember enough to do the following exercise.
Consider the information needs of the users of financial information listed above.
7 The objective of general purpose financial reporting
Introduction
The Conceptual Framework states that:
'The objective of general purpose financial reporting is to provide 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.'
These users need information about: the economic resources of the entity; the claims against the entity; and
changes in the entity’s economic resources and claims
Information about the entity’s economic resources and the claims against it helps users to assess the entity’s liquidity and solvency and its likely needs for additional financing.