Purpose of the conceptual framework

The conceptual framework defines the models that lie behind the preparation and presentation of financial statements for users. The conceptual framework gives direction to the professionals in emerging future standards and resolving accounting issues which are not mentioned openly in the International Accounting Standard or International Financial Reporting Standard (IFRS). This purpose of this report is to make comparison of  the new framework with the 1989 IASB (International Accounting Standards Board) framework. The comparison is done on preparation and presentation of financial statements (Chen, Gavious & Lev, 2017). It also discusses the opinions and arguments for the use of fair values in the presentation of financial statements. The report also includes the comparison to the historical cost convention.

The conceptual framework has been left unchanged since it’s initiation in 1989. The IASB and FASB revised conceptual framework in 2004. It was developed to provide direction to users in preparation of financial reports and principles. It provides the concepts that can be applied in emerging International Public Sector Accounting Standards (IPSAS). IPSAS are established to apply in other countries and jurisdiction with different forms of government (Christiaens, Vanhee, Manes-Rossi, Aversano & Van Cauwenberge,  2015). In 2011 the conceptual framework was reactivated and finalised. It provides various open conceptual issues which are faced in various current projects. So, IASB decided to add project to it’s agenda in 2012. It focuses on the topics which are not yet covered such as presentation and disclosure and shortcomings which are need to be improved other than the amendment of framework. In the first step it covers all aspects of framework which were issued in 2013. The purpose of conceptual frame work is to improve conceptual framework and provide base for evolving future accounting standards. It also aims to serve direction to the board in emerging future IFRS standards and address issues (Christensen, Lee, Walker & Zeng, 2015). It also considers the definitions and measurement concepts such as income, expense assets and liabilities in the IFRS framework.

The users of financial reporting are investors, lenders, creditors and prospective shareholders. They make use of information for taking decisions like buying, selling or holding equity or debentures. The users need information about future net cash inflows and resources of entity. The general purpose financial reports do not provide data required by users to take economic decisions. It is also needed to consider relevant information from other sources (Hoyle, Schaefer & Doupnik, 2015).

Development of the conceptual framework

The sensible parties and market controllers find general purpose financial reports more useful. According to board the objective of financial reporting and objective of financial regulations may not be constant. So, the controllers cannot be considered as main users. The purpose of financial reports cannot be mainly directed to regulators. These are not considered to demonstrate the value of a reporting entity. It is also the objective of financial reporting to provide relevant data to board of an organisation which can be used for planning, analysing and decision making. In case of listed companies it provides information about various aspects of organisation to the parties like shareholders and public. It also provides information about the resources of organisation and how the resources have changed overtime. It offers information how an organisation is using it’s various resources. It makes available information to shareholders about performance of organisation and how it is discharging fiduciary obligations and responsibilities (Davidson, Dey & Smith, 2015). It enhances social welfare by taking care of interest of employees and trade union.

There are two underlying assumptions which are used for the preparation of financial statements:

Harmonization: The term harmonization focuses on the minimising differences between accounting standards. It is the process of increasing compatibility of accounting practices. It can be done by reducing alternatives and differences in processes. The users want financial information not only to be intellectual but comparable also so harmonisation is focussed (Brusca, Caperchione, Cohen & Rossi, 2016). The lack of harmonization can put financial burden on MNCs.

Convergence: Convergence is the process of coordinating accounting standards which are issued by regulatory bodies. The objective of convergence is to produce common set of accounting standards to enhance uniformity, comparability and effectiveness of accounting standards (Davies & Hopt, 2013).

The similarity between harmonization and convergence is that both works on reducing accounting principles and creating single set of accounting standards which are used in major capital markets (Henderson, Peirson, Herbohn & Howieson, 2015). The difference between harmonization and convergence is that harmonization focuses on GAAP along with IFRS whereas convergence does not involve GAAP.

The revised framework extracts difference between the qualitative characteristics. These are important in providing financial information:

Fundamental qualitative characteristics:

• Relevance: The relevant information can make difference in the judgements made by operators. The financial information is useful when it is associated to an economic decision otherwise it is useless. The revised framework conveys concept of material as element of the relevance. It is based on the nature and size of entity. The financial information should have analytical or positive value to make a difference.  The analytical value helps in forecasting future outcomes. Positive values empower a user to check earlier forecasts. Materiality is an important aspect of relevance which means material to a particular entity may not be material to another entity. The information can be considered material if it is capable enough to influence decision of operators.  
• Faithful representation: It replaces the term used earlier ‘reliability’ and is the second fundamental characteristics. The financial information shows what it purposes to represent. It represents what really are present like position of assets and liabilities and what really happened like position of income and expenditure as per the case (Frias?Aceituno, Rodríguez?Ariza & Garcia?Sánchez, 2014). The characteristics of faithful representation are:

Completeness: The financial information should be adequate, complete and include all the necessary explanations.

Neutrality: The representation of information should be fair and free from bias. The financial information should not be deployed to influence decision of operators. The true and fair view is referred in accounting.

Importance of the conceptual framework

Free from errors: The financial information need not necessarily to be free from errors. A faithful information can be achieved if is free from errors and inaccuracies. No error should be made at the time of producing financial information. There are still chances of arising inaccuracies, mainly at the time of making estimates. The estimates are made not on random basis; these are made on genuine basis (Martínez?Ferrero, Garcia?Sanchez & Cuadrado?Ballesteros, 2015).

 Enhancing: The enhancing qualitative characteristics distinguish useful information from less useful information.

• Comparability: The comparability empowers comparison within and across entities. The information is compared from one accounting period to another at the time of making comparisons within entity. For instance, income can be compared for the years 2017, 2016, 2015. The comparison of information across entities empowers analysis of correspondences and differences between different organisations (Macve, 2015).
• Verifiability: It helps in assuring users that information represents reliably what it aims to represent.  It is sustained by evidences and individuals can see whether the information is authentically represented or not. If the information can be audited than it is verifiable.
• Timeliness: The timeliness refers to the information provided to users is capable enough to influence users. The information can become obsolete if it is not reported within the time period. It is of no value if it is delayed (Leuz & Wysocki, 2016).
• Understand ability: It requires financial information to be clear and understandable. The financial information of a business should be presented with reasonable knowledge of business. It should have ability of comprehension. To make report simple and understandable, the complex items should not be excluded.

The elements of financial statements focus on the items relating to measure performance and report financial position. It identifies the resources and changes in the objective of financial reporting (Chen, Collins, Kravet & Mergenthaler, 2014).

Assets: Assets are the first component of financial statement. These are the items which have the possibility to provide future economic benefits to an enterprise. The money value is attached to the assets. For instance, cash, accounts receivable, marketable securities, inventory, goodwill and more (Goh, Li, Ng & Yong, 2015). The assets can be categorised into:

• Tangible assets: The tangible assets have physical existence which means these can be seen and touched. For instance, machinery, building etc.
• Intangible assets: The intangible assets do not have physical apperance. These cannot be seen and touched. For instance, trademarks and patents.
• Fixed assets: The fixed assets are the assets which can be put to use for more than one accounting period. The profit can be attained in the longer period. For instance, computer and land.
• Current assets: The current assets can be easily changeable into cash. These are the most liquid assets such as bills receivables.

Liabilities: Liabilities are the present obligations of an organisation outstanding to an entity or individual to transfer resources in the future. For instance, taxes payable, borrowings, accounts payable, bank loan, tax payable and wages payable. The liabilities require the future payments of cash. The liabilities can be categorised into:

• Current liabilities: The current liabilities are repayable during a current accounting year. For instance, creditors and bills payable.
• Noncurrent liabilities: These payments can be kept due for longer period of time. There is no need to release instantly. For example long term loans.

Equity: Equity represents the remaining interest of an organisation in the form of stock. It is also called shareholder’s equity. For instance, ordinary share capital and retained earnings. It belongs to the owners of an organisation. The movement of assets and liabilities decide the increase and decrease in equity. The items recorded in equity can be assumed as share capital, payment of dividends, retained earnings and revaluation gain (Zeff, van der Wel & Camfferman, 2016). Equity can be calculated as

Income: Income is generated by increase in assets and decrease in liabilities. It is the increase in owner’s equity which is result of inflow of assets. For instance income can be generated by selling of goods and services, dividend received from investments and interest generated from bank deposits. The principles such as cash basic and accrual basic are used to recognise income.

Expense: Expenses are the decrease in economic profits during an accounting period. It results in outflow and depreciation of assets. For instance, depreciation, repair, maintenance, transportation cost and salary expenses are type of expenses.  The expenses are identified different from the capital expenditure. The capital expenditures are paid for the purchase of fixed assets.

Users of financial reporting

Financial capital: The financial capital is linked to the equity of a company as it is equivalent to equity. The capital of a company can be maintained only if the net assets are equal or exceeds financial amount at the end of an accounting period. The equity at the beginning should not be higher than net assets at end.  It excludes contribution from owners. According to the financial concept, profit can be measured as the excess of equity or net assets. The financial concept of capital is based on the money terms in the period of inflation. The influence of inflation is not taken into consideration. But in the constant purchasing power accounting method, the financial concept is based on real terms and the impact of inflation is fully considered (Nobes, 2014).

Physical capital: In the physical concept, the capital is taken correspondent to productive capacity. In this concept profit can be dignified as the excess of productive capacity at end and over production capacity at beginning. The impact of inflation is taken into consideration at the time of measuring capital and common inflation is ignored. The physical financial concept of capital can be used only when the statements are concerned with operating capacity. It is the ability of company to endure future cash inflows. The business owners who understand the concept can avoid cash flow pitfalls (Pablo-Romero & Sánchez-Braza, 2015).

The use of fair value: IFRS 13 describes the fair value and framework for the measurement of fair value. It involves disclosure of fair value measurements. It can be applied when another standard requires disclosure of fair value measurements except the special circumstances. The special circumstances are governed by the standards. For instance, IFRS 13 does not specify and discloses measurements. It defines the value or price that can be used to sell an asset or allocate liability. At the time of assessing fair value, the entity uses conventions which can be used by market participants at the time of pricing assets or liability (Cascino & Gassen, 2015). IFRS 13 provides fair value hierarchy for attaining at fair value:

• Level 1: Unadjusted mentioned prices for the undistinguishable assets and liabilities in the active markets.
• Level2: Recognizable inputs for assets and liabilities such as mentioned prices in active markets for the like assets and liabilities for undistinguishable assets and liabilities which are not active.
• Level 3: The unobservable inputs are established by using the best information available. It is developed when there is no activity in market for assets and liabilities at the date of dimension.

The use of historical cost: The historical cost is the basis of measurement and frequently used. It records assets at historical value. This is vital for proper functioning of accountability. It is combined with other bases of measurement. It is used to determine amount of depreciation expense. The assets are valued at the original cost in the historical cost concept. It does not apply to certain assets such as cash and trade receivables (Ellul, Jotikasthira, Lundblad & Wang, 2015).

These both measurements are used to calculate value of fixed assets of an entity. The difference is fair value is used to calculate on the basis of fair value whereas historical cost is calculated on the basis of historical cost of fixed assets. The fair value affects assets in different way. However historical cost never affects book value of assets (Voormolen, Junginger & Van Sark, 2016). Depreciation may be deducted for calculation of fair value of assets.

Accurate valuation: The fair value accounting make available accurate estimate of assets and liabilities. When the price of assets and liabilities increases it marks up the value of assets.

Financial statement improvements: Fair value increases the worth of the assets of the company. It is due to appreciation in value under the current market conditions (Cannon & Bedard, 2016).

Subjectivity: The assets which are not traded on public exchange, the fair value measurements are limited to subjectivity.

Loss recognition: The value of assets changes when the losses are reported. It does not happen when they are involved in transaction.

Underlying assumptions for the preparation of financial statements

Simple and convenient: The historical cost concept is simple and convenient. The transactions can be recorded only at original amount. A person does not have need to restate financial statements every year.

Reliable accounting information: the historical cost concept sustains reliable accounting information. Data is not manipulated due to availability of reliable accounting information.

Accuracy: It does not accurately represent the current market value of assets. It is because a user does not restate financial information every year.

Incomparability: The historical cost provides misleading impression of financial statements.

Conclusion

From the above report it can be concluded that the common conceptual framework makes a significant commitment for the convergence of US and international accounting standards. The framework develops future accounting standards. IFRS 13 has been defined which is type of such standards. The background and objective of financial reporting has been discussed to evaluate conceptual framework. The essential assumptions for the preparation of financial statements have been discussed. Along with this qualitative characteristics and elements of financial statements justifies conceptual framework. Further concepts of capital and capital maintenance and use of fair values in preparation and presentation of financial statements have been explained.

References

Brusca, I., Caperchione, E., Cohen, S. and Rossi, F.M. eds., 2016. Public sector accounting and auditing in Europe: The challenge of harmonization. Springer.

Cannon, N.H. and Bedard, J.C., 2016. Auditing challenging fair value measurements: Evidence from the field. The Accounting Review, 92(4), pp.81-114.

Cascino, S. and Gassen, J., 2015. What drives the comparability effect of mandatory IFRS adoption?. Review of Accounting Studies, 20(1), pp.242-282.

Chen, C.W., Collins, D.W., Kravet, T. and Mergenthaler, R.D., 2014. Financial statement comparability and the efficiency of acquisition decisions. Contemporary Accounting Research.

Chen, E., Gavious, I. and Lev, B., 2017. The positive externalities of IFRS R&D capitalization: enhanced voluntary disclosure. Review of Accounting Studies, 22(2), pp.677-714.

Christensen, H.B., Lee, E., Walker, M. and Zeng, C., 2015. Incentives or standards: What determines accounting quality changes around IFRS adoption?. European Accounting Review, 24(1), pp.31-61.

Christiaens, J., Vanhee, C., Manes-Rossi, F., Aversano, N. and Van Cauwenberge, P., 2015. The effect of IPSAS on reforming governmental financial reporting: an international comparison. International Review of Administrative Sciences, 81(1), pp.158-177.

Davidson, R., Dey, A. and Smith, A., 2015. Executives’“off-the-job” behavior, corporate culture, and financial reporting risk. Journal of Financial Economics, 117(1), pp.5-28.

Davies, P.L. and Hopt, K.J., 2013. Corporate boards in Europe—accountability and convergence. The American Journal of Comparative Law, 61(2), pp.301-376.

Ellul, A., Jotikasthira, C., Lundblad, C.T. and Wang, Y., 2015. Is historical cost accounting a panacea? Market stress, incentive distortions, and gains trading. The Journal of Finance, 70(6), pp.2489-2538.

Frias?Aceituno, J.V., Rodríguez?Ariza, L. and Garcia?Sánchez, I.M., 2014. Explanatory factors of integrated sustainability and financial reporting. Business strategy and the environment, 23(1), pp.56-72.

Goh, B.W., Li, D., Ng, J. and Yong, K.O., 2015. Market pricing of banks’ fair value assets reported under SFAS 157 since the 2008 financial crisis. Journal of Accounting and Public Policy, 34(2), pp.129-145.

Henderson, S., Peirson, G., Herbohn, K. and Howieson, B., 2015. Issues in financial accounting. Pearson Higher Education AU.

Hoyle, J.B., Schaefer, T. and Doupnik, T., 2015. Advanced accounting. McGraw Hill.

Leuz, C. and Wysocki, P.D., 2016. The economics of disclosure and financial reporting regulation: Evidence and suggestions for future research. Journal of Accounting Research, 54(2), pp.525-622.

Macve, R., 2015. A Conceptual Framework for Financial Accounting and Reporting: Vision, Tool, Or Threat?. Routledge.

Martínez?Ferrero, J., Garcia?Sanchez, I.M. and Cuadrado?Ballesteros, B., 2015. Effect of financial reporting quality on sustainability information disclosure. Corporate Social Responsibility and Environmental Management, 22(1), pp.45-64.

Nobes, C., 2014. International Classification of Financial Reporting 3e. Routledge.

Pablo-Romero, M.D.P. and Sánchez-Braza, A., 2015. Productive energy use and economic growth: Energy, physical and human capital relationships. Energy Economics, 49, pp.420-429.

Voormolen, J.A., Junginger, H.M. and Van Sark, W.G.J.H.M., 2016. Unravelling historical cost developments of offshore wind energy in Europe. Energy Policy, 88, pp.435-444.

Zeff, S.A., van der Wel, F. and Camfferman, C., 2016. Company financial reporting: A historical and comparative study of the Dutch regulatory process. Routledge.