Conceptual Framework Essay by Nuradilah

7/28/2019 Conceptual Framework Essay by Nuradilah

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Accounting Theory and Practice Bkaf3083

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CONCEPTUAL FRAMEWORK ESSAY

There is no definitive view of what constitute a conceptual framework but it can be

applied in many disciplines. However, in accounting field, FASB defined its conceptual

framework as a coherent system of interrelated objectives and fundamentals that is expected to

lead the constituent standards and it also acts as structured theory of accounting. In a broad

sense, a conceptual framework can be seen as a statement of generally accepted accounting

principles (GAAP) that form a frame of reference for the evaluation of existing practices and the

development of new ones. As the purpose of financial reporting is to provide useful information

as a basis for economic decision making, a conceptual framework will form a theoretical basis

for determining how transactions should be measured (historical value or current value) and

reported.

A conceptual framework must consider the theoretical and conceptual issues surrounding

financial reporting and form a coherent and consistent foundation that will underpin the

development of accounting standards. It is not surprising that early writings on this subject were

mainly from academics. At the highest theoretical levels, it states the scope and objective of

financial reporting. At the next fundamental conceptual level, it identifies and defines the

qualitative characteristic of financial information such as relevance, reliability, comparability,

timeliness, and understandability also the basic elements of accounting report including assets,

liability, equity, income, expenses and profit. The Conceptual Framework project aims to update

and refine the existing concepts to reflect the changes in markets, business practices and the

economic environment that have occurred in the two or more decades since the concepts were

first developed.

Some accountants have questioned whether a conceptual framework is necessary in order

to produce reliable financial statement. They argue why must they bother with formulating a

general theory of accounting now, although at past there is no general theory of accounting. It is

true that this profession has survived so far without a formally constructed theory and could

probably continue so, however since many problem has arise and the reason is lack of general

theory, so the conceptual framework of accounting is developed in order to solving this arising

matters. Past history of standard setting bodies throughout the world tells us it is. Even though

accounting bodies have issue standard, creating more constraint on the choice of accounting


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methods, many are of the view that accounting practice is overly permissive. This view is held

mainly because accounting standards allow alternative accounting practice to be applied in

similar circumstances. In the absence of a conceptual framework, accounting standards were

often produced that had serious defects. The problem arises is including, they were not consistent

with each other particularly in the role of prudence versus accruals/ matching principles. They

were also internally inconsistent and often the effect of the transaction on the statement of

financial position which is considered more important than its effect in income statement.

Moreover, standard were produced on a fire fighting approach, often reacting to a corporate

scandal or failure, rather than being proactive in determining best policies. Some standards of

setting bodies also were biased in their composition and this influenced the quality and direction

of the standard. Furthermore, the same theoretical issue also revisited many times in successive

standard.

It could be argued that the lack of a conceptual framework led to a proliferation of rules-

based accounting systems whose main objective is that the treatment of all accounting

transactions should be dealt with by detailed specific rules or requirements. Such a system is

very prescriptive and inflexible, but has the attraction of financial statements being more

comparable and consistent. By contrast, the availability of a conceptual framework could lead to

principles-based system whereby accounting standards are developed from an agreed

conceptual basis with specific objectives.In developing a conceptual framework for accounting it is considered that there are a

number of building blocks that must be developed. The framework must be developed in a

particular order, with some issue necessarily requiring agreement before work can move on to

subsequent building blocks. The building blocks are what the conceptual framework describes

as the elements of financial statements (assets, liabilities, revenues, expenses, and so forth),

which are defined in FASB Concepts Statement No. 6, Elements of Financial Statements. Figure

6.1 provides an overview of the framework developed in the late 1980s by the International

Accounting Standard Committee (IASC), and which later adopted by the IASCs successor- the

International Accounting Standard Board, IASB. While initially referred to as the IASC

Framework, it is now referred to as theIASB Framework for the Preparations and Presentations

of Financial Statements (or simply referred to as the IASB Framework).


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The AASBs statements of accounting concepts (SACS 1 to 4) and the IASBs

Framework were developed following the lead of United States standard setter, the FASB. In the

period 1987 until 2000, the FASB issued seven concept statements covering the topics including

objective of financial reporting by business enterprise and non-profit organization, qualitative

characteristic of useful accounting information, elements of financial statements, criteria for

recognizing and measuring the elements and use of cash flow and present value information in

accounting measurement. The Framework for the Preparations and Presentations of Financial

Statements was issue by the International Accounting Standard Committee (IASC), the

predecessor of the IASB, in 1989 and was subsequently adopted by IASB in 2001. The

framework describes the basic concepts by which financial statement are prepared. It serves as a

guide to the IASB in developing accounting standard and to resolving the accounting issues that

are not covered directly in an international accounting standard (IAS), an international financial

reporting standard (IFRS) or an IFRIC interpretation.

A number of countries, such as United States, the United Kingdom, Ireland, Canada,

Australia and New Zealand have undertaken various activities directed to the development of a

conceptual framework. The IASC also undertook work to develop a conceptual framework.

There are many similarities and maybe some differences between the various conceptual

frameworks developed in the jurisdictions. It is arguable whether any standard-setter anywhere

in the world has developed what could be constructed as a complete conceptual framework.One country particularly active in developing framework in relation to financial reporting

was the United States. Initially, some of the work involved developing prescriptive theories of

how accounting should be undertaken, while other research related to the development of

descriptive theories of how accounting was generally performed. For example, in 1961 and 1962

the Accounting Research Division of the American Institute of Certified Public Accountant

(AICPA) commissioned studies by Moonitz (1961) and Sprouse and Moonitz (1962). These

theories prescribed that accounting practice should move towards a system based on current

values rather historical cost. This work was considered to radically different from generally

accepted principal (AICPA, 1973) and was abandoned by the profession. The AICPA then

commissioned Grady to develop a theory accounting. Grady (1965) was basically descriptive of

existing practice, thereby being quite uncontroversial. His work led to the release of Accounting

Principal Board (APB) statement No. 4, Basic Concepts and Accounting Principles Underlying


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the Financial Statement of Business Enterprise in 1970. As it was not uncontroversial and simply

reflected generally accepted principles of the time, APB Statement No. 4 had a high probability

of being acceptable to the AICPAs constituency.

Because the objectives focus on an entitys economic resources, the claims to those resources,

and the changes in them, it follows that the definitions of assets, liabilities, and other elements

necessarily are central concepts in the framework.

The framework consists of two main components which are first, the objectives of

financial reporting and second, the concepts that result and follow logically from those

objectives. The objectives flow from the more general to the specific. The objectives begin with

a broad focus on information that is useful in investment and credit decisions. That focus then

narrows to investors and creditors primary interests in the prospect of receiving cash from their

investments in or loans to reporting entities and the relation of those prospects to those of the

entities. Finally, the objectives focus on information about an entitys economic resources, the

claims to those resources, and changes in them (including measures of the entitys performance).

That information is useful to investors and creditors in assessing the entitys cash flow prospects.

The objectives, therefore, focus on matters of wealth. Investors and creditors seek to maximize

their wealth (within the parameter of the risks that they are willing to bear). Likewise, businessentities also seek to maximize their wealth. It follows, then, that information about the wealth of

those entities and the changes in it is relevant to investors and creditors that are seeking to

maximize their wealth by investing in or lending to those entities. The concepts flow from the

objectives. Comprehensively reviewing all of the concepts in the FASBs conceptual framework

is not feasible in a short article like this. However, it is useful to briefly consider one of the less

well understood aspects of the frameworkthe fundamental building blocks of financial

statements.

In 1978, the FASB Statement of Financial Accounting Concepts (SFAC) No 1 (paragraph

34) stated the following basic objective of external reporting for business entities are financial

reporting should provide information that is useful to present and potential investor and creditors

and others users in making rational investment, credit and similar decision. Both IASB and

FASB framework consider the main objective of financial reporting is to communicate financial


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information to users. The information is to be selected on the basis of usefulness in the economic

decision making process. This objective is seen to be achieved by reporting the information that

is useful in making economic decisions, useful in assessing cash flow prospect and the financial

reporting must be about enterprise resources, claims to those resources and changes in them.

In order to provide useful financial information, the accountant must choose which

information to transmit. It therefore becomes necessary to develop a hierarchy of qualities which

make information useful. Principal qualitative characteristics include understandability for

decisions makers, relevance and reliability and comparability (and aspect of those qualities such

as materiality, faithfulness representation, and substance over form, neutrality, prudence and

completeness. SFAC No. 2 and the IASB Framework explain the qualitative characteristic.

Understandability refers to the ability of information to be understood by users. Users are

assumed to have a reasonable knowledge of business and economic activities and accounting,

and willingness to study the information with reasonable diligence. Information has the quality

of relevance when it influences the economic decisions of users by helping them evaluate past,

present or future events or confirming or correcting their past evaluations. To be reliable,

financial information should faithfully represent transaction and events without material bias or

error.

The boards concluded that a comprehensive reconsideration of all concepts would not be

an efficient use of their resources. Many aspects of their frameworks are consistent with eachother and do not seem to need fundamental revision. Instead, the boards adopted an approach

that focuses mainly on the improvement and convergence of their existing frameworks, giving

priority to issues that are likely to yield standard-setting benefits in the near term. The boards

also decided to focus initially on concepts applicable to business entities in the private sector.

Once concepts for those entities are developed, the boards will consider the applicability of those

concepts to financial reporting by other types of entities, such as not-for-profit entities in the

private sector and, in some jurisdictions, business entities in the public (governmental) sector. In

this phase of the conceptual framework project the boards are considering conceptual matters

relating to the reporting entity. Other active phases are considering many conceptual matters,

such as the objective of financial reporting and the qualitative characteristics of financial

reporting information, and also the elements of financial statements measurement. The boards


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will consider, in later phases, matters of presentation and disclosure and, as discussed above, the

applicability of the concepts in earlier phases to other types of entities.

There are four important key issues in developing conceptual framework. The

development of conceptual framework is influenced by the issue such as principles-based versus

rules-based approaches to standard setting, information for decisions making, decisions-theory

approach and lastly users in accounting information. In 1974 the Accounting Principles Board

within the United States was replaced by the Financial Accounting Standard Board (FASB). The

FASB embarked on its conceptual framework early in its existence and the first release,

Statement of Financial Accounting Concepts (SFAC) No. 1: Objectives of Financial Reporting

by Business Enterprise occurred in 1978. This was followed by the release of five more SFACS

with the latest one, SFAC No. 6, being issued in 1985. The initial SFACs were quite normative

that is, they attempted to prescribe how accounting should be undertaken. However, when SFAC

No. 5: Recognition and Measurement in Financial Statement of Business Enterprise, was

released in 1984 the FASB appeared to opt for an approach largely descriptive of current

practice. Rather than prescribe a particular valuation approach the FASB describe some of the

various valuation approaches commonly used such as historical cost, current cost (replacement

cost), current market value (exit value), net realizable value, and the present (discounted) value

of future cash flow. The failure to take the lead and actually prescribe a particular valuation

approach was referred to as a cop-out by Solomons.Other countries such as Canada, Australia, and New Zealand have devoted resources for

development of a conceptual framework. In Australia, Work on the conceptual framework

started in 1980s, with the first of four Statements of Accounting Concept being issued in 1990.

The Australian conceptual framework had a number of similarities to the FASB project and, as

with the FASB, prescribing a particular measurement principle was a major stumbling block. In

Canada, initial efforts were incorporated in a document entitled Corporate Reporting: Its Future

Evolution, which was released in 1980. This report was written by Edward Stamp and become

known as The Stamp Report. This report appeared to rely heavily on The Corporate Report and

like The Corporate Report was embraced by the accounting profession. Subsequently, further

work was undertaken towards developing a conceptual framework with a number of similarities

to the FASB project. In 1990 the Accounting Research and Standard Board in New Zealand also

commenced some work related to the conceptual framework. It has many similarities to other


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framework developed in other countries. At the international level, the IASC published a

conceptual framework in 1989, entitled Framework for the Preparations and Presentations of

Financial Statements, which is also similar in many respect to the conceptual framework

developed in other countries.

At their joint meeting in April 2004, the IASB and FASB discussed plans for

coordinating their future activities, which included a staff proposal to undertake a joint project to

develop a common conceptual framework for use by both Boards. The Boards decided not to

make an agenda decision at that time, but instead directed the staff to develop a plan for

conducting such a project for discussion at their joint meeting in October 2004. At their joint

meeting in October 2004, the Boards discussed the staff plan and they decided to add to their

agendas a joint project to develop an improved and common conceptual framework that is based

on and builds on their existing frameworks, (i.e., the IASBsFramework for the Preparation and

Presentation of Financial Statements and the FASBs Statements of Financial Accounting

Concepts). That framework will consider developments since the Boards issued their original

frameworks, including considering the frameworks of other standard setters.

From 2005, the IASB and the FASB have been jointly working towards the development

of revised framework that will be used by both parties. The need for this revised framework has

arisen because of the convergence project in which the IASB and the FASB are working together

to converge their two sets of accounting standard. Prior to convergence, many difference existedbetween the respective standards release by both boards. There were also many differences

between the conceptual frameworks developed by the respective boards. Given that efforts are

underway to converged accounting standards being by released by the IASB with those being

released by the FASB, there is a need for one uniform conceptual framework.

As part of their due process, the boards plan to consult interested parties by publishing

common discussion papers and exposure drafts of the common and improved framework. The

boards may also consult by publishing other due process documents to seek views on particular

issues before developing preliminary views on those issues. The boards also expect to continue

to consult in other ways, such as through discussions with the IASBs IFRS Advisory Council,

the FASBs Financial Accounting Standards Advisory Council and in round-table and other

meetings with interested parties.


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The project by the IASB and FASB to develop a joint conceptual framework, derived

from their existing frameworks, is likely to influence the development of accounting standards

for many years to come. It is therefore not surprising that the first discussion papers resulting

from the project have attracted much fiercer criticism than the standard setters seem to have

anticipated, or that much of this criticism has come from within the European Union, which is

committed to adopting the International Financial Reporting Standards (IFRS) of the IASB. The

issue that seems likely to attract most controversy is that of measurement, which has not yet

reached discussion paper stage within the conceptual framework project. In particular, the

IASBs perceived preference for fair value as a measurement objective is likely, if expressed in

the conceptual framework discussions, to be strongly contested. This issue has already been

raised by an earlier discussion paper issued (but not endorsed) by the IASB, and authored by

staff of the Canadian Accounting Standards Board (2005), which praised the positive properties

of fair value. Controversy has been stirred further by the IASBs publication, as a discussion

paper (November 2006), of the FASBs SFAS 157 (2006), which attempts to prescribe the

interpretation of fair value within FASB standards as being a current market sale price, ignoring

transaction costs and free of entity specific assumptions. Many critics feel that the adoption of

this within IASB standards would change present practice significantly and adversely, because

IFRS apply fair value more widely to non-financial assets than do FASB standards. Sale prices

are seen as less relevant and less reliable in the case of non-financial rather than financial assets.Although fair value is a focus for much of the recent criticism of the IASBs standards and is

also likely to be so for its conceptual framework project, the reasons for the criticism lie in other

elements of the framework. Critics of fair value are, in fact, offering an alternative world view of

financial reporting, although this view is usually not well articulated. Nor, for that matter, is the

fair value world view well articulated: the argument is usually conducted on the basis of

accepting a few simple assumptions that make fair value seem to be an obvious choice, whereas

the assumptions themselves should be under discussion.

The development of conceptual framework met with criticism in the United States,

Australia and elsewhere. In all question of accounting standard setting or debate on accounting

principles, we find ourselves asking the same basic questions: What is value? How do we value

the basic elements of accounting reports such as assets and liabilities? Within the FASB

conceptual framework project, it is precisely on these crucial issues of recognition and


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measurement that dissension issue. This was basically a description of the elements of

accounting reports and was based on the observation of the current practice. Depuch and Sunder

also argue that nothing in the FASBs conceptual framework seems to be of much help in

resolving contemporary disclosure issues. They support this assertion by selecting three issues:

deferred tax credits, treatment of costs of exploration in the oil and gas industry, and current

value accounting. We can make similar criticism of the IASB framework. Assets and liabilities

are defined in very similar terms to those in a US projects. Not only is the definition of assets

rather vague, but the recognition criteria are couched in terms of probability- a subjective

concept. In addition, the recognition criterion fails to offer any guidance on the measurement

problem, which is fundamental to accounting. Again the definition is open-ended and it appears

that any measures would be acceptable as long as the cost or value can be reliably measured.

Why is a conceptual framework necessary? First, to be useful, standard setting should

build on and relate to an established body of concepts and objectives. A soundly developed

conceptual framework should enable the FASB to issue more useful and consistent standards

over time. A coherent set of standards and rules should be the result, because they would be built

upon the same foundation. The framework should increase financial statement users

understanding of and confidence in financial reporting, and it should enhance comparability

among companies financial statements. Second, new and emerging practical problems should be

more quickly solved by reference to an existing framework of basic theory. For example,Sunshine Mining (a silver mining company) sold two issues of bonds that it would redeem either

with $1,000 in cash or with 50 ounces of silver, whichever was worth more at maturity. Both

bond issues had a stated interest rate of 8.5 percent. At what amounts should the bonds have been

recorded by Sunshine or the buyers of the bonds? What is the amount of the premium or discount

on the bonds and how should it be amortized, if the bond redemption payments are to be made in

silver (the future value of which was unknown at the date of issuance)? It is difficult, if not

impossible, for the FASB to prescribe the proper accounting treatment quickly for situations like

this. Practicing accountants, however, must resolve such problems on a day-to-day basis.

Through the exercise of good judgment and with the help of a universally accepted conceptual

framework, practitioners can dismiss certain alternatives quickly and then focus on an acceptable

treatment.


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Conceptual framework is absolutely an important document for the Board as well as

constituents. I believe the primary use of the framework is to make sure that the FASB does not

issue standards in a random fashion. The framework provides a necessary common conceptual

underpinning that helps the Board resolve issues. Besides that, it also brings the discussion about

accounting standards to a higher level. So, every time the assessing is made to an accounting

issue, we dont start from ground zero again and debate what an asset, liability, is and so forth.

We start with the understanding that those concepts have been defined and those are the tools

with which we have to work to come up with an answer on an accounting issue. Understanding

the framework is important to constituents, because it helps them understand how the Board

thinks about issues and puts them in a stronger position to influence the Board on those issues.

Having said that, if they are engaging the Board in a discussion to convince them of they position

on an accounting issue, they will have to use the same language they use. Unfortunately, that has

probably been deficient over the years because I dont believe many preparers and other

constituents have used the conceptual framework to raise issues with the Board to justify their

views. It is inconceivable to think that they can make a difference or influence the Board without

understanding the basic language that is being used in this process.

In international standard setting, the issue of having a common language is amplified, and

it is even more important from a global perspective because standard setters come from such

different backgrounds. It can only be imagine how much more useful it would be at aninternational level with people from various countries, cultures and backgrounds, coming to the

table and trying to set common standards and converge. Take, for example, the task of bringing

together U.S. standards and international standards. It would be critical to have that common

language inherent in the conceptual framework. The conceptual framework also becomes the

foundation for a number of amended or new accounting guidelines that the FASB is in the

process of formulating for ultimate implementation. The conceptual framework is essential

because it adds a level of rigor and disciplines those results in more consistent final statements,

and also provides constituents with the detailed rationale that underlies new and/or modified

accounting rules. In some cases, FASB constituents may debate the merits of adopting an

accounting standard change or newly-formulated statement. The Board can then justify the

reasoning and rationale behind it by referring to relevant principles within its conceptual

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At this time, the conceptual Framework are believed will supports the contention made

by many analysts and investors that U.S. GAAP provides a higher level of conservatism and

transparency in corporate reporting policies as compared to GAAP frameworks in countries

outside the United States. As a result, the United States is typically regarded as the safe haven

during periods of significant global economic and financial turmoil; this is a competitive

advantage. There are a number of benefits that could accrue to the FASB if it decides to highlight

(or revisit) this issue to standard setters outside the United States. These would include the fact

that the United States has a conceptual framework that underlies all of its GAAP statements,

existence of the conceptual framework ensures that the FASB adheres to a rigorous and

disciplined standard-setting due process; and lastly conceptual framework is the basis for

corporate reporting policies and U.S. GAAP standards that have definitional and historical

consistency.

In Malaysia, Conceptual Framework of Accounting is managed by The Malaysian

Accounting Standards Board (MASB) is established under the Financial Reporting Act 1997 (the

Act) as an independent authority to develop and issue accounting and financial reporting

standards in Malaysia. The MASB, together with the Financial Reporting Foundation (FRF),

make up the new framework for financial reporting in Malaysia. This new framework comprises

an independent standard-setting structure with representation from all relevant parties in the

standard-setting process, including preparers, users, regulators and the accountancy profession.As a conclusion, we have seen that conceptual frameworks are made up of a number of

building blocks that cover issue of central importance to the financial reporting process. From a

technical or functional perspective it has been argued by accounting standard setter that the

development of conceptual; framework will lead to the improvement in financial reporting

practices, which will in turn lead to reports that are deemed more useful for the economic

decisions made by the reports users. With a well formulated conceptual framework there is an

expectation that information will be generated that is one or more relevance to report users, as

well as being more reliable. The use of logically derived conceptual framework will allow

constituents to understand more fully how and why particular accounting standard require

specific approaches to be adopted and will provide prepares with guidance when no specific

accounting standard exist.
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Conceptual Framework Essay by Nuradilah

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