Introduction and the IAS Framework Wiecek and Young IFRS Primer Chapter 1.

Introduction and the IAS Framework

Wiecek and Young

IFRS PrimerChapter 1

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Chapter Overview

Introduction and the Framework The U.S. experience to date Looking ahead Measurement model End-of-chapter practice

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Introduction and the IAS Framework

A common set of global accounting standards Conceptual framework for the preparation and

presentation of financial statements GAAP hierarchy

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A Common Set of Global Accounting Standards

Do we need a common set of global accounting standards?

Various GAAP have been developed in many countries due to differences in the legal, regulatory, social, economic, and cultural environments.

– Results in financial statements that are not comparable and difficult for users to interpret

This acts as a barrier for global capital movement

Recently, there has been a movement toward harmonization and convergence of GAAP

– Most significant initiative being led by the International Accounting Standards Board (IASB)


IASB: Reports to the IASC Foundation Structure: www.iasb.org 12 full-time and 2 part-time members Mandate – single set of high quality, understandable,

enforceable global standards– Transparent, comparable information

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The IASB works with national accounting standard setters to move toward global convergence. To date, nearly 100 countries haveconverged (require or allow IFRS) or are on the path to convergence.

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Political and Regulatory Issues

One issue with convergence is enforcement

Once standard setting moves to a global arena, this fragmented regulatory environment will prove to be a challenge

With so many entities regulating the markets, is it possible to be consistent?– In October 2005, IOSCO announced that it would create an IFRS database

for regulators to share decisions on the application of IFRS

Is there or can there ever be total acceptance of IFRS? – It may be required only for consolidated financials and for public companies – National GAAPs are still in existence and are widely used

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Can one set of standards meet the needs of all users?

There is a concern that private companies would not benefit from using IFRS

Many operate in a local market and have more simplified business models

On the international front, there is a move to establishing more simplistic standards for these entities

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Principles or rules—which are better?

IFRS is referred to as being principles-based– They are more loosely framed, allowing for professional judgment to be

applied– Results in accounting that is more flexible to deal with unique economic

and business circumstances– Some argue that allowing professional judgment introduces bias

At the other end of the spectrum is a rules-based GAAP model that is more prescriptive

– Provides a rule for every situation – Body of knowledge too large and complicated – Although more guidance is a comfort to some, it becomes difficult to

ensure that the standards are all consistent.

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In January 2008, the CEOs of the Big 6 accounting firms concluded that the key elements of a principles-based accounting standard were as follows:

www.globalpublicpolicysymposium.com

CONCEPTUAL FRAMEWORK FOR THE PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS

Purpose Formal status Users and objectives Qualitative characteristics Elements

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What is the role of a conceptual framework? The conceptual framework sets out the concepts that underlie the preparation

of the financial statements

The purpose of the framework is to:

(a) assist the IASC in the development of future International Accounting Standards (IAS)

(b) assist the IASC Board in promoting harmonization of regulations

(c) assist national standard-setting bodies in developing national standards

(d) assist preparers of financial statements in applying IAS

(e) assist auditors in forming an opinion on whether financial statements conform with IAS

(f) assist users in interpreting the information contained in financial statements prepared according to IAS and

(g) provide those who are interested in the work of IASC with information about its approach to the formulation of IAS

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What is the formal status of the conceptual framework? Not an IAS in and of itself and nothing in the framework overrides a

specific accounting standard

IASB notes that there may be cases where the framework is in conflict with a specific standard and, in these cases, the standard would override the framework

Where there is no specific standard, the framework should govern the accounting

Applies to the financial statements of all entities, whether public or private

Currently the subject of a joint project between IASB and FASB

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Users and Objectives According to the framework, users of financial statements include:

– Investors, employees, lenders, suppliers, creditors, customers, governments and the public

The overall objective of financial reporting is to produce financial statements that present fairly the results of operations and the financial position

The objective is articulated in the framework as follows:

-Financial statements are to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions

-Financial statements prepared for this purpose meet the common needs of most users

-Financial statements also show the results of the stewardship of management, or the accountability of management for the resources entrusted to it

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Qualitative Characteristics of Useful Information

Understandability: One benefit of a common set of quality accounting standards is that they create

less confusion and are more likely to be understood by users internationally

Relevance: Relevant information must at least have the following characteristics:

1. Predictive value— many users use historic information to predict the company’s future profits and cash flows. Although the past does not necessarily allow users to predict the future, it does provide information that can be used to assess the future potential of the entity

2. Confirmatory value— many users use the information to confirm their prior expectations and to assess management performance

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CONCEPTUAL FRAMEWORK FOR THE PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTSRelevance (continued):

The concept of materiality is useful in that it defines the level of inclusion of information

As noted in the framework, information is material and useful if its omission or misstatement could influence the economic decisions of users

Information might be material based solely on its nature or alternatively, on its size or dollar value

Currently the standard does not have a quantitative definition for what is material and what is not

Often in the past, materiality has been defined as an item that is larger than 5 –10% of income

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Reliability: Information is considered reliable if it has the following characteristics:1. Faithful representation—the objective of financial reporting is to communicate

information about the entity and its economic events and transactions. In the proposed framework, this concept replaces reliability

2. Substance over form—this is often referred to as economic substance over (legal) form. Accounting should reflect the substance of a transaction and should look beyond the legal form

3. Neutrality—unbiased information is better information. Biased information is of lesser quality since it is not objectively prepared

4. Prudence—this concept is similar to conservatism. Many uncertainties are associated with information in the statements and prudence acts to ensure that the assets and income are not overstated. In the proposed framework, this concept disappears

5. Completeness—refers only to material items and, in terms of the other criteria, the benefits must exceed the costs

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Comparability: The main benefit of having one set of global standards is comparability Use of the conceptual framework by all entities, whether they are publicly

accountable or not, would enhance this IFRS still allows a fair bit of choice in the various standards and the IASB

is trying to reduce the number of incidences where choices are available

Balance/trade-offs: The proposed framework separates the qualitative characteristics into two

categories -“fundamental” and “enhancing” – It is proposed that fundamental characteristics will include relevance

and representational faithfulness, while enhancing characteristics will include comparable, verifiable, timely, and understandable

Materiality and cost will be seen to be pervasive constraints

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Elements of Financial Statements Elements are recognized when probable and measurable with reliability

Assets: a resource controlled by the entity as a result of past events and

from which future economic benefits are expected to flow to the entity

Liabilities: a present obligation of the entity arising from past events, the

settlement of which is expected to result in an outflow from the entity of

resources embodying economic benefits. Liabilities may be legally

enforceable via a contract or law, but need not be

Equity: a residual interest in the assets of the entity after deducting all its

liabilities

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Elements of Financial Statements (continued)

Income: increases in economic benefits that result in increases in equity (other than those related to contributions from shareholders) Income includes both revenues (resulting from ordinary activities) and

gains Gains are not treated as a separate element since they may also arise

due to ordinary activities. Income may be realized or unrealized

Expenses: decreases in economic benefits that result in decreases in equity (other than those related to distributions to shareholders) Expenses result from ordinary activities Similar to gains, losses may also result from ordinary activities so are not

treated as separate elements Expenses may be realized or not realized

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GAAP Hierarchy

IAS 8 identifies the GAAP hierarchy as follows:

1. IFRS (including IFRS, IAS, IFRIC, and SIC) and implementation guidance

2. If no standards exist, financial statement preparers may look to similar situations and related issues that are covered by IFRS and the conceptual framework and

3. If there is no guidance, we may look to other standard-setting bodies as long as they do not conflict with the above

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The U.S. Experience to DateThe rise of principles-based standards? Historically, U.S. GAAP developed without much outside influence and has

been viewed as being a very robust model and gold star standard

The pressures to converge are mounting due to the recent and not-so-recent abuses of the rules-based GAAP such as Enron and WorldCom

IFRS for Foreign Filers Since the SEC has now allowed foreign filers to use IFRS without a

reconciliation to U.S. GAAP, the question arises as to why U.S. companies are not able to follow IFRS

The SEC has just published (September 08) a roadmap that proposes to allow public companies to use IFRS starting in 2014

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The U.S. Experience to DateConvergence with IASB In terms of the convergence/harmonization mandate, the following steps

have been taken:– The Norwalk Agreement (2002)– Roadmap for convergence (2006)

Roadblocks in the Roadmap– The fate of the codification project?

Significant funds spent to date– Additional disclosures and safe harbor rules

IFRS requires more disclosures in the financial statements – will this mean more risk of lawsuits for preparers and auditors?

Any legal protection?– Decreasing influence of U.S. constituents– Funding for IASB – independence?

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Looking Ahead The IASB is currently overhauling the framework with FASB

According to the proposed framework currently being finalized:

The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential investors and creditors in making decisions as capital providers

The emphasis is on resource allocation (lending and investing) and assessment of management stewardship

With regards to the qualitative characteristics of useful financial information:– Faithful representation is attained when the substance of an economic

phenomenon is depicted completely, accurately, and neutrally– Conservatism/prudence will be excluded from the qualitative characteristics

of accounting information as they conflict with neutrality– Reliability is now gone from the framework (absorbed into the concept of

faithful representation)

Looking Ahead The IASB and FASB have agreed on the following changes in definitions.

(these views have not yet been exposed in an Exposure Draft)

The following definitions have been proposed:

-An asset of an entity is a present economic resource to which, through an enforceable right or other means, the entity has access or can limit the access of others

-An economic resource is something scarce that has positive economic value. It is capable of being used to carry out economic activities, such as production and exchange

-A liability of an entity is a present economic obligation that is enforceable against the entity. The framework will define a liability as an economic obligation rather than a probable future sacrifice

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Measurement Model

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End-of-Chapter Practice

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Introduction and the IAS Framework Wiecek and Young IFRS Primer Chapter 1.

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