After reading this chapter, you should have an appreciation of the following:

E ,t u role of a conceptual framework

E ,tr" objectives of a conceptual fiamework
! developinga conceptualframework
I a critique of conceptual framewo* projects
! a conceptuat framework for auditing standards.

-7

Worldwide accounting academics and standard stters alike have auerapted to develop
a conceptual framewort that provides a defnitive staternent of the nature and purpose
of financial accounting and reporting and which provides guidance for all accounting
practice. Individual academics drone most of the early attempts. Their main aim was to
provide a solid theoretical base to explain accounting and to make it logical for their
students. Since the early 1980$ 3tandad setters and professional accounting bodies
have shown strong interest in the developmenr of a conceptual Samework to guide
the preparation and presentation ofgneral purpose fnancid reports in the public and
private secton,
C.onceptud framervork proiecB were canied out in the 1980s and early 1990s in the
United Stats, Canada, theUnited Kingdom and Austratia. fie li'imo*htrcountln'g
Standards Board (IASB) i$ued its*dqarrcrk in 1989. Progress on conceptual framervorks
in all iurisdictions has been slow,-riiif,?isagreenr-Gbout their content and appticaburty.
In panicular, standard setters encountered difticulties when attempting to address

fundirmental isires relating to measurement. Polirical intenrention also hampered

developmmt of conceptual frameworks. In the latter )rgars of the 199G, greater progress
-promulgating
was made in
individual standards than rhrough development of the
conceptual framework. this chapter describes the role and obiectirres of a concepnral
framework It provides an overview ofdevelopment ofconceptual frameworks by the IASB
and in the United States by the Financial Accountirg Srandards Board (F.{SB).
The esublishment ofthe IASB/FASB convergence proiect in 2002 rekindled intereet in
the conceptual framework The process of harmonising accounting shndards highlithrs
the need for a robust framewor& to guide standard setten in the task ofconverging and
developing new standards. Thus, in 2004 the IASB and FrISB began a ioint proiecr to
dwelop a single connplete and internally consistent concepnral framework. The structure
ofthe proiect is outlined in this chapter. lt is likely that the proiea will face nany ofrhe
diffiorkies encountered in previous attemprs to develop concephral frameworla, which
we also discuss in this dtapter. In addition, many criticisms of conceptual fnmeworls
have been presented. A disctrsion ofthese critiques condudes the chapter. g-

.-,|llll-

THE ROI-E OF A CONCEPTUAT FRAMEWORK

A conceptual framework ofaccounting aims to provide a suuctured theory ofaccounting
At is highest theoretical levels, it states the scope and obiective of financial reponing.
At the nxt fundamental conceptual level, it identifies and defines the quatiutive
draracterirtics of financial infoimation (such as relevancg reliability, comparability,

timeliness and understandability) and the basic elements of accounting (such as assets,
liabilities, equity, rwenue, experuees and profit). At rhe lower operational levels, rhe
conePtual framework deals with principles and nrles of recognition and measurement
of the basic elemenc and the type of information o be displayed in financial reports.
Figure 4.1 provides a diagrammatic representation of the possible components of a
conceptual framework. Tfte diagram, created by standard setten ftom Ausrralia shows
the maners which are considered in the various levels ofa conceprtual framework.
It is often argued that there should be a tcienti6C mahodology behind the framework
for it to be legitimare. The scientific methodolo6y applied to daermine principles and rules
of accounting measurement is assurned to be deduced from previously defined obiectives
and conceps. For orample, the FASB has defined the conceptual framework as:
coherent systPm of intemlated obiectives and fundamentals rhat is expecred to lead
to consirtent standards and that prescribes the nature, firnction and limits offinancial
accounting and reporting. I
...a

PART

Theory and accounting practice

Standard

1. Definition of financial reporting

5etting

2. De{inition o{ the repo.tiog entity (SAC 'l)

Levels

1. Border of discipline/authority
2. Subject
3. Objective
4-5. Fundamenals

H.

Operational
3.
Obiective (SAC 2)

9-12. Display
I 3-l 7. Standard-seuint policy
18-19. Enfo.cement
4.
Qualitativecharacteristics

. Wealth
. Financial structure
. Capacity to adapt
. Solvency/l iquidig

(SAC 3)

Change in rvealth
variability of change
in rveal*r

Financing activities
In\sting activitis

Mdeting

of

rquiaements
re 9, l0 and

ll

mm::#if;
FICURE 4.1 Tentative building blocks ofthe conceptual framework for regulated
financial reporting
Source; Au*.llian Accounting Reserrch Foundalion and Austtalian Accountiog Standar& Eoard
statement of Accounting Concepts {SAO 4 'Delinition and Recognition of the Elements of Financial
Strtements', |995.

Sudr words as 'coherent system' and 'consistend indicate that the FASB advocates a
theoretical and non-arbitrary frameworlq and the word 'prescribes' supports a normative
approadr.
' Some accountants ask whether a conceptual framework is nec6sary. They argue
rhat formulating a general theory of accounting through a conceptnl framework is
not necessary. We have not had a general theory of accounting in the past" so one is
not neceesary now. AlthoWh it is true that th profession has suwived so far without
a formally constructed theory and could probably continue to do so, numerous

problems have adsn because ofthe lack ofa general theory. Some people hold the view
that accounting practice is overly permissive because it perrrits altemative accounting
practices to be applied to similar circumstances. This permissive mode of operation was
described in a special repon to a committee of the New York Stod< Fxdrange as long ago
as 1934:
The more pracrical altematiw worrld be to leave ever,w corporation ftee to choose its
own methods of accounting within the very broad limits to which reference has..been
made ..

.2

Allowing entities to select their own accounting methods within the boundaries of
generally accepted accounting principles is deemed desirable by sorne.3 Accounting
---.r -.^-

L--.-

.,.:

^J .^ ^-.-Lt:-|.

^,1^- L,, :.^!in,

l ^--^.,
-.i^-.._ ^-^..- -^-^t.,.: ^-- ^- u
swer^ur5

standards. Some of the early regulations were a distillation of pnctice, supponed by

arbirrary arguments rather than a set of consistent principles. Some cunent practices
are due to the direct influence of laws, rules of govemment agencies, pressures from
business managers and even political opediency- The Accounting Principles Board
(APB) in the United States admited as much in 1970 when it declared that generally
accepted accounting principles are:
. . . conventional
that is. rhey become generally accepted by agreement (often tacit
agreement) rather than by formal deriwation from a sa ofpostulate or basic concpts.
The principles have developed on the basis of experience, rgasorl crstom, usage, and,

to a sitnificant rcenl pnctical necessity.a

There are many.sources of authority in accounting. For examplg rhe US Intemd

Revehue Service accep$ rh last-in-fim-out (UFO) nahod for inventory valuation
and the accelerated method of depreciation; hence, the methods are accepted by rhe
profession. Business managers and executives sometimes persuade accountants to
devise 'accepuble' accounting schemes for the purpose of minimising their tax orpense
or inoeasing their reponed profit. In this regand, Paon once took issue with the method
of lower of cost and market value for inventory valuation. He said:

'

The ... enthusiasm for the device .. . was not a tribute to the merits ofthe scheme as a
wonhwhile accounting mechanism . . . but as an immediate method of reducing taxable
income. ln other words, the wide use of the rule in the United States is not as timehonoured as many thin( and it waxed on account ofconsiderations far removed ftom
development of sound accountings

lnconsistency of practices has bem seen as a problem. Gellein, a former member

of borh the APB and FASB, commented that because of the lack of a conceptual

framewodg 'Greshamt law somaimes takes oven bad pnctices at times triumph over
good practices.'6
Before the conceptual ftamework debate, accounting standard setten followed the
route ofprarious professional bodies in trying to provide answers lo specific accounting

questiot$, However, providing answene to panicllar problems presupposeg a 'theory'

which provides the basis for deriving these answers. Since no generally accepted theory
of accounting exists, the recommendations of authoritative bodies can be viewed only

as

somewhat random solutions to pressing problems of the moment. On reviewing the

hisory of formulating accounting principles, Storey concluded:

. . . solutions resulting from the play-ir-by-ear approach have rarely rumed out to be
lastingsolutions (even taking into considention the dynamic nature ofaccounting) . ..7

The

PART

Theory and accounting prectice

Solomons argues that someone has to make

iudgement about the type of accounting

whidr is desinble. He argues against standards being sa by inductive observation

because the ruult of this process is that:
A principle or practice would be dedared to be'right because ir was generally accepted;
it would not be generally accepted because it was tighd.s

Solomons also sees the conceptual bamework as a defence against political

interference in the neutrality of accounting reports. He notes that accounting policies
can be implemented only by making a value iudgement, but rhere is no way of proving
that the value iudgements of any individual or group are beter for society than those
of othen. Thus, the provision of a 'coherent theortical base' from which standards are
derived provides a concpnral defncr:
If a standard setting body cannot show that irs standards will lead to tlre production
of information having the qualides and draracteristics nece$ary to anain a detrned
accounting obiective it will have no defence agairut sectional interest that sees a
standard as inlurious to its welfarg for if a sundard is not derived ftom a conceptual
framework, how can it be shown that one standard is better than any other?g

the

benefits

of a

conceptual framework have been summarised by Australian

gtandard setters as follows:

(a) Reponing requiremenB will be more coruistent and logical because they will stem
frod an orderly set of concepts,
(b) Avoidance of reponing requirements will be mudr more difficult because of the
odstence of alkmbracing provisions.
(c) The boardr that establirh the rquiremene will be more accountable for their aclions
in that the lhinking behind specific requiremmt will be more erglicil as will-any
compromises that may be included in panicr.rlar accounting

standards. :

(d) The nied for specific accounting standards will be reduced to those circumstances in
whidr the appropriate applicarion of concpts is not dear-ort, rhus minimising the

risla of over-regulation.
(e) Preparen and auditors will be able to better underutand the financial reponing

requiremmc they face.

(f) The sating of requirements will be more economical because

need to be redebated fiom difiering viewpoints. l0

@*

issues should

not

OBIECTIVES OF CONCEPTUAT FRAMEWORKS

In 1978, the FASB Stakment of Financial Accounting Concepts (SFAC) No. 1
(paragnph 34) stated the following basic obiective of ocemal fnancial rcponing for
businss entities:
is usefirl to precent and potential
making rational investment sedit and

i-*inancial reponing should provide information that

I-

investors and creditors and other usen

similar decisions.

in

Both the IASB and FASB frameraorla consider the main obiective of financial
reporting is to communicate financial information to usdr. The information is to be
selected on the basis of
usefulness in the economic decision-making procds. This
obiective is seen to be achieved by reporting information that is:
o useful in making economic decisions
o useful in assessing cash flow prospectr.
o about enterprise rsources, claims to drose resources and dranges in them.

ir

CHAPTIR

A concptual f.amewo

tk

.,.;:l:'':"-j
"9.7.,'..''.:

ln order to provide useful financial information, the accountant must droose whidt
information to transmit. It therefore becomes nece$lary to dwelop a hierardry of
qualities which make information useful. Principal quditative draracteristics indude:
understandability to decision-makers, relerrance, reliability and comparability (and
i$pects of those qualities such as materiality, faithful representation, substance over
form, neutrality, prudence and completeness). The hieraidrical arrangement of the
qualitative characteristics presented in SFAC No. 2 is shown in 6gure 4.2.
SFAC No. 2 and the IASB Framwork orplain the qualitative characteristics.
Understandability refers to the ability of information to be understood by users. Usen
are assumed to have a reasonable knowledge of business and economic activities and
accounting and a 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 pasL present or future e\rents or confirming or conecting

their past evaluations. To be reliable financial information should faithfully represent

uZris-a-ctiona and ettentS witlt-out m?terial bias or

error

(IA,SB Frameuorh, paragraphs

i

24-42).
Users

of

ri

Decision makers and their chancteristics

(for example, undenta4ding or prior knowledge)

accounting
information
Pervasive

constraint
User-specific

qualities

Primary

decision-specific
qualities

Ingredients of

primary qualities
Secondary and
interactirre qual ities

Threshold for

recognition
FIGURE 4.2 SFAC No. 2 Qualitative characteristics of accounting information
Source.' FASB/IASB, 'Revisiting the concepts: A new conceptual framework project', diagram p. 4.

j
:

.gA

.::.rli-.'- ,

'

The IASB's kamanrkwas developed followingthe lead of the United States standard
setter, the FASB. In the period 1987-2000 the FASB issued seven concept statements
covering the following topics:
o obiectives of financial reporting by business enterprises and non-profit organisations
o qualitative characteristics of usefrrl accounting information
. elements of financial statements
. criteria for recognising and measuring the elements
. use of cash flow and present value information in accounting measurements.

PART 2 Theory and accounting practice

The IASB has frist one concept statemenL the hanatnrh for the hEaration and
Prnatution of Financbl Staull,r;nts. ft was issued by the Intemational Accounting
Standards Committee (IASC), the predecessor organisation to the IASB, in 1989
and srbsequmdy adopted by rhe IASB in 2001. The Fnmeuork desoibes the basic
concpts by which financial staternents are prepared. It serves as a guide to the LASB in
developing accounting standards and as a guide to resolving accounting issues that are
not addressed direcrly in .an Intemational Accounting Standard (tAS) or Intemational
Financial Reporting Standard (IFRS) or Interpreration. The IASB states that the
Franetw*:
o defines the obiectives of frnancial statemmrs
. identifies qualitative characteristics rhat make information in financial statements
usefirl

o defines rhe basic elements of financial statements and the concepts for recognising
and measuring rhem in financia.l statements. The ft'amework aclcrowledges
that a variety of measurement bases are used in financial reports (eg. histotical
cos! curent cos! net realisable value and present value) but it does not indude
principles for seleaing mezrsurment bases (paragraphs l, 100, fOl).
lN I hesenutior of Finarcial SaEnenB and IAS 8 Accunting Polici*, Clunges in
Ac@unting rf,tit uus and Errors deal with the presentation of financial statements and
make reference ro the kanewo*. IAS 8 (paragraph r0) requires that in the absence
of an IASB rtandard or interpretation that specifically applies to a transaction, other
event or conditio& nnnagement mu$ use iB iudgernent in developing and applying
an accountiDg policy that results in information that is:
o relevant to the economic decision making

needs of users
reliable in that the financial satments:
(i) represent faithfully the financial position, financial pe ormance and cash flows

ofthe entiqr

(ii) reflect the economic

subrstance

of transactiong odrer events and conditions, and

not merely the legal form;

(iii)

are neutral i.e. fue

(iv)

are

(v) are

ftom bias;

prudent and
complete in all material

rcsPecrs.

of accounting pronouncemnts.
required
in
requires that in making the iudgement
Paragraph l0
IAS S (paragraph

1l)

provides a 'hierardr/

It

managemnt shall refer to, and consider the aPPlicability o0 the following sources. in
descending order:
the lequiremmts and guidance in Sandards and Interpretations dealing with similar
and related isues; and
o the ddnitions, recognition criteria and measurement concePB for aaeets, liabilitie,
income and sryenses in the Framatorh'

statement aniorlates the relationship of the Franannt*, the standards and

interpretations of the standards. It also makes material in the Fnmalotk binding on
prepareB. C,onsequently, rhe development of the revised framervork is being dosely
scrutinised by constiormts. Deliberations about its content are being and will be subiect
to the political process whidr accompanies standard setting.
Since the Fwnaror* was issued in 1989 many n61' surndards harre been issued,
including standards that conflict with the Ftanwprle. Fot anamPlg Bradbury outlines
many inconsistencies between IAS 39 Fiar'ncitl Instrurrllenr,: Re@gnition and Measuremmt
ani! the Franew*.ll 'Ihey arose because of the demand for a standard to be pan
of the set of core standards presnted to th Intemational Organization of Securities

this

CHAPTTR

4 A conceotual tramework

Commissions (IOSGO) in 2000, the complexity of accounting for financial instruments,

the incompleteness of the Framewark, and the lack of acceptance of a kametnrk based

solution by preparers. Areas where theFramauorh provides inadequate guidance indude

accounting for derecognition of financial assets and hybrid financial instnrments.
Further, Bradbury sugests that the Framework ignores risk one of the main attributes
of financial instnrments. Not only should hamworh guide the standard setting
process, it shouid also assist piactitioneis to interpret standar-ds. Theoiy in action 4.1
explores whether the Frameutork appears to have assisted in deriving an interpretation,
case IFRIC 3 (released by the lntemational Financial Reporting Interpretations
Committee), which relates to emissions trading. g*

in this

--l

IFRIC 3 and Emissions Trading

Accounting foi caibons

by Georgina Dellaportas, ICAA

Development of IFRIC 3
Cap-and+rade schemes have been in operation in Europe for a number of years. In December
2004, the International Accounting Standards Board (|ASB) issued IFRIC 3 Emission Rights

to address

accounting for emission rights arising from such schemes. However, the
interpretation met with significant resistance on the basis that it resulted in accounting
mismatches between the valuation of assets and liabilities leading to potential volatility in
the profit and loss. Consequently, the IASB decided to withdrawihe interpretation in June
2005 despite the fact that it continued to consider it to be an appropriate interpretation of
existing IFRS.

Possible approaches
Until definitive guidance on accounting for cap-and-trade emission rights schemes is issued,
an entity has the option of either:

r
'

applying the principles of IFRIC 3 (UlG 3 in Australial or

developing ib own accounting policy for cap-and-trade schemes based on the hierarchy
of authoritative guidance in IAS 8/MSB 108 Accounting Policies, Changes in Accounting
Estimates and Errors.

IFRIC 3 approach

lFRrc 3 takes the view that a capand-trade scheme gives rise to various items that are to be
accounted for separately:
(11 An assetfor allowances held: allowances, whether allocated by government
or purchased,
are to be accounted for as.intangibleassets under IAS 3SIMSB 138 lntangibte Assets.
Allowances issued for less than fair value are to be measured initially at the'ir fair value.
On a go-forward basis, entities have the choice to carry the intangibies at cost or at fair
value (to the extent that there exists an active market foi the allowJnces).
(21 A government grant: this arises when allowances are granted for less
than fair value and
represents the differential between the fair value and the nominal amount paid. The grant
is accounted for under AASB 120 Accounting for Government Grants and is recogn'ised
as deferred income in the balance sheet and subsequently recoqnised as incomd on a
systematic basis over the compliance period for which ihe aliowancls are issued regardless
of whether the allowances are held or sold.
(3) A liability for the obligation to deliver allowances equal to emissions that have been made:
as emissions are made, a liability is recognised as a provision under lp\S 371MSB 137
Provisions, Contingent Liabilities and Contingent fusets. The liability is the best estimate
of the expenditure required to settle the obligation at the balance sheet date. This would
usually be the. present market price of the number of allowances required to cover the
,emissions made up to the balance sheet date.
Theory and accounting practice

The application of IFRIC 3 met with significant resistance on the basis that it rsulb in the
following accounting mismatches:
a measurement mismatch between the assets and liabilities recognised
a mismatch in the location in which dre gains and losses on those assets are reported; for
example, to the extent that the intantibles are carried at fair value any upward revaluation
would be recognised in equity while changes in the liability would be charged ro the

.
.

income statement
a possible timing mismatch as allowances would be recognised when they are obtaind,
typically at the start of the year, whereas the emission liability would be recognised during
the year as it is incuned.
Civen these mismatches, veiy few overseas companies in countries where such schemes
exist have applied IFRIC 3 on a voluntary basis.

soutce: An exce.pt tro|n an adicle by Georgina Dllapo.hs, CA, Char|er magazine, ,une 2008, The
Institute ol Chanered Accountants in Australia.

Questions

1. What would be the likely impact of the 'mismatch' arising under IFRIC 3?
2, To what extent is 'matching' a principle proposed by the lA5B Framework!

3, In what ways can you see the influence of the IASB Frameworl< on IFRIC 3?
4. fn relation to IFRIC 3, do you consider that the IASB Framework provides a 'theory of
accounting'That is, does the Framework explain and predict accounting practice?

-,,.

[fG. DEVETOPINC A CONCEPTUAL FRAMEWORK

The development of conceptual frameworla is influenced by the following key issues,
which we will disnrss in detail:
o principles versus rules-hased approadres to sundard setting
o information for decision making and the decision-theory approach.

Principles-based and rule-based standard setting

Conceptual Fameworks have an imponant role in the standard setting proces.s as they
provide a fnmework for the development of a body of coherent standards based on
consistent principles. The IASB aims to produce principlesbased standards and thus
it loola to the conceptual tsamework for guidance. It rPresna the basic ideas which
underpin the developmant of the standards and assist users in their interpretation of
the standards. While the IASB aims to be a principles-based standard sater, standards
sudr as IAS 39 have been criticised as being overly rule-based. Nobes suggests that the
reasons standards becorne rules-based is that they are inconsistent with the conceptual
frameworks of standard setten. He argues that the use of appropriate principles could
lead to clearer communication and more precision without the need for detailed rules
currmtly induded in standards.l2
Nobes ldmtifies six oramples where IASB standards have detailed technical rules, namely
lease accounting employee benefO Gnancial assets, gonemment grants, subsidiaries and
equity accountiry He argues that rhe need for nrles results from lack ofprinciples or use
of an inappropriate principle (i.e. one that is inconsistent wift higher level principles
applicable in the sundard). However, rule-based standards have some advantages which
agtain their popularity. These indude increased comparability and increased verifiability
for auditors and regulators. Rule-based standards may reduce the oPPortunities for
eamings management however they allow for the specific structuring of transactions to
work around the rules.l3 Determining principles-bard standards is not a simple matter.
The issues are illusaated in relation to leare accounting in lhory in action 4.2.

<''

CHAPTER

A conceptual

Lrn".a'q4

.;'trOl

.;

Principles ns rules: Lease Accounting

Arbitrary and Capricious Rules: Lease Accounting

- FAS 13 v. IAS 17 OplEd
by

I Edward

Ketz

One of the main arguments against a rules-based accounting standards-sefting system is that
resulting rules are sometimes arbitrary; correspondingly, proponents of principles-based
accounting claim that resulting standards will not be arbitrary, but rather logical, consisten!
transparenL and informative to financial statement users. Lease accounting is often presented
as an exemplar of this point. Since the IASB standards are purportedly principles-based, let's
rlla ?q?-ip5t
connoafe the FASR .-.ar i__-_._-r_
nrinrinle_
x44nrnrino rrrlc
and lnnk
-.o-....-_ the intelnatlOnll ::-_-_-_..i::!:::6:-:=
-=:,
at the differences. FAS 13 versus IAS 1 7.
IAS I 7 classifies leases
finqqge leases,or operating leases, but this is mere words. Finance
-as
leaies corresp6nd io the Financial nccounting'Sdnd;;dsfoard's lapital leis6s. There are five
criteria for determining whether a lease is a finance lease; they are:
The lease trahsfers ownership to the lessee;
The lease contains a bargain purchase option to purchase that is expected to be exercised;
The lease is for the major part of the economic life of the asseq
The present value of the minimum lease payments amounts to substantially all of the fair
value of the leased asseq
Only the lessee can use the leased asset.
The first four criteria correspond strongly with those of FASB; the last one is also contained
in FAS 13 even though it is not specifically included as one of the criterion to determine
whether a lease is a capital lease.
critics are correct inasmuch as FASB included bright lines in criteria 3 and 4 (the z5 percent
and the 90 percent thresholds), whereas IASB did not. One wonders, however, whether that
change eliminates or enhances arbitrariness in financial reporting. True, FASB chose thresholds
that cannot be defended while IASB does not contain them. fhe upshot might be to move
the threshold from the standard-setter to the preparer and the auditor, without the investor/s
being privy to the debate. For examplg the preparer might have a lease in which the prese4t
value of the minimum lease payments amounts to (say) 95 percent of the fair value of the asset
and.argues for operating lease treatment. What power and authority does an auditor have to

.
.
.
.

that assertion?
Yes, FAS 13 conhins bright lines that are inherently arbirary as no economic theory supports
the 75 percent or the 90 percent thresholds. But, the lack of biight lines does not solve the issue
at all
merely shifu the decision about the threshold from thl $andard-sefter to the preparer
chal lenge

-.it

and to the auditor. This adds subjectivity to the determination of an appropriate cutoff point
hYTn w-hat-i1a capihl or an operating lease. Unfortunately, this reaiii places the deiision
in the hands of the one being evaluated by the investment community, and the last decade has
shown us what happens when we entrust accounting policy making to managers.
Jo ty way of thinkin& the arbitrariness in FAS 13 is significantly less than the arbitrariness
inherent in lAS 17.To ny it another way, the transparency of FRSB's arbitrariness to the
investment community trumps the opaqueness of lASB,s rule.
The present value of the lease is calculated with the interest rate implicit in the lease, if
practicable; otherwise, the present value is determined with the business enierprisets incremental
borowing rate. Notice that IASB thereby allows financial engineering by the managers of the
entity. Managec.can argue that they do not know and cannot find out ahe impticit nte, obain a
loner present value of the leased item, and then be in a better position to argue that the lease is
an operatin lease. lA58'sposition conceptually is no betterthan FASB,s on this point.
IASB defines assets and liabilities as follow:

An asset is 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.

[.."#

PART

Theory and accounting practice

A liability

is a presnt

obligation of the entity arising from past events, the senlement

of which is expected to result in an outJlow from the entity of resources embodying

economic benefiE.
These definitions are not substantially different from FASB,S definitions. Most importantly,
notice that if one is truly principled, he or she must conclude that leased items are jssets and
lease obligations are liabilities. There is no room for operating leases if managers or audilors
are adhering o the principles imbedded in thedefinitions that hSB gives assetiand liabilities.
Both FASB and IASB have ignored their own conceptual frameworks in FAS t3 and IAS 17.
Under both ses of delinitions, leased items are assets and lease obligations are liabilities. The
only logical conclusion for FASB and IASB is to require capitalization of all leases.
When American corporations are allowed to employ international rules. as seems highly
probably, then U.S. managerc will have a field day in hiding rheh lease obligationl
"nu,iing
IASB doesn't have the courage to amend IAS lZ. Justice will come when clas action
suits
will be filed against the managers and directors of such companies and perhaps their auditors
as well. When the plaintift' atbrneys read these lA58 definitions and note that the managers
did nor follow the principles in these definitions, they will go a long way in proving-the
defendant/ intent to deceive. Europeans may quash legal redresses on their continenf but
American courB are not so easy to intimidate.
FAS | 3 is one of the most deficient standards ever isued by FASB. ye! IAS I7 contains most
of the same erorc and shortcomings. lB only improvement
removal of the britht lines
is actually a detriment because it assists managers in their efforts to obfuscate meaningful
communications with investors and creditors. lf thafs the best example of principle+baied
accountin& tive me rules any day.

sou.ce: SmartPros O ?0OB SmartPros Ltd. All Rights Rese.ved, hltp//accounting,snla(pro5.com.

Questions

1. What
2. What
3.

are the criteria in |ASB and FASB standards for classifying a lease as a finance lease?
is meant by'bright lines' in accounting standards? Cive examples ofthe,bright lines,
in US leasing standards.
Mr Ketz does not believe the IASB approach of principles-based standards will be effective
lor leases. Provide details of the arguments he presents in favour of his case and consider

the alErnative view.

4. Do accounting practices under cunent

IASB leasing standards comply with the definition

and recognition critsria of tlre IASB Framerarork?

-,)'Ihe

accounting standards ofthe United States have often been desqibed as rule-based
standards because thq contain many deuiled requiremen$ in:relation to ireatmenu
which must be followed to comply with the accounting standards. Schipper'poinrs out
that in fact llnited Sutes' standards are inithlly formed in relation to principles, whidr
represent a starting point on which the rules are based.lr tn 2002 the Sarbanes-Oxley

Act required the United States regulator (rhe Senfities and Exchange C,ommission or
SEC) to conduct a study of the use of principles in the standard setting process. The
sudy R@mmended that accounting standards be developed using a principles-based
approadr and that standards should have the following dtaracteristics.
o Be based on an improrad and consistently applied conceptual framework.

e Clearly gtate the obiective of the standard.

o Provide sufficient ddail and gructure that the standard can be operationalised and

applied on a consistent basis.

Minimh the use of orceptions from the standards.

o Avoid use of percentage tests (bright lines) that allow financial engineers to achieve
technical cornpliance with the standards while evading the intent ofthe srandard.rs
CHA.TER 4 A conceprual framework

,:ilP..:,,,.,,;;

The greater emphasis on the conceptual framer,rork principles and obiectives arises
from events in 200r-2002 in the United States. It follows the corporate collapses at
Enron and WorldCom, whidr have been blamed in part on the rule-based approach
taken in preparation of financial statements. The Sarbanes-Oxley Act 2002 introduced
many changes to improve the quality of financial reporting and auditing. This overhaul
of financial reporting regulation also changed the approach to standard setting.
Establishing a principles-based approadr as a FASB obiective is timely in terms of the
IASB/FASB convergence program. The production of converged standards by the IASB
and FASB demands that the approach to developing the standards is the same. A lack
of the same underlying approadr would make converging standards and producing
standards for use in both iurisdictions more difficult. Thus, the SEC decision to
refer to obiectives in the production of standards is necessary and timely in terms of
intemational convergence of accounting standards.
One of the reasons for the preponderance of rules in standards in the United
States wai that SEC staff requested niles fiom FASB to use in interpreting accounting
standards. Oqe role of SEC staff is to determine whether companies have complied
with the financial reporting requirements contained in accounting standards.
Howerrer, the interpretation of accounting standards may require skill and iudgemenL
particularly where the standards refer more to principles and rely less on rules. In
some cases, two different arperts (such as auditors from the'Big 4'audit firms) could
interpret the requirements of an accounting standard differently. The SEC has in the
piilil requested rules from the FASB to darify how accounting standards should be
interpreted to ensure compliance with standards. Auditors have sought guidance in
the form of rules to protect thern from litigation.r6 Rules assist reporting entities to
appty the requirernents of accounting standards in the same way, thus increasing the
comparability of financial reporting. While both the F.{,SB and SEC have supported the
emphasis on producing standard based on principles and obiectives, they operate in an
environment where many rules srist and listed companies, auditors and the SEC staff
are trsed to having rules to follow. Consequently, Zeff raises the question whether US
standards

will

become any shorter or less detailed and whether SEC staff

will

become

with deuiled norms. He points out that highly

specific and presoiptive standards are part of the United States accounting culture and
cultural change is not easily adrieved.rz The depth and complotity of GMP has led the
IASB to produce a standard for small and medium enterprises (IFRS for SMEs) that can
be used by entities for which compliance with the full set of IFRS is not cost effective.
Case study 4.1 allows students to explore the benefits of IFP"S for SMEs.
less insistent on company compliance

lnformation for decision making and

the decision-theory approach
It is widely

accepted that accounting data are for decision making or evaluative

purposes in relation to a specific entity. Accounting information for decision making
begins with the stewardship function. In earlier times, the steurard in charge of the
estate had to account to the master. In Pacioli's era, an accounting had to be made to
the 'silent' partners after a venture was completed. Today, managene are accountable
to the equityholders of the company. Those who supply the capital to a business want
to know what the stewards, or manage6, have done with the economic resources
entrusted to them. The information on how managers have discharged theirstewardship
responsibility is used by the equityholders to evaluate the performances of the managers
and the firm.
PART

Theory and accounting practice

._

..

r,,.ri:r13

Since the early 1960s, emphasis has been placed on the decision_making
aspecs
accounting information. For oample, Moonitz stated:

of

Quantitativ data are helpfrrl in making rational economic dcisions, i.e. .. . in making
droices among altemadrres so that actions are conecfly related to consequences.18

reasol for this emphasis was, perhaps, the development of decision theory.
Informadon for decision making however, is not seen to reprace information relating
or accountability. Information for decision making implies *or. th"i

_ 9ne

1o-stewardshin
information_on stewardship. FinL the urers offinancial information-are greatly oganded
to indude all resource providers (such as potential in'estors and aeditors), recipients
ofgoods and services and parties performing a radew or oversighr fimction (Frarrazorr,

pangraph-9). &cond accounting information is seen as inpui data for thi prediction
models of users. We musL therefore, ask the question: What Hnd of accounting
information is relevant to users' predictions of future performance and position? Thirdl
whereas stewardship is concemed mainly with the past in order to assess what
has been
accomplished, prediction looks towar& the future. Accounting information for o<ternal
users is, ofcourse, based on past events, but rhe future cannot be ignored when decision
making is emphatically stated as the objecrive of accounting.
For many, the emphasis on decision making strongly implies the use ofcurrent values.
If it were possible users would prefer to have actual information about the future evenrs
affecting the company. However, we an only predic these events. As they have not yet
occuned funrre events and values are not obiective and cannot serve as a reliable basis
for decision making. For many accountana, current ralue is the most. relev-ant value
for-decision making because the present is closest to the future and stiil gounded in
reality. Hovrever, advocates ofconventional accounting believe that historical cost is still
releyant for decirion rnaking.
the decision-theory approadr to acounting is helpful o test whether accounting
adrieves

is

The theory should serve as a *andard by whictr accountin;

In other words, it should be the blueprint for the consrruction
nany individual systems in practice. If rhe individual systems provide useful
9f-the
informatioo then the theory on whidr the systems are based can 6e considered effective
or valid. The process is presented in fgure 4.3. The anows indicate rhe output of the
theory system or model.
practices are iudged.

FIGURE 4.3 The declsion-theory process

- The mo.lel maps the process by whidr the outputs of the accounting system provide
inpub ro the decision model of the user. Financial information may have i wider
range ofusers. For oamplg the IASB Framewoih.indtdes investors, emfloyees, lenden,
supplien and trade creditors, customers, govemments and their ageniies, and the
public as potential users (paragraph 9). Ttrc Franator* further states that users have
different information needs, some of wNch will not be ma by accounting information
(paragraphs 6-11). Thur as we evaluate the output of accounting systems, we mrx
cHAprER 4 A conceptuat framewor*

...._1.:0{:,aj

consider the odent to which information is usefirl for a range of decision maken. Theory
in action 4.3 orplores a situation where preparers were dissatisfied with performance
measures based on accounting standards. Ttrey provided other measures (of 'undertying
eaminp') whidr they considered berter to meet users' information needs.

-{*

Guidelines for reporting'proforma' earnings

Mind the gap: AICD, Finsia set guidelines

by Marsha lacobs
Losses related to the global financial crisis should be easier to identify in company accounts

after an industry standard on profit reporting was issued yesterday, finance executives and
company directors said.

The Financial Services lnstitute of Australasia (Finsia) and the Australian lnstitute of
Company Directors (AICD) issued voluntary guidelines outlining seven key principles for
reporting underlying profit, which they said would lead to more consistent reporting and give
investors a better understanding of company performance.
The issue of underlying profit was elevated last year after a lgng list of major companies,
including Lend Leasg Axa Asia Pacifig Foster's Group, Newcrest Mining and 5t George
Bank, reported huge differences between their statutory and underlying profit figures.
Underlying profit normally excludes one-off items or unusual adjustments and is considered
by media and analysB as a better indicator of a company's performance.
However, the calculation of underlying profit is not done using the same strict accounting
rules as the statutory profit figure, allowing greater opportunity for malleability in the
underlying profit figure.
John Colvin, chief executive of AICD, said directors were encouraged to follow the principles
'so that any references to underlying profit are easily undentood, consistent and any potential
controversies over one-off adjustments are limited, particularly given the scrutiny of results
announcements in the current economic environment.
"These principles are designed to both promote good reporting practices, and also to
discourage any poor practices, such as inappropriate adjustments to statutory profiS or
window dressing" Mr Colvin said.
KPMG director Michael Coleman, who is the chairman of the AICD reporting committee,
said directors were concerned that statutory resuls did not focus on the same issues that
directors were focused on in a comPany.
He said diredors were more and more concerned to make sure shareholders had a good
level of understanding about what is actually driving a business.
"With greater use of international financial reporting standards, greater use of market
value accounting, greater focus on impairment of assets and write-downs of goodwill, many
directors believed a statutory result was not a proper reflection of what the underlying nature
of the business was,o Mr Colvin said.
"The paper should provide guidance to directors about issues they should consider."
Martin iahy, chief executive of Finsia, said industry adoption of the principles would
improve the overall quality of company rePofting.
"Too often, analysts contend with contradictory and opportune adjustments to statutory
profit figures from one reporting period to the next," Dr Fahy said. 'These principles establish
a new benchmark for companies to clearly articulate the adjustmenB made in calculating an
underlying profi t figure."
Soure: The Australian Financial Revrc'w; l0 March 2009, p. I l.

Questions
is meant by 'underlying profit'? How does underlying profit
profit?
from
statutory
differ
2. Why did the AICD and Finsia release guidetines about reporting underlying profit?

1. According to the article, what

PART

Theory and accounting practice

3. According o

4.

the article, why do some dirctors consider that shtutory profit is not a ,proper
reflection'ofthe underlying business? Explain whefter you agree with the directors, view.
Discuss whether the aclions of (a) directors in releasing an underlying profit figure and

(b) the AlCDrFinsia guidelines are supportive of the IASB/FASBt conciptual

frjmework

proiect.

- -..

Dean and Clarke describe many issues that are relevant to undentanding why the

development of conceptual fiameworla at a national level has been problemitic.rs

The authors argue that development of conceptual frameworks has bem more
ia search for a rationale for ctrrent practice than a re-affrmation of the l"grl, social
and economic framework within which accounting is to function. They suggest that
curent concepnxrl framework projects have sought to develop a. constitution-based
framework for accounting instead of focusing on concepls underpinning ordinary,
everyday commerce. This analysis is highly retevant to intemational standard setting It
will be diffcult to obtain suppon for a framework that depans from odsting practice
and difficult to determine a framework to represent pnctice, when this differi between
countries.

International convergence ofaccounting standards and adoption ofLASB standards in

the European Union, Australia and many other countries has increased the imponance
of the IASB. Lonically, it has also made standard setting more diffiorlt for rht IASB as
many parties are now actively concdmed about dre content of accounting standards. In
this environmeno the conceptual Famework that unde.rpins rhe accounting standards
becomes more importanl ,ones and Wolnizer suggest that the conceptual framework
has a crucial role in sating the agreed scope obiecrives, qualiutive and miruremmt
characteristics of accounting which infuence standard smingzo Such a frarnework
would assist the IASB ro withsrand the political pressures in the standard setting process.
However, Iona and Wolnizer argue that convtgence to the IASB &anazor& will mean

that initiative and innovation in denelopment of conceptual frameworla will dedine

as national stteni no longer work independenrly on conceptual framework proiects.
As part of itr convergence proiect with rhe FASB, the IASB has undertaken a proiect to
relrise its hamdaorh

''

whidr is discussed in the next section. -.,

lnternational developments: the IASB

and FASB Conceptuil Framework
In October 2004, the FASB and IASB added a ioint proiect to their agendas to develop
an improved common conceptual framework. The revised framework will build on rhe
exiaing IASBT and FASB's frameworla and consider developmmts subsequent ro the
issuance of those tameworlcs. The Boards state that such a ftamework is esmtial to
fidfilling the Boards' goal of developing standard! that arc principles-based intemally
consistent and intemationally converged. Ihey haintain that such srandards will lead
to financial reponing that provid. es the information capital provider need to make
decisions in their capacity as capital providers. Ihe FASB states that the project will do

the following

I. Focu on

dranges in the environment cince the original tsameworla were issued, as

well as omissions in the original Famesrorks, in order to effciendy and effectively
improve complae and converge the aisting fiameworks.
2. Giv priority to addressing and ddiberating rhose isuer within each phase that are
likely to yidd bndtc to the Boards in th short term; that is, cross-c tting isrues rhar
affect a number of their proieas for new or revised $andards. Thus, wori on several

CHAPTTR

4 A conceptual framewo.k

+oi:

.:,,:..

f -'I-i,-'-i l

phases of the proiea will be conducted simultaneously and the Boardp e,eect to
beneft from work being conducted on other projerrs.
3. Initially consider conceps applicable to private sector business entities. later,

the Boards will iointly consider the applicability of those concepts to private sector
not-for-profitorganisations. Representativesofpublicsector(governmental) sundardsening Boards are monitoring the proiect and in some cases, considering the potential
consequencs of private sector deliberations for public sector entities.2l
Ttre boards are conducting the ioint proiea in eight phases. Each of the first seven
will address and involve planning researdr, initial Board deliberations, public
comment, and redeliberations on maior aspects of the Boards' frameworks. Ttre phases
are shown in 6gure 4.4.

phases

Phase

A
B

c
D
E

Topic
-O.llectiv*e-all-d-QqalltallveCh-aacteristics
Elements and Recognition

Measurement
Reporting Entity
Presentation and Disclosure, including Financial Reporting Boundaries
(lnactive)

Framework Purpoce and Stahrs in GMP Hierarchy (lnactive)

Applicability to the Not-for-Profit Sector (lnactive)

Remaining lssues (lnactive)

FIGURE 4.4 IASB/FASB Conceptual Framework Project

Source: Conceptual Framework
loint Project of the IASB and FASB, proiect information page,
www.tbsb.org.

'

For eadr phase the Boards plan to issue documenb that will seek comments from
the public on the Boards'tentative decisions. The Boards will consider these comments
and redeliberate their tentative decisions. While the Boards plan to seek comments on
eadr phase separately, they have not precluded seeking commen8 on several phases
concurrently.22 By 30 lune 20O9 the Boards had issued and received comments on an
e'(posure draft (ED) relating to Phase A Obiectives and Qualitative Characteristics. A
discussion paper relating to Phase D Reporting Entity had been issued and work was
continuing on Phase B Elements and Recognition and Phase C Measurement.
The decision to defer consideration of not-for-profit sector issues has been
contentious. In countries such as Arstralia and Neev Zaland, which follow a 'sectorneutraf approadr to standard-setting issues relating to the not-for-pro6t sector need
to be addressed at the same time the concepts are developed for the for-profit sector.
(A sector-neutral approadr means that the same standards are applied in the public,
not-for-profit and private sectors). Feedback from nationd standard setters (from
Australia, Nenr Zealand, Canada and the UK) has suggested three areas where current
Board deliberations raise issues for the not-for-profit sctor.
They are:
an inzufficient emphasis on accountability and starardship
a need to broaden identified users and establish an altemative primary user group
the inappropriateness of the pervasive cash flow foans.23
McGregor and Street2a state that the IASB has some sympathy for the arguments
adrnnced by constituenG. However, ortending the scope of the conceptual framework
project at this time to indude not-for-profit entities will increase the work load of the
Boards and expose the project to the risla of further time delays and greater difficulty

.
.
.

[.;rtiii'

Theory and accounting practice

in reaching decisioru. In an interesting derrelopment, which challenges the IASB,s focus

on the for-profit sector, the IFAC's tntemational public Seaor fucounting Standardi
Board (IPSASB) has began a proiect to develop a conceptual Famework foi the public
sector ntities. The obiecrive of the proiect is to develop a public Secor Conceptual
Framer,rork whidr is applicable to the preparation and presentation ofgeneral purpose
financial reports of public sector entities. A discussion paper was released in September
2008.25 Case study 4.2 at rhe end of this chapter focuses on financial reponing in the
not-for-profit sector. Specifically, it allows snrdents to consider the quality of financial
reporting in this sector using reponing guidelines proposed by a profesional accounting
body (the Institute of Chanered Accounrants in Ausualia" or ICAA).
Comments on the Phase A o(posure dnft (ED) idmtifi several key issues for
stakeholders. whittington26 states that these issues were considered to be uncontroversial,

but this has not proved ro be the case. The ED discusion adds to material in the
existing IASB Frumetwrk (i.e. iu form and argument) and brings it under the scrutiny
of sukeholders who were not involved in the development of the l9g9 FrameworhControvenial matten include the percpective underlying financial reporting (entity vs
propriaonhip), the primary r$er group and the obiective of financial reponing and
the qualitative draracteristics of 6nancial reponing. Eac} of these issues is discussed
below.27

Entity vs proprietorship perspective

in rhis book the mtity and proprietorship perspectives represent
different approaches to financial reponing. The Boards recommended that financial
reports should be prepared ftom the penpective ofthe entity rather than the perspective
of the owners or a panictlar class of ownen. Many respondenrs ageed that the entity
is distinct from its orinen and thus concurred with reponing ftom rhe perspective
of the entity, Others noted that the notion of reports being produced ftom an entity
peFpective was being introduced for the first time (i.e. it was not pan of previous
frameworks) and that the boards did not provide enough information to luitig the
As discussed later

choice of the entity pespective over other perspectives (sudl as the proprietorship and
parent company pempecri\as). The perspeaive adopted is important as it affects work
in Phase D, Reporting entity, where altemative perspectives are under discussion-2s

Primary user group

The Boards proposed that rhe primary user group for general purpose fnancial reponing
is present and potential capital providers. Most respondmts ageed with the Boards,

approadr that present and potential capiul providers (equity investors, lmders and
other crediton) of the entity are the primary user goup. Howeeer, it was noted that
having a diverse primary goup could oversimplifr the rdationship beueen the entity
and individual usen. Other respondene were concemed about the focus on a primary
user group and rhe effect rlris could have on recognition of needs of orher parties, such
as charities and

corponte govemance rnonitoring groups.

Decision usefulness and stewardship

According to the Boards, the obiecrive of financial reponing should be troad enough
to encompass all the decisions that equity investors, lenders, and other creditors make
in their capacity as capital providers, induding resource allocation decisions as well
as decisions made to protect and enhance their investments.'-?9 Many respondents
agreed with the Boards' view. However, many other respondent were concemed that
CHAPTER

A conceptual framework .,..tr|X)

l;-.'.,,t'i

..:.

,-i

the obiective of stewardship is not suffciendy emphasise{ while the role of financial
statementrl in providing information to mable users to forecast future cash flows is
overemphasised. For eramplc a group representing European national standard setters
produced a report specifcally addressing stewardship/accountabilty as an obiective and
conduded that there is broad consensus in support of stewardship/accountability as a
separate obiective of financial reponing.3o
Whitr.ington coruiders that the obieaive of stenardship has been 'sidelined' in rhe
ED and notes that this is not acceptable to many constituents, panicularly in Europe
where stewardship is a key pan of corporate govemance and company regulation.3l
He states that stewardship has been subsumed into the decision usefulness obiective
in the ED. However, it can be argued (and was argued by some IASB Boud members
during discussions of rhe issue) that accountability enhils more than the prediction of
cash flows and that stewardship is about monioring the past as well as predicting the
future cash oows. It may be as mudr concemed with integrity of manatement as with
ecoriomic prformance.

Qualitative characteristics
The IASB hancworh includes four principal qualitative draracteristics, namely
understandability, relevance, reliability and comparability (paragraphs 24-421. The
oposure draft proposes that rhe qualitative characteristics that make information
usefirl arc relev-ance, faithful repruentatio& comparability, vedfiability, timeliness and
understandability; and that the pervash/e coBtraints on financial reponing are materiality
and cost. The qualitative characteristica are distinguished as either fundamental
(relev"ance, faithful representation) or enhancing (comparability, verifiability, timeliness
and undentandability), depending on how they affect the usefrrlness of information.

Nearly a'ery rerpondent commenting on the ED agreed that relevance is a

fundamental durecteristic. A maiority agree in relation to faithful rcproentation,
but suggested the Boards have not adequatdy iustified replacing reliability with
hithful representation and that the terms have different meaaings. Whittington notes
that the 1989 Framanft allowed for a trade off between relevance and reliability
but the ED fails to acl<nowledge that rel*ance and hithfirl represmtation are
relative not absolute properties of accounting information.32 He considen that this
approadr has implications for practice relevance will be considered 6nr followed by
reprsenhtional faithfulne$, nther than allowing for a trade-off which recognises the
relative importantg in rhe panicular situation, of the eadr chancteristic. Penno argues
that an accounting conceptual frameworl< must acknowledge the necessity of what he
descibes as 'vagumess' in its terms.33 The difficulty in capturing concpts in the tenns
used in the Franomh and the implications whidr follow from the use of panicular
terms is well-illustrated in the following IASB disorssion about reliability and hithful

'

reprsentation:
Although some Board members were cautious about losing the term 'reliabld ftom dre.
genenl IFRS lo<icoo other Board menrbers and LASB senior staff noted that 'reliable
ratas one ofthe mo3t problematic terms in that loricon. Some used ir to imply precision;
ohen used it as an excuse to avoid recognising liabilities; others to imply verifiability.
The Board conduded that the only way to avoid this misus and the consequent
miscommunication was to focus on what the &an4!ori was trying to communicate
was to use a difrerent term. 'Faithful tepresentation' was perhaps not the ideal term, but
it was the best rhey had.3'

Not surprisingly, many people suggested changes to the qualitative draracteristics

listed in the ED. Respondene sutgestd that undentandability and verifiability

lt,;..i1o,,'
r l'.'i'

PART

Theory and accounting p.actice

be elevated, as well ag the addition of prudence or concepts such as substance

over
fom, true and fair view, and transparency. The ED reiects the concept of prudence

as inconsistent with nzutrality (which is freedom from bias). some constitueng,

for
whom stewardship is an important obiective may be uncomfortable with removing

prudence. whittington queries the removal of prudence as a quarftative

characteristii
bccause of its importanc in resrraining managerial opportunism.:s In addition, he
daims the concept is still aaively used by the IASB, for example in a recent standard
ll,s 36 lmpairment (i.e. recognise impairmmt losss but not increases in a$et values).
the boards are continuing their work on phase B and phase C Measurement.

In

telation to Phase B, the existing definition of rhe etements of financial reporting (assets,
liabilities, equity, revcnue and o<pense) are being modifed and new recognition criteria
are being proposed,36

As r,toted earlier, prior onceptual framo,r'orla have struggled to deal effectively

with the issue of measurernent. For the same reasonq phase D will be controversial.
Whittington notes that given the cunent reality of financial reponin& the pursuit
of one universal mearurement mahod may be ftuitless.37 He suggests that a more
appropriate approach could be to define a clear measuremnt obiective and to selea
the measurernent method that best meets that obiective in the panicutar ircum$ances
that exist in relarion to each item in the accounts.
The LA$B and FASB need to make progress on the conceptual fnmework as it is
fundamtntal to developing standards and it underpins convergence efforts. Case study
4.3 at the end of this chapter provides an opponunity to consider further the issues
raised in tbis chapter in relation to the IA,SB/FASB conceprual frarnarork pioiecr. The
boards need some meirure of consensus and support about obiectives of financial
reponing and qualiutive draracteristics of financial information to be able ro issue
framewo* chapten that are accepuble to constituents. Feedback cornmmts reoresent
many individual perspectives and views about key atuibutes of informatibn, which
relate back to indMdual views about the purpose of accounting information. We have
seen rhar stakeholders are making their viervs known through the consultation process.
The proiect has many challenges ahead and it is a test ofwhether panies can set aside
individual differences to adrieve the goal of harmonisation of financial reporting.

@=

A CRITIQUE OF CONCEPTUAT
FRAMEWORK PROfECTS
The derrelopment of conceptual frameworla m". wfth criticisms in rhe united states,
Ausealia and ekeryhere. An analysis of rhe criticisms wilt help orplain reas6ns for the
pradous slow darelopment ofthe frameworla and highlight issues relevant to achieving
progress in the cunmt IASB/FASB proiect
There are two approaches we can u,se in our analysis. The fint is to assume that the
conceptual framework sho.ld be a 'scienti6C approach based on the methods usd in
other areas of rientific inquiry. Accounting prescriptions or obs*rrations arising from
an approadr must iustify their validiry by recourse to logc and empiriciinr, or
both. Ttre second is a professional appmach which concenuates on prescribing rhe test,
course of action by re(ourse to 'professional values'. This is similar to a constitutional
approaci to rule settin&
We will discuss two broad areas in our analysis:
r scientific criticisms

y{r

o descriptive and non-opentional.

CHAPTIR

4 A conceptual framework

ll7

In all questions of accounting standard seting or debate on accounting principles

we 6nd ounelves asking the same basic questions: What is realue? How do we value the
basic elements of accounting such as assets and liabilities? One purpose

ofa conceptual

framework is to answer such questions, thereby avoiding repetitious arguments over

rhe meaning of such terms. Prior agreement on these fundamentals should minimise
inconsistencies and inequities arising from differences in ludgement. Given the order
where tenns are previously de6ned and agreed upon
and elhciency of this approadr
it is dear that the onceptud framework
and concepr fit together like building blocks
is intended as a fundamenully prescriptive prolecu The aim is to provide guidance and
prescriptions to practising accountants on how to account for information which is

relevant for economic decision making

Within the FASBs conce-otual fcamework proiecr, ft is on these cnrcial issues of

recognition and measurement that dissmsion arose. The SFAC No. 5 on measuremmt
and recognltion problems, released in 1984, was basically a description of thq.elgmgnts
of accounting reports based on the observation of orrrent practice. By the time SFAC
No. 5 was isgued the Board's approach had becorne almost totally descriprive. Indeed
Shtemenr No. 5 shows that the aims and philosophy of the conceptual hamework had
been lost by the time it was issued. SFAC No. 5 states in several places (paragraphs 35,
51, 108), that concepts are to be developed as the standarrd se$ing prccss volves.
Sudr an arolution philosophy, which sees concepe as being the residual of the
standard cetting process, is in direct contndiction to the purpose of the conceptual
framework38
Funher, Dopudl and Sunder consider that the definitions of the main elements of
assts, liabilities, owners'equity, revenues, expenses, gins and
financial statements
losses
depend <in unspecified rules and conventions:

How can a onceptual hamework guide choices ftom among altemative principles and
rules if the elemmts of the framework are defined in these very same terms?39

Dopudr and Sunder argue that nothing in the FASEs conceptual framework seems to
be of much help in resolving con'temporary measurement and disdosure isues. they
suppon this assenion by selecting three issuis: deferred tax credirs, treatment ofcosts of
exploration in the oil and gas indu*ry, and current value accounting. They condude:
The definition of liabilities is so general that we are unable to prdict the Board's
position on deferred taxes;
2. The framework supports two opposing principles of accounting (full cost and
succesful efforts) and is preliminary evidmce that the ftamewo* is unlikely to be a
usefirl guide in ruolving the measurement issue; and
3.lt does not addresg the problem of estimatio[ on which past effo4s to encounge
publication ofcurrent co$s have foundered.{
1.

'

We can rirake similar criticisms of the IASB Franeuot*.ln this documenc assets and
liabilities are defined in very similar rerms to rhose in the United States proiect. Not
only is rhe definition of asses rather vague but the recognition criteria are couched
a subiective concept. In addition, the recognition criterion
in terms of probability
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 measure would
be acceptable as long as the cost or value can be 'reliably' measured. Recent work by

the IASE/FASB in the conceptual framework proiecr is addressing these criticisms.

ls it imponan! as it is in scienc, lhat prior agreement is readred on lhe precise
definitions of the elemeots ofaccounting? Cerboth contends that real knowledge comes
from investigation of the subiect matter, not from prior agreement on definitions. He

lt2

PART

Theory and accounting, pr.tciic

daims that to base an accounting framework solely on the fimited undersunding

conveyed by such dednitions would be inational.ar
In order to reinforce whar Gerboth perceives to be the negtigible role that
definitions

play in borh human affairs and science, he quotes from pofpJr:

ln science, we should take care that the statemen$ we make should never depend
on
the meaning ofour terms. Even where the trm! are de6ned, we never
try to derive any
informadon from the definitioq or to base any argument upon it That is why
our tsm;
make so litde trouble. We do not orrerburden thim. We try to anach
to them as little
weight as possible..2
This is not the approach of rhe conceptual framework proiecs. When
thery attempt
to defne 'asets', 'liabilities' and other elemenb accounting regularors intend
that rhe

valuadon decisions should depend on rhe definidons. Co"u".l, to popper,

rhe FASB
sought to make the definition bear as much weight as possible.ri
Some argue that the attempt to base accounting practice on prcconceived
definitions
risla a kind of medranical decision- making. Although a concepual framework may
provide a consistency in that ir is elhcient and orderly, it is a clnsistency
of a triviar
soru consi,stency with an abstractioo not consistengr with real ends. This trivial
consistency is a direct consequence of dogmatism whereby pronouncemmtr
issued by
the FAS& or other authoritative bodies, are acceptd by the profession. Ihis
approacfr
canies lhe danger that the framework may become an end in irself, consumini
time
and effort whidr may be berrer foctsed on filling the gaps in accountants substantive
knowledge.-Definitions and prior agreemnt on the meaning of terns are
imponant
to the development of a consistent, intemlated and meaningful system. However, it
is the over-reliance on definitions that popper cdticises. A cJnmry argument
is that
the conceptual framework is necessary and a common understanding
of definitions is
crucial to consistent preparation and interpretation offnancial statemenr,

Ontological and epistemological assumptions

Th-roughout the conceptual framaaror& proiecrs, the focus has been
to provide
information to users offinariciar reports in an unbiased and obiective manner.
Freedorn
from bias, or neutrality, has been defined as ,an informatlon quality that avoids

leading users to conclusions lhat secure the panicular needs, desiru or preconceptions
of the preparers'.a Solomons orptains fuedom ftom bias as ,financial mapmaking,.
Accounting_ is financial mapmaking: the bmer the map, the
_more complaely
the
phenomena
cornplor
that
are
being
mapped.
We
io not iudge a map
Jepresents
by the behavioural etrecrs it produces. The disribution or naturil weao
shown on a map may lead o population shifts or ctranges in industrial location
"", which
the govrnment may tike or dislike. That should be no concem ofthe canographer.
We
iudge their map by how well ir represents the facts. people can then react to it as they
will.45

lt

.i"air

This philosophy of rsalism comes about in accounting from the assumption

rhat
we can obssve, measure and communicate an obiecive economic reality. Some

philosophers of science, for example Feyerabm4 argue that scientific

truth is not
absolufe-- it refers only to a statement about a constructed reality. A given statement
or belief wanants acceptanc only after the evidence conforms with presaibed and
aged-upon rules about what is scimtift methodologr. Hines points out rhar rhe
problem with the economic realisny'measur"-ent
adoptei by rhe conceptual

"pp-".h
framework proiecr in rhe United States (and rhis applies
o the UiSB framework as wrll)
is that within many scientific communities, reality is now viewed as
beiirg constructei
CHAPTER

A conceptual

fta.nework

lfii

and sustaind by social pracrices, thereby polluting accountants' perceptions of

economic reality.r6 In the social scimces, the underoining of the realism philosophy is
even more complee. Within the social scienc6, acton act in accordance with prerailing
definitions and concepts of reality. By doing thi+ they maintain and perpetuate rhat
reality.
but we have not so mudt gasped reality, as crated it by thinhng of it in a cenain
way, and teating it that way ... But whan people have a preconceived notion ofwhat
reality is, wdl we can't afford o go rgainst it! Why not?
..

We are suppcsed to communicate reality in accounting. If people have a cenain

concption of reality, thm naturalh we must reflect that Othawise people will lose
faith in

us.a7

'Ihis makes it questionable whether theories forming the basis of a fiarnework can
E(ssipn of this argumg4t is that
a conceptual framework cannot Provide a completely obiective means of measuring
economic reality since such a reality does not exist independent of accounting
practices. Hines considers that it is a twoway intenctive relationship in which financial

ever be nzutral, independent arld free-.from bias-. Thr

accountan$, by the process of measuring and communicating a picture of reality, play

a critical role in deciding what is reality. Therdore, they create lhat reality.
Hines funher claims thar mainsteam accounting researdr is based on 'takm'forgranted' commonsense conceptions and asumptions, which ntn counter to questions
on how sociat rsality arises and ir maintained and legitimised. For example, conceptual
frameworkc avoid relying on deductirre and empirical evidence for asening their
conectne$. If they did take sudr an approadr, generally accepted accounting principles
would be deduced ftom the higher level beliefs, obiectives and assumptions of the
Famework Instead, the reverse seenrs to occur. These elemen$ are held to be uuths
through an inducrive process of deriving accounting principles whidr have never
been formally te$ed against logic and empirical evidence. The 'authority' equivalent
of science for the concePtual framework is traceable to the opinions of authoritative
bodies and individuals. This is where science and accounting as manifsted in the
coocepnral frameworh seem to diverge.

Funher, the strudure of conceptual framework proiects bears some resemblance

to a hypothetico-deductive approadt.

The hypo&etico'deductive approach to

scientific explanation has two main consequences. 'Ihe first leads to universal laws
or principles from whidr lower level hyporheses may be deduced' Secondly, there is
a tight connection between eiglanation, prediction and the techniques applied. For

and FASB conceptual frameworks have generalised assumptions

and obiectives ftom which principles (standards) and procedures (methods and rules)
should be able to be deduced. lhe essential purpose of this approach to science is lo
arrive at an understanding of our environrnent in order to be able to oPerate more
effectively in that environment. However, rcme authors disagree with this approach
enampla the

LASB

to science:
accounting rleardrers belierrc in a (confused) notion ofemPidol tctability. DesPit
this lad< ofclarity as to whether rheories are 'veri6ed' or 'hlsified', rhere is widespread
...

acceptance

of Hempet's [19651 hypodretico-deduaive account of what constitutes

'scimtifi c oElanation'.r8

This hypothaicodeducline approach inlluences the

epistemological and

methodological assumptions about 'tests of truth' and the manner in which most
accounting research is undenaken' For oramplg emphasis is placed on large+cale
sarnple suweys and empirical analpes using 'statistically sound techniques' and on

|.,

[:,_

11

PART

2 Theory and accounting p.actice

deriving general theories. Assumptions are also made about behavioural dtaracteristics
(e.9. ntional wealrh maximisation and information needs of users, relating to future
cash flows and current values) and about the way people relate to one another and
to societf. These approadres preclude to som rxten! rueardr tedrniques which are
individualistic and/or focus on case studis. As Homgren commmB:
Eadr person has draracteristie that limit dre usefulness of a conceptual frarnewo* . . .
Almost everyone says he or she wan6 a conceptual ftamworh but his or her conceptual
ftamewo* may not be lours.ae

Circularity of reasoning
As we have see& one of the stated obiectives of a conceptual framework is to guide
the everyday practic of accountants. A superficial view of the conceptual frameworla

indicates that accountants at least follow one scientific path

that of deducing
principles and practice from generalised theory. However, various countrieJ existing
conceptual frameworks are typified by an intemal circularity. For oample, within FASB
Statement No. 2, information qualities such as reliability are stated to depend on the
adrievenrent of other qualities, such as representational hithfulness, neutrality and
verifiability. Howyer, these qualitis, in tum. depend on other non-operationalised
information qualities. For example the disctssion of neutrality relies on relevance,
reliability and representarional frithfulness, but rhe necessary and suftcient conditions
for obuining any of these qualities are not stated. The FASB framework attempts to
break out of, or iustify. this circrlarity of reasoning by refening to the notion of an
informed accounting person who will have suftcient and appropriat knowledge to
daermine and interpret financial rcporrs. However, it provides no specific guidance as
to how this should be adrieved.

An unscientific discipline
ls accounting a science? Conceptual frameworks may have attempted to adopt rhe
deductive (scimtific) approadr, but this approadr is questionable if accounting does
not qualifr as a science to begin widr. Accounting has been variously described as an
an or a cnft in addition o its scientific description. In 1981, Stamp said:

llntil

we are sur in our minds about the nature of accounting

it is fruitless for the

profession to invest larye resources in developing a concptual framework to suppon

accounting standards.s

tndee4 Stamp considers that accounting is more dosely aligned to law than to the
phpical sciences, since both the accounting and letal professions ded with con0icts
between different user goups with varying interestr and obiectives. He describes law as
a normatirre discipline whidr is presciptive in nature and full of value-laden conceps.
Accounting faces imperfett markec and involves subiectively base4 human decisionmaking processes. In contirst, the phpical scierres are considered to be positive
disciplines, descriptirre in nature and draractuired by ralue-ftee concepts.
Theoretical and empirical elenents are somewhat loosely defined and applied in
accountir8 and it lada a defnitive scientifc paradign. Early (normative) accounting
theory had many weaknesses. Positive accounting theory is still in its embryonig
possibly pre+cienti6c, stage. This does not necessarily indicate the laci< of a scientific
approach, however. Irrovided the theoretician is rigorous in apptying the ontological,
epistemological and methodological rules relating to the field of study, the scientific
methodologr may be said to be applied.
CHAPTER

4 A conceptual tramework

-,.1t! ,
-. ..:

'

;.-, ;:..jj

Positive research
It has been argued that the basic focus of the concepural fiamework proiects
providrng frnancial information to help users make economic decisions
ignores
the empirical findings of positive accounting researdr. Early market research has cast
doubt on the ability of published iccounting data ro influence share prices and on the
irnponance of accounting data for making economic decisions relating to the share
market. Some argue that the drare market does not appear to be fooled by creative
accounting techniques, the valuarion of asses and liabilities is not a ral issue and that
the rnarket is relativdy efficimt in the semi-strong form. Furthermore, agency rheory
offers an oglanation for the obserrration ofmany different accounting tedrniques.lhese
accounting tedrniques are demanded by agents who seek to minimise monitoring costs
in the most cost-efficient Eanner. The accounting technique of least cost will naturally
vary baween firms and industries. and variation in accounting practice is therefore
desirable. Nonetheless, for decisions with multiple drglces, accounting infoq4ation
may 6e usdfrrl. ftis is an area tliit behaiiourai research has not yet fully considered.
Furthermoe, those who argrre that positive accounting research and a conceptual

ftamework are in conflict sometimes ignore the rnounting evidence that capital markets
are not completely efficient. Even if they are effcimt, the fact that the market responds
immediately to information in fnancial reports does not mean that individuals
process the information efficiantly or that individuals or groups cannot make incorect
investment, lending supply, or purchase decisions. lf a conceptual framework could
ensure that these people received useful information, it would sewe a useful purpose.

The conceptualframework as a policy document

As a generalised body of knowledgc the conceptual frameworks fail a number
of tcientific' tests. Even if we argue that redity is merely a social construct anyway,
there is no deduaive process inherent in rhe ftameworks to apply them to empirical
phmomena in order to drange the reality to a more prdened state in terms of assumed
goals. Whettrer the framervorla can be considered completely normative models for
accounting practice is also a problem, because accepted practice has been determined
laryely by adopting existing procedures whidr the fi'amenvorks anempt to legitimise.

An

'
.

ahemative

to

viewing the conceptual frameworks as either scientific or

deductively derived normative models is to consider them as policy models. Iiiri

differentiates betrveen normative and policy models.sl He says that a nonnative model
is based on certain assumptions concerning the goals to be senad; the researdrer does
not necesarily subscribe to the assurned goals. Thus, although a normative model
has policy implications, it is differmt from a policy iudgemmt, which involves a
commitment to goals. Whether de*riptive or normative, a model is a theory which
can be scientifically veri6ed. This is different ftom policy statements based on value
judgements and opinions. Iiiri points out that theoric and policies are intermingled
in accounting whercas in other empirical sciences the distinction is well stablished.
For oomple economic policies are treated quite differently fiom economic theories. In
contrast accounting theories alwap seem to be tiied to policies.
C-ontroversies among accountiag theorists cenue mainly on how accounting practices
should be canied out
an issue that dearly belongs to accounting policy acrording to
iiiri.t2 Funher, ifone accepts Tinke/s view, then even the positivisr, descriptive approach
ofresearchers is simply an anempt to legitimise an ideologlcal poaition at the theoretical
level.s3 Perhaps a more redistic approach is to reiecr rhe conceptual frameworks as bodies
of tcientifically' derived theory and accept them as policy statements based on value

ifl5

PART

2 Theory and accounting p.acrice

iudgements and opinions. This approadr also has implications in relation to the question
ofwhether conceptual frameworla are largely a refleaion ofprofessional values.
The distinaion betrveen theories and policies is imponant. policy issues are generally
resolved by political means. This can be <rucial when looking at conceptual frameworks
in terms of their interprctation of reality and politlcal processes. political power can be
defined 'as the ibility ofan individual or group to impose their definition of reality on
another individual or group'.s{ Since accounting does nor operae in a social, economic
or political vacuu[L it may be that the resulting conceptual frameworks are to some
enmt a reflection of either the will of the dominant group or, altematively, a consensus
benveen compaing and conflicting political infuences. This view tends to conform

with Buckle/s 'constitutional' approach to policy models, whereby principles

are

derived from a:rioms.5s Such truths as continuity, obiectivity, consistency, materiality

and conservatism are considered self-evidenl The conceptual frameworks appear ro
reinforce this consdtutional approach, largely re-endorsing pre-existing principles. The
FASB, in facL defines a conceptual ftarnework as a 'constitution,, as well as a ,coherent
system of interelated objectives and fundamentals'.s6
The constitutional approach conforms with Bunget assertion that people clainr rhey
can have insdnctive knowledge independent of controlled orperience:
They left science the boring task

offnding the deuils ofthis knowledge but its essence

they hel4 without prooc to be attainable either by special intuition or by reason alone
(rationalism), in any case without e<trospection and e<periment.t?

The constitutional approach also conforms with the assenion that accounting largely
relies on self-evident or dogmaric bases for esrablishing criteria for rruth. Extending this
to the conceptual ftameu,ork truth may simply be the ideas embodied in tlie conventions

and docrrines ofaccounting. That is, in line with the historical-constitutional approach,

the conceptual ftarnework is litde more than the perpetuation of- unquestioned
accounting conventions. This approach is oqressed in Chambers' dairn:

...

all we have as fundamental or basic is a set of propositions that are more or

less arbitrarily establishe4 or which are plain dogmas. There is no body of ideas or
knowledge by reference to which we can iudge whether or not th$e propositions are
prefenble to otheo we must simply accpt rhem.$

ln defending the FASB approach to building a conceptual ftarnework, its chairman

at the time, Kirk daimed that the view that sundarrds can be set by consensus is pan
of a belief that standards are conventions and conventions are formed by agreement.
He promotes the idea that a conceptual framework best serves the public interesL
it is a conceptual approach. Standard stting by conseii-sug compromise or
cotrsquene does not serve the public intercs! because it is a political approach.se
Howwer, this is problematic since the public interest is represented by users who have
confliaing needs. Kirl(s remarks are compromised by a research suwry which he quotes.
The survey showed that a majority of rcspondents from universities, govemmen! the
financial media and the large accounting firms wanted a framework rhat would result in
significant changes in fnancial reponin& In contrast, a maiority of company managers
and security industry officials favoured a framework that afrrmed the status quo.
because

The faa that the FASB conceptual framewo* in many instances describes elisting
practice teods to indicate that the political process prevailed in the development of
the framework. Miller has claimed that the FASB and irs conceptual framework will
suwive only by mainraining a position that reflects the interests of the beneficiaries of
the capital marka. He reiects Kirl/s daim rhat the FASB managed to avoid having to
develop a conceptual framework based on consensus, claiming that standards emerge
CHAPTER

A conceptu.l

framework

117

from 'a vested s* of political processs that qeate inconsistencies as the search for a
congensus continues'.o
The political nature of accounting and its reflecion in conceEual framework proiects
has been stressed in dre accounting literature. For orample, Burdrell and his colleagues
stitt:
. . . ihe roles whidr lfinancial accountingl sewes are suning to be recognised as being
'
shaped by the pressures which give rise ro accounting innovation and ..iange rather
than any essence of the accounting mission.5l

If we accept that rhe conceptual framework will develop to be a description of present

accounting practica rhen it will also be merely an ouqrowth of institutional and social
proesses. This is the very reason Hines believes that the FASB's conceptual ftameerork
and, by implication" the IASB/FASB's cunent ioint proiect" will fail. Irs stated obiective
embraces uuthfulnss and realism. Ttre success of the accounting profession is iudged
against this obiective. Solutions to accounting controversies will always be deterrnined
by social interaction and will be situation+peiidc5z

-J

Professitinal values and self-preservation

An eirplanation ofconcepnrd framewoda in terms ofself-preservation and professional
values may at first appear to be a contradiction in terms. Self-pruewation' implies the
punuit of self-interest" whereas professional values' suggests idealism and altruism.
However, 'professional yalues' can mean several things. Greenwood points out drat
professional organisations emerte as an er<pression of the growing consciousness-ofkind on rhe pan of the profesion's numbers. 'Ihey promote group interests and aims.6j
The outcome of this social interaction is a professional culture with social yalues. The
social values of a professional group form the basic ftrndarnmtals: the unquetioned
premises on whidr its very existence r6ts. Foremost among these values is rhe perceived
wonh ofthe service which the professional goup provides to the community, together
with a strong sense of responsibility to the community.
Gerboth congiders that this sense of personal responsibility
the essence of
professionalism
is what makes accountants' decisions objettive. The key to obiectivity
lies in the values of those who practise accounting, Accounting must tale ia direction
not ftom its concepts or from its intellectual strucnr, but ftom its professional
conducc Gerboth argues:

Of necessity, accountants make man;r iudgernents. And when thq dq their decisiors
may difrer from those that other accountants would make. But that does not make the
decisions arbitrary. Accounkn$' fteedom to decide is not fuedom to decide as they
please.

their personal responsibility for the decisions

;,Htf,*lt*:rf-ation

forces a diligent search for rhe best

of accounting tnrth, and rhat responsibility leaves no room

It was stated earlier in tNs chapter that conceptual ftameworls do not operate in a
social vacuurn. Where complex human affain are involved, it is probably impossible
to develop a comprchensivc prescriptive framework and decision model. For example"
Agnwal, in reference to the United States' framework cites a series of isues ranging
from comparability to cost-effectivmess which cannot be resolved by recourse to
the framewo*.55 These can only be decided by iudgements which will inevitably be
subiectira. ludgement is also largely based on professional rralues. Greenwood refers
to this as the value of rationality where there is a commitment to obiectivity in the
realm of theory and technique.ss Morc conuoversially, he daims thaL because of
this odentation, nothing of a theoretical or technical nature is regarded as sacred and
unchallengeable simply because it has a history of acceptance and use.

. ll8

PART

2 Theory and accounting practice

I

The impossibility of agreeing on normative accounting standards, and therefore

a prescriptive framework is supponed by Demski.cz Demski offers mathematical
eiridence that, in general, no set ofstandards o<ists thar will identify the most prefened
accounting altemative, without specifically incorporating an individualt beiiefs
and
nyfereryes. Stdr beliefs and prderences may be a mix if penonal and professional
values. Thereforg Bromwich believes that the best approach to accounting
standard
setting is to. issrre a srream of 'panial, *andards which consider accounting problems
in

isolation_(similar to current practice before the conceptual fuamework pro1e615;.es ryi6

a narrowly defned panial standards approadr, consensus may be mori
easily obtained
among accounting users and limited resources can be targaed and decenrralised.
A steady stream of standards provides more orplicit evidence of activity to alleviate
pressures on the accounting profession for immediate reform.
The less idealistic aspecrs of professional values are the concepts of professional
authority and monopoly.

'Ihus, the proposition that in all sewice-relared matters the professional

group
'
infinitely wiser

is

than the laity is regarded as beyond argumentlce

This concept conforms with the constitutional approach argued by Buckley. It

is
by rhe propocition that sundard sening is connected witir monoioly-

ftended

seehng behaviour by the profession.zo This is achiarcd by issuing increasingly complex

standards and concepts. The result is that the general public does not undersand the

paraphemalia of complex accounting principles and rules. The public rherefore

has
to rely increasingly on accountants and audiors to prpiu ani interpret financial
reports. This cate* to the economic enhancement ofthe profession by ei:tablishing
and
perpetuating a monopoly on profesrional knowledge. It could actually be
inconsistent
widr. the stated obiective of
to gve a servi& to users by
producing objectively derived relerrant and reliable information.

conceptual

H-ine1 argugs that the

profession

will

ability of the accounting profesion to retain iegirimacy as a

ofrhe apparent theoraical deferuibiiity of

be judged by society in terms

the professiont body of knowledge. This leads to the need for

a conceptual frameworic:
Viewing.conceptual framework proiects as constituting a strategic manouvre
to assisr
in socially constucting. rhe appearance of a cohereni differen-tiated knowledge base
for accounting standard$, thus tegitimising standards and the power, aurhority and
self-regulation of rhe accounting profession, may help in
"-plaining why conceptual
rramework proiects are continually undertaken by the profession . . .71

Hines funher argues that ifaccounting practice is seen by society as nothing more
than
an arbitrary collecrion of unrclated methods, then rhe social legitinacy ofthJ profession
would suffer. The fact that attempts to constuct a conceptual framework may
result in
failure is not imporranl Th existence of standard satin! bodies comprisingmembers
skilled in accounting rheory and practice, ogether with a ionceptual framework
testifies
to the presumed existence of a coherent theoraicar core whicrr underlies practice. This
provides rhe accounting profession with a continued legitimacy.

f-.

CONCEPTUAT FRAMEWORK tOR

AUDITING STANDARDS
discussed earlier, rhe 6rst major attempt to state a general comprehensive
theory of
auditing was by Mauu and Sharaf in 196l.z2 tn a contemporary revi-ew of rhe to<t" Miller
emphasised that Maurz and Sharaf attempted to proria" dreoretical underpinning
iA,s

CHAPTER

A conceptual framewo.k

for a discipline which at that time was primarily regarded as a practical o<ercise.73
Fundamentally, Maue and Sharaf saw auditing not as a subdivision of accounting but
as a discipline based in logic. This led them to the condusion that auditon are not
naturally limited m a verification of accounting information.T4 Modem developments
in some of these extensions of auditing services are surrreyed in chaptr 14. However,
Mautz and Sharaf also questioned the compatibility of auditing and consulting sewices
and recommendd separarlcn of these two t)ryes of services in order to protect auCitor
independence one of their auditing theory's key concepts.Ts
MauE, and Sharafs work was dweloped funher in the early 1970s by the
Statement of Basic Auditing Concepts (ASOBAC), issued by rhe American Accounting
Association.T6 ASOMC had a strong focus on the process of collecting and evaluating
evidmce, another of the fundamental concepts idenrified by Mauu and Sharaf. The
focus of theoretical debate in auditing during the 1980s was the role of structure and
quandfication in the evidence gathering and evaluation process.TT Knedrel describes
this is a period of rapid growth in audit practices, rhb orpansion of the professidnal
personnel popl, improvements in technologr, and the perceived need to reduce costs
in the audit process. All these contdbuted to the movement towards highly structured
and formalistic processes in accounting firms.78
However, Knechel argues that by the 1990s the Eaditions of auditing and the
profcssion's efforts to formalise audit processes began to face opposition fiom other
forces.lhese forces included pressure from clients on auditors to reduce audit fees and
deliver more value. Knechel proposes that one interprctation of the interplay betrreen
these factors was that it led to change in traditional auditing methods. 'Ihere began to
be less ernphasis on direct testing of transactions and balances and more reliance on
testing dients' contiol systems as a means to gather evidence on the fnancial statements
that are produced by those systems. 'Itris involved a reduction in time devoted to an
audiL and a reduction in substantive testing and sample sizes. Ihis process became
krown as business risk auditing
Business risk auditing is a form of auditing that considers dient risk as pan of rhe
audit evidence proces.?e the formalisation of audit risk occuned in the 1970s.80 The
audit risk model requires an auditor to consider the risk of an inappropriate audit
opinion as a function of the inherent risk of errors occuning the risk that the dients
control system will not prevent or detect those enors, and the risk that the auditols
procedures will not detect the error.El lhe focus on audit risk was not new; 6ren in
the 1940s, auditors were instructed to begin their audit with a thorough investigation
of the dient s system and consider its safeguards against fraud and error.62 However,
Knechel argue": that the professionls perceptions of risk began to change dramatically
with the release ofthe 1992 repon 'lntemal Control
- Integrated Framework by the
Committee of Sponsoring Organizations (COSO). Auditors became more aware of
the relation between intemal controls and the conduct of an audit. Clienrs with more
effective inemal controls were seen to be at lower risk of fraud and enor, and this
provided the opponunity to iusdry a reduction in resour<es, costs and -audit fees for
these clients. ln addition, gaps in dients intemal controls provided an opportunity to
sell non-audit services.sl
Business risk auditing emphasises the threats to a client's business model ftom the
complexities in its business environment, and business risk is seen to drive audit risk.Ea
The key conceptual change that business risk auditing brought to auditors was the
requirement to think through the causal relation from the clientt business model and
opentions to the financial accounts, rather than to think in terms of accounting enors
6rst.s For example, the decline in 2007-08 global financial markets would cause auditon

l.:,

PART

2 Theory and accounting practice

II

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I"-

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to coruider the riskto a banlcl loan loss provisions and going

concem assessmenL in
addition tq focusing on specifc as.t
liability
iusiness .tuk
"nd beyond "auaiioni.
meant the audit had to eryand its horizon
the strict confines of the dient iJ
indude key process ownen outside the organisation.Qo
Dorclopment of the business risk model was primarily
undertaken at the large
accounting firms. For exarirple, KpMG's audit methodology
during the period $g;_
2006 has been forrral$ .r srrategic sptems Audit.sT tio*etr.rl
ahhough the new

ilil;;

a-Rnroach was suPposed-to emphasise planning

and business understandin! proce$es,
there is some evidence that auditors were reluctant to do
so, and the aairnel emcienqy
benefig were slow to materialise.s other cotnmentatonB suggest
that business risk
auditing was not really very rorolutionary. The large auditorstready
had a foos on
risk although it was not necessarily clearly-artiailatea until the l990s.se
critics argre that not only was business risk auditing used to justify
a pgsh to sell
consulting services; it ultimately led to the accounting roid.l,
.t Enron and elseurhere.eo
This criticism implies auditors misused business riik auditing
methodology to

brylT

iustify
opportunistic behaviour. Regulators have acted through *]*,
O" Sarbanes-oxley
Act (2002) in the US and the CLERP 9 revisions to the Ausualian
corporations Act
to
the opponunities for auditors to provide consulting seryices
1e1uia
to their
clients,

and there is evidence of increased emphasis on fraud detectioi

in ,h" 2000s.er Knechel
suggests that the funrre of business risk auditing
courd be constraine4 but the focus
on auditing dims'intemal controls in the US legislation still provides
a clear focus
for auditors to consider risla in the client's proce$es and
environments as part of the
fi nancial statement audit.

CHAPTER

,.\

A conceptuat

framework l2l'

Therole of a conceptualframework
ln discussing the role of a.conceptual framework we noted that conceptual framet^'orlc
have been under development since the 1980s in the United States, Canada, the United

f-.

Kingdom, Australia and at the IASB. Ttreir goal is to provide a coherent and prescriptive
framework which will guide and improve accounting practice. Thus, a conceptual
framework aims to: reduce inconsistent practices, delimit the potential for political
interference, and enable better understanding of reporting requirements.

@.
r

The obiectives of a conceptual framework

noth the IASB and'FASB framorrorks consider the main obiective of financial rePorting is
to communicate financial information to users. The information is to be selected on the
basis of its usefulness in the economic decision-making process. This obiective is seen to
be actrieved by reporting information that is useful in making economic decisions, useful
in assessing cash flow prospects, and about enterprise reliources, daims to those resources
andchanges in them.

IID4

Developingaconceptualframework
Dweloping a conceptual framework has been a complicated and lengthy Process.
In recent iint"r, standard setters' attention has re-focused on the derrelopment of
a conceptual framework for two reasons. Fint, in resPonse to corPorate collapses in
ZOOI-OZin the United States, the FASB has been directed to take an objectives-oriented
approach to standard setting ratherthan a nrle-based approach. Aconceptual framework
is considered important in providing underlying principles to be used in obiectives-

based standards. Secon4 the IASB and FASB commenced a convergence proiect in2002
to reduce the differences between US G,AAP and IASB standards. To further this aim, it is
argued that standards should be based on a common conceptual framework Since there

are differences between the oristing IrdSB and FASB frameworla, a proiect to derrelop
a joint conceptual framo,rork was commenced in 2004. Present work has focused on
the obiectivei and qualitative characteristics of financial reporting. Constituents have
expressed a ftlnge of views on these topics. The fnmework which otentually emerges will
reflect the s<teni to which parties with diverse views about financial repoiting are able to

compromise in the interest of harmonisation of accounting.

Eell.
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PART

2 Theory

A critique of conceptual framework projects

We observed that many people are critical of the edsting and proposed conceptual
framework documents. Significant criticisms of prwious conceptual statemen$

and accounting practice

indude measurement is based on unspecified rules, the logic is circular, there is no

prior agreement on obiectives, and the definitions of the elements are unworkable and

provide no guidance to practising accountants.

Others debate the imponance of these criticisms. They argue that prior agreement is
unimportant and may lead to mechanical decision making. loose and imprecise logic
and definitions may indicate that accounting is only in the pre-science stage. Further
criticisms focus on the ontological and epistemological assumptions. Accounting can
never be neutral and unbiased. Accounting as a social science is two-way and does not have
an obiective and separate existence from accountants. In measuring and communicating

'

realtty, accountants play a critical role in creating that reality. Particular methods and
methodologicd assumptions also dominate accountin& whidr leads to generalised and
large-scale empirical research. This tlpe of researdr ignores the micro level of practising
accountants who may require a situation-specific problem-soMng approach.
Some people view the conceptual frameworks as policy documents based on
professional values and self-interest. Therefore they are seen to be a reflection ofthe
political will of the dominant group, which is dominated by professional values. One
motivation is to increase economic power through monopoly-seeking behaviour.
Further, having gained social acceptance and power, the accounting profession seela to

maintain its position and to manipulate attempts at public regulation. The conceptual
frameworls, as a respor$e, testify to the presumed ercistence of a coherent theoretical

core which underlies practice, thus alleviating criticism. There is some evidence,
however, that the ecistence of the conceptual framework proiect has increased the
larel of conceptual debate in the standard setting lobbying process. Furthermore, it
provides guidance for dealing with issues that are not yet the subject of an accounting
standard.

lf?j!f+

A conceptualframework for auditing standards

;i
Early auditing theory emphasised the role of logic and key concepts sudr as auditor
independence and erridence gathering. By the I 990s the formalised auditing processes and
$tructures were under pressure from clients for lower audit fees and greater value. There
was a shift away from substantive testing towards a greater emphasis on consideration of
audit rish in particularthe role of client business risk Business risk auditing emphasised
the impact ofthreats to the dient's business model from entemal factors and the resulting
risk of fraud and error in the financial statements. Critics believed that business risk
auditing was an attempt to iustify less audit work and greater consulting. kgislative
changes since the early 2000s have restricted the opportunity for consulting to audit
dients but also increased the focus on auditingdients'intemal controls.

Questions
1. How do conceptual frameworks of accounting anempt to create a theory
of accounting? Describe the components of the ll$B kameunrh and how it
contributes to a theory of accounting.
2. Some people argue that there is no need for a general ttreory ofaccountin& as
established in a conceptual ftameryork. Thqy say there is no overall theory of phpics,
biolog;l, botany or psycholory, so there is no need for an overall theory of accounting.
Furthermore, attempts to derrelop sudr a theory are futile and unnecessary, since
accounting has not needed a concepnral framework so far. Debate this view.
3. What doa the llrSB Framernrft describe as the basic objective of accounting? What
are its implications?
CHAPTER4 Aconceptual framework

.!.71,..'..

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4. what type of information do you think is useful for shareholders, lenders and
crediton? Is this the type of information that is currmtly provided?
5. .The oEressions 'truth', Justicd and 'faimess'have all been applied to describe
desinble draraaeristics of accounting information. Whatrole do youthinktheyplay
in practice? fue *rey induded in the L{SB franawrl{l If so, how? If noL why not?
6. E:rplain the role of accounting in rdation to:

lr
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.i

t^\:-l:-,:1..-l^
ta, ututvtuud,ro

(b) firms
(c) the Australian economy.

e:rn accounting ever provide an unbiased map of economic reality? why or why not?
8. some argue that the development of a conceptual framework is inappropriate
because accountants constantly ded with soecific issues that will not be envisaged
by an overall, general conceptud framer'vork. In particular, a conceptual framerrork
makes no allowance for differences in the social contocs where accoun-ting is
7

;l

ippiiea. rhey alio argue thit it would uC pi*enute to a*erop ."r""fiani

solutions to accounting issues, based on case study researdr, and bearing in
mind the social contorts of all accounting decisions. Discuss this view, presenting
arguments for and against it.
9. What is the difference between art and science? Is accounting an art or a science?
Does it matterS Why or why not?
10. 'The development of a SME standard by the IASB will defeat the purpose of
intemational harmonisation.' E:rplain whyyou agree or disagree with this statement.
11. In Australia the conceptual framework did not proceed to SAC 5 concerning
measurement.
(a) Why do yoir rhink that was the case?
(b) Do you think that accounting standards have been moving towards a particular
measurement method? If so, what is that method?
(c) How can standards lead the development of a formarised conceptuar
framer,rrork?

12. Give reasoru for your answens to the following questions

(a) Hon, important is it that standard settes agree on obiectives, concepts and
definitions before they de'elop a conceptual framework of accounting?
(b) How important is it that the conceptual framework is generally accepted by the
business community before it is applied to develop accounting standards?
(c) \{try do the FASB and IASB require a common conceptual framework?
13. Explain the advantages and disadvantages of principles-based and rule-based
standards.

::l

PART

14. Why has the F.{'SB been directed to produce more objective-based standards? Do
you consider this to be a realistic standard setting objective?
15. Discuss whether the ll$B Frameunrh is merely a policy doarment based on
professional rralues and self-interesf without scimtific foundation. In your
discussion, state your opinion on whether the conceptual framework should serve
as a policy document in this manner.
16. Assume that you have been contracted by the Australian Accounting Standards
Board to dwelop a'proposal rqgarding whether to issue an accounting standard on
accounting for the costs of environmental damage. Draft a proposal of r5oo words
or less outlining why you think it is appropriate, or inappropriate, to develop an
accounting standard on this issue. Also outline the key issues that would need to
be covered by the standard and horu the conceptuat framework can conuibute to
resolution of those issues.
Theory and accounting practice

i
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17. Write a report of 1500 words or less to the drairpercons of the Financial Reporting
Council and the Australian Accounting Standards Board, commenting on the

following argument:
Attempts to bring about radical change through the introduction of a
conceptual framework have failed. When it appeared as though SAC 4 would
reguire fiuns to report their true liabilities, lobbying began in eamest and
business ensured that any innovation was quashed. As such, the best that
can be hoped for from a conceptual framework is that it legitimises current
practice, maintains eristing social and economic status, and staves offpublic
sector attempts to conuol accounting standard setting.'
18. what is business risk auditing? How does it differ from uaditional substantive
auditing? Why do critics believe it is used to iustify selling more consulting services to
audit cliens? How could business risk auditing be blamed for failures such as Enron?

Additional readings
Alfredson,

K [eo, K

& loftus, L Clarh K

& Wise, V2009, Applyinginternational

financial accutnting stnndards, Brisbane: lohn Wiley & Sons Australia, Ltd.
Bradbury ME, g Baskerville, Rs 2008, The "NZ" in "NZ IFRS": Public Benefit Entity
Amendments'. Australian Acaunting Raniau,vol.18, no. 3, pp. 185-90.
Foster, L & Johnson, L20Ol,'Understanding the issues: why does the FASB have a
conceptual framework?', www.fasb.org.
Loftus, | 2003, The'CF and accounting standards', Abe61!s, vol. 39, no. 3, pp. ZgB-324.
Nobes, C 2008, 'Accounting Classification in the IFF"S Era', Australian ,kmunrtng Raniant,

vol.

18,

Picker,

no.3, pp. 19f-98.

Page, M & Spira, L 1999, The conceptual undenvear of financial reportihg', Accounting
Auditing anil Acuuntnbility lournal, vol. 12, no. 4, pp. 489-501.
Psaros I &Trotman, K 2004, The impact of the type of accountingstandards and prep.uers

judgements',

-l

vol.40, no. l, pp. 76-93.

S 2003, 'Measurement a wayforward', Abccts,vol. 39, pp. 356-24.

Abacus,

Walker, RG & Jones,

Big GMP, small GMP: accounting for

Note; in this article

IFRS

IFRS for SMEs is refened to by a

SMk
prior title,

|FRS for Private Entiries.

for Private Entities: a practical guide

by lrene O'Keeffe

Comparability of companies' financial information

The application of IFRS for Private Entities will significantly improve the comparability
of entities within an industry and across different industries, regardless of where the
reporting entity is domiciled. Under the IFRS for Private Entities, similar transactions and
economic circumstances are accounted for and presented more consistently than under
varying national requirements.
Intemationally, financial indicators are not comparable because different recognition
and valuation principles are applied in each country. This makes it difficult for uiers of
financial statements to make informed decisions on a private entityts performance and
cash flows. Private companies that move to widespread use of IFRS for Private Entities

CHAPTER

A conceptual

framework

fl
,!4

ii:::::1;:

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I'',.,i

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should find that it improves both the comparability of information and the quality of
commun ications to stakeholders.

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u is itions, partnersh i ps and cooperation atreeme nts

The adoption of IFRS for Private Entities will often make

Acq

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it easier to implement
planned cross-border acquisitions and to initiate proposed partnerships or cooperation
agreements with foreign entities. Furthermore, maintenance of financial information
under this IFRS-based standard may simplify the sale of the reporting entity itself,
eidrer as a whole or on a piecemeal basis. This is because financial staternents are key
documents for evaluating an acquisition and negotiating a purchase price, as well as for
assessing potential partnership or cooperation agreements. Interpreting the performance
of the other party's business becomes significantly easier, and agreement is more likely,
whpn hoth sidFs elrpadv havp finanrial 5t2.tg4g11-c prepared uslng a sinnilar acccunting
framework. lf financial information is based only on national requirements, additional
time and expense mustbeinvesled in ordertounderstand thedifferentbasis of accounting
-and
reach a clear asieshent-of the otherpirty'i perfoimlnie. poit acquiiiiion, the
ccts of integrating the financial reporting systems are lower where both the acquirer
and the acquiree use the same accounting framework.
Building relationships with overseas customers
The use of IFRS-based information should help private entities involved in buying/
selling goods or services across national borders to initiate new relationships with
customers and suppliers. As the spread and acceptance of |FR$based standards grows
internationally, so should the importance of IFRS-based financial statemenB as a tool to
cultivate a positive image. lt is not only large foreign groups that now demand financial
statements from companies as part of the process of supplier selection and evaluation.
Suppliers that only prepar.e financial statements under their national CAAP may well
find themselves at a disadvantage compared to competitors with lFR$based financial
statemenB. To eliminate disadvantages in the global competition for new contracts and
allow businesses to compete on their merits, an entity must be able to provide highquality information that, at the very least is as convincing and as relevant for decisionmaking as the information its competitors provide. This is particularly important when
entering into long-term trading relationships: in thesecircumstances, potentialcustomers
or suppliers usually want reassurance about the entity's solvency before committing to a
relationship. This information can be better conveyed using an internationally-accepted
accounting framework, such as the proposed IFRS for Private Entities, rather than a
national framework that needs to be

explained'

Dealing with finance providers

..

. .-

Demonstrating compliance with an lFR$based accounting framewo*should sreng$ren

.
.

a company's position in negotiations with credit institutions and ieduce the costs of
borrowing because of the positive effea it can have on credit ratings. IFRS can also result
in more accurate risk evaluations by lenders and, in many cases, a lower risk premium.
This is because financial information prepared using an IFRS-based standard emphasises
the economic substance of transactions and tends to provide higher4uality information,
with bener disclosures and tnnsparency than many national accounting frameworks.
Compliance with an lFR$based accounting framework may also help private
companies to take advantage of alternative forms of finance. Equity financiers, just like
credit institutions, want top-quality information to help them assess the risks and rewards
of the entity orprojectto be financed. IFRS-compliant i4formation should facilitateclearer
comparisonof investmentopportunities in variouscountriestobemade,and help investors
to identify the specific advantages of each. The better the information for investors, the
easier it should be to aftract them and the lower the risk premium for the company.
Source: Accountancy lreland, vol.4Q, no.6, December 2008, pp. 30-31.

:.'.......'.
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!.:i.--.-.:,'--!-

PART2 Theory and accounting practice

:
:

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Question
The international harmonisation of accounting standards raises questions about which
entities should use international standards and whether one set of standards is suitable
for all entities. For example, should use of international standards be limited to large
international companies for which international comparability is important? Can one
set of standards be used for all entities, regardless of size and structure, independent of
whether the entity is from the private, public or not-tbr-profit sector?
UK GMP has tbr many years incorporated dit'erential reporting. That is, it has different
reporting rules for companies based on size. UK GMP includes a standard tor small and
medium entelprises (SMEs) called the Financial Reporting Standard for Smaller Entities
(FRSSE) which exempts certain conrpanies from compliance with the full set
of UK
accounting standards. In recognition of concerns about the applicability oi the full set of
IASB standards for some entities, the IASB included the IASC's SME proiect on its agenda.
An exposure draft was issued in 2007 and the International Financial Reporting Standarcl
for Smalland Medium-sized Entities (IFRS for SMEs) followed in July 2ggj.st
The SME standard is the result of extensive consultation over a five.year period. The
aim oi the standard is to provide a set of financial reporting principles, based on IFRS,
which meet the needs of entities that are not publicly accountable. These entities are
estimated to be over 95 per cent of all companies worldwide. lt is a self-contained
document which has modified IFRS requirements based on the needs of users of
SME financial statements and cost-benefit considerations. Simplifications include the
omission of irrelevant topics, reduction in accounting policy options, simplification of
IFRS recognition and measurement principles and a reduction in disclosures.g3
Based on this information and the article by lrene o'Keeffe, answer the following
question:
Under the lbur headings in the articlg discuss the possible benefits of an SME standard
identilied by the author. In your discussion, name the parties most likely to,benefit from
the SME standard and explain the extent to which you agree or disagree with the views
presented by the author. You should also consider what factors may inhibit the success
of the SME standarcl.

Usefulness of accounting information

Public sector and not-for-profit entities

ln the existing IASB and FASB conceptual framework documents, standard setters have
identified 'decision usefulness' as an objective for financial reporiing. To meet this
objective financial information should have the following qualitativetharacteristics:
understandabilty, relevance, rel iabi lity and comparabil ity (Frame work, pangraphs

2+421.
Reproduced below are guidelines which may assist in enhancing the quality of
information provided by not-for-profit entities (NFps).
t--*--ii 3. Overall recommendations

reporting

| 3.1 Recormendations to enhance NFP annual

j the following recommendations are designed to enhanie the q"ualiry of annual
reporting by NFPs. The recommendations are based on research carried out by,

the fnstitute and information gathered in the review of submissions to the 2oo1
PricewaterhouseCoopers Transparency Awards.

CHAPTER

A conceptual framework

127

li
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Provide more information about what NFPs are trying to do

(their mission), their obiectives, orplanations of activities to
adriarc those obiectives, and how those activities are funded.

Obiectives

Itovide a summary of the strategy to assist readers reviewing an

NFPs performance for the year. NFPs suiving for best practice

Suategy

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against
targets and progess reporting
those taryets.
Make the strategic plan or, at a minimum, the strategic goals
for the period available on the website. A link or cro$ reference
to the website could be induded in the annual report.
Frrttrre nlanc

Pro.lrde nore infor:netlon reqardinq

Govemance

Greater tmnsparency around govemance struchrrer and processes

through incltrsion ofa comprehensive govemance statement will:
> Initially, lead to improved govemance reporting as the NFP
strives to demonstrate best practice
> Assist Board members in protecting their reputation
> Potentially provide a competitive advantage.
Examples of govemance statements can be found in section 4.2

structure and
Processes
-

fi11rq14

n!anc

in this publication. Additionalty, specific guidance erists for

sporting body NFPs.t
Risk
management

Stakeholder

reporting

Ideally readers of the annual report should be provided with

sufficient information to understand the risla faced by the NFP and
the ongoing management of those risks. This could be achieved by
providing a summary of policies on risk oversight and management
of material risks in the govemance statement.

Identify major stakeholders

- people groups or organisations
who impaa or could be impaaed by the NFPs actions
- and
provide an overview of the relationship with each stakeholder.
Specifrc attention should be paid to employees and volunteen.
Consider disclosing employment policies, policies for engaging
volunteers, an overview of the training prwided'to both
employees and volunteers, and recognition of employee and
volunteer achievements

Funding

Provide more detail about sources of funds

as

well

as fundraising

activities. Although the quantum offunds raised and usedbyNFPs

can be determined from their financial statements, additional

information on the sources of funds would enhance transparency.
Consideration should be given to providing information regarding:
> The proces$es to secure govemment funding

> Policies for public fundraising

> Which costs are induded in fundraising costs
> T.he rvenue models and the NFP's approach to funding
> The use of websites to generate donations.
l. Sgrrting body NFPs can achieve hesl practice in governance rqxnting by comparing their slructure to the
Australian Sporling Ccrmmission's Na|'irurt,al SryxlingOryenillli<m (iovenante Principles of Eest Practice.ll
ne(fsary, they can take rc.medial action to align lheir governance structu. with lhis best practice.
Sourca: Exlr.'rd from 'Enhancing noFirrr-profit annu.rl ancl fin.rncial regrorting', ICAA reports,
Nl.rrr.h I 009, Exlrncl p. 7, rvwrv.ch;r rtt redaccoun t.rnls.c(.rnl.au.

728

PART

Theory and accountinB praclice

,'.1.

ilir

Question

l.

Your task is to find an anlu-al report for a not-for-profit entity and to rate the quality
of the information provided on a scale of 1 to r d, with I being poor and t 0'being
excellent. Use the reproduced recommendations in the table above to assist you
the rating process. For each of the seven areas listed, rate the quality of information
provided in.each sFecific- area and give reasons for your rating. provide possible
reasons for the quality of disclosure observed.

ii

In 2004, the IASB and FASB announced a joint project to revisit their conceptuat
frameworks. The followingmateriat providesiome'baikground about the project and
raises questions for discussion.

Revisiting the conceptual framework

The.FASB and IASB began a joint agenda project to revisit their conceptual frameworks
forflnancialaccountingand reporting in2OOZ. gach board bases its accounting standards
decisions in large part on the foundation of objectives, characteristics, definiions, and
criteria set forth in their.existing conceptual frameworks. The goals of the new project

are to build on the two boards'existing frameworks by refinin[, updating completing

and converging them into a common framework that both Boarfs ."n ur"-in developifi
new and revised accounting standards. A common goal of the FASB and IASB, sharej
by their constituents, is for their sandards to be ,piinciples-based,. To be principlesbased, standards cannot be a collection of conventions but rather must be roodd in
fundamenhl concepts. For standards on various issues to result in coherent financial
accounting and reporting the fundamental concepts need to constitute,a framework
that is sound, comprehensive, and internally consiitent.
without theguidance qrwide-d by an agreed-upon framework, standard setting ends
up being based on the individual concepts devetoped by each member of the staidard:etl!n8.My. Sandard setting that is based on thi personal conceptual frameworks of
individual standard setters can produce agreemeni on specific standard-setting issues
only when enough of those penonal frameworks happen to intersect on that issue.
eyen
$o1 agreements may prove transitory hcause, as the membership of
the standard-setting body changes over time, the mix of personal conceptual frameworla
changes as well. As a result, thit standard-setting body may reach significantly different
conclusions about similar (or even identical) issues than it did previoisly, with standards
not being consistent with one another and past decisions not being indicative of future

lo1"r"l

ones. That concern is not mrely hypothetical: subsantial diffrcuhies in reaching

agreement in ib first standards projects was a major reason thatrthe original FASI
members decided to devote substantial effort to develop a conceptual framework.
The fASB Framework is intended to assist not only standard setiers but atso preparers
of financial statements (in applying international fi-nancial repofting sandards jnd in
dealing with topics. on which standards have not yet been'devel6ped), auditors (in
forming o.pinions about financial statements), and users (in interpretin; information
contained in financial statemenB). Those purposes also are better servei by concepts
that are sound comprehensive, and internaily ionsistent. (ln contrast, the FASB Conceps
statements state that they do not justify changing generaily accepted accounting and
repofting practices or interpreting existing standards based on personal interpretitions
of the concepts, one of a numbeiof differences between the trruo frameworks.)
_ Another common goal of the FASB and IASB is to converge their standards. The
Eoards have been pursuing a number of projects that are aimed-at achiwing short-term
convergenceon specific issues, as wellasseveralmajorprojects thatarebeingconducted

Ti
CHAPTER4 Aconceptual framework

r29

iointly or in tandem. Moreover, the Eoards have aligned their agendas more closely

to achieve convertence in future

standards. The Boards will encounter difficulties

conveing thek srdndards if tlrey base their decisions on different framework.
The FASB's current Concepb Statements and the lASE's Framework, developed
mainly during the 1970s and 1980s, articulate concepb that go a long way toward
being an adequate foundation for principles-based standards. Some constituenE accept
those concepts, but others do not. Although ihe current co ceps have been helpful,
the IASB and FA58 will not be able to realise fully freir goal of issuing a common set of
principles-based standards if those standards are based on the current FASB Concepts
Statements and lA5B Framewo*. That is because those documents are in need of
refi nemeng updating completion, and convergence.
The planned approach in the joint proiect will identiry troublesome issues drat seem
ro reappear :ime an<i iirrre agairr irr a varieiy of siarrdani+eiting prujecis arrj uiicl i,, o
variety of Suises. That is, the focus will be on issues that cut across a number of different
.proiecb, Because it is not possible o address those cross-cutting issues comprehemively

in the context of any one sandard+level projec! the conceptual framervo* proiect
provides a hgtter way to consider their broader implications, therery assisting the boards
in developing standards-level guidance.
As noted in the chapter, the boards have issued and received comments on an exposu re
draft relating to Phase A Objectives and Qualibtive Characteristics. A discussion paper
relating to Phase D Reporting Entity had been issued and raork is continuing on Phase
B Elemens and Recogrition and Phase C Measurcment.
sou/cc. Eicerpts fron Hnlsey C. Eullen and (imberley Crook, 'Rvisiting the concepts: A new
c0nceptual framework proiect', Moy :!005, FASB and IASB. www.fa5b.o,g or wr.vw.iasb.ort.

Quesrions

1. Explain why principles-based sandards requirc a conceptual framework.

is it important that the IASB and FASB share a common conceptual

2. Why

framewort?

3. lt is sug8ested that

set eral parties can benefit from a conceptual framework. Do

you consider that a conceptual framework is more impottant for some panies than
othen? Explain your reasoning.
4. What is meant by a 'cro6ecuttin8' issuel Suggest some possible oramples of crosscutting issues.

Endnotes
1, Financial

Arcounting Sundarrds

Soard (F.ISB), Siatcmnt of Financial

Accour ing Cofte?t! No. 1,

'Obicaivcr of Financid Rcponing

by Eulincls Entrpri!6', Nowrnber
197& p. l.
2. The Arnerican lrutitut of Cenlid
ttrblic Accountaot! (AICPA),'Audirs
ofcorporate ac<ounr', Nerv York
1934, p.9.
3. Sc R

Wltt! and I Ammcmrae

IWifue

usnng &a*

Englailood

Clift,

Nr: PEndc-HdL 1986.

4. Accou ing Principler Board (APB),
Staiement No. 4, Baric Conctpt! and

130

PART

Theory and accountiig practice

Amnti;lg

Acounting Pdrciples Underlying

Financial stakmenB of Busincst
Enterpris6', para. 139, 1970.
5. w Paton, 'Comment on 'A rtatcmelt

of accounting principlel'' , Ianal

l,

'Guidc lo Propo!d Statment of

A(counting Crnaepe', Decembr

framervork Necdr and tlse!', F SB

P.52.

Aultnlian Accounting Rcleardr

Foundador (AARF), Sedcs No-

A@,/'rutrcf, Mzrdr 1938, W. 2Ol-2.

6. O Cillio Th coreptual

8. D solomons, The polirical

implications of accountint and
accounring standad seuing',

rwrclt

f. ibid., p. 1t5
10.

ol

Viwpoint4 19 Autust 1980.

7 . R Sto.ey, me *orch lor aanuntiag
tdncipra, Naat York AICPA 1964,

and bwinzrs

Spdng 1983, p. r09.

1987.
I

l. M Bradbuy, 'lmplications for the

conceptual hamewor* arising from
accoundng for financial intuumerrr,
Abr'f,ltt, w,l. 19, no. 3, 2003,

pp. 388-e7.
Nob6 'Rule! based standards and
thc lad< of principles in accountingf,

12. C

Afi,tll',tirg Hairt
20Os,

rs,

vo,. 19,

\o. I,

W.25-34.

13. MW N&o&

'Bhaviounl cvidcrrc

on the cffens of primipl6 and ruIe!

ba!d standalds',

vol.
fa.

lZ

lr@nlt@ Huiztttl

no. r,2003, pp.9l-104.

Sciipper, 'Principtes.bascd

accouoting staodad!"

Hori.t

ts,

wL lZ no.

Lco&ting

l,

2003,

pP.6l-72.
15. Scudtics aod hrchange Commission
(SEG), Smdy purnrant m Section

t08(d) ofthe Sarbanes.Oxlq Acl of

2002 on fie adoFion by rhe United
Srats Financial Reportiry Sysrm
of a principles-bared accounring
rystm', 2003, wwwsec.gov,
16. SA Zeff, A perrpective on rhe US
publi{private rector approadr ro
the rcgulation of fnancial rponing,
Aecd,./nai,8 HorlatLt, voL 9, no. l,
1995, pp. 52-70.

fuff, Th erclution of US
cMP: The polirical forces behind
pmfe$ional !rsndad!', ?rl' Cp,t

17. SA

Ioumql vo1.75, $o. 2, 2@1

pp. 18-29.
16. M MoodE, ?ftr Ddsic pottui,,e6

4cflrlairE,

Ner.e Yor&:

p.21.
f9. G Dar and F Clarfte, 'An a.olving
onceptual framcwork?' A&co.J,
vol. 39, no. 3. 2003, pp. 229-92.
20. S lon! and P Wolnizer.

?larmonizarion ud th comepntal
framerrorh An intemadonal
pcspeOive', lEacus, vol. 39, no. 3,
2003, pp. 375-87 .
21. Conceptual Framework
Joint
Proiecr ofthe IASB and FAS& proiecr
Information Page Larest rvilions as
of3 Augult 2009.

22.ibid.
UK

Coocepttal Fnme$ork ploirt

24.

w Mccrgor and

,IASB

D Sut,
aod FAS! hc challe0g6 in puFuir
of ioinr conceprual frameworl(,
The towrd 4 Inwtat'n ul Financial
Mttaganana ad t|qiouttti^& yol lg,

tlo.l,2007, W.39-51.
25. ln&.natiooal Publi< Scctor
Accounting Standads Boald,
'Conceptual Franwork for General

ltrpose Fioancial Reponing

by Rrblic Secor Entities: The
Obiectiver of Financial Rponin8,
Thc &ope of Financial R@nio&
Th Qualihtive Char.ctristic

of

lnformadoo lnduded in Genenl

R.poning E iy, Septcmbs

2008, loternational Fderation of
Accountan$, wwr^,.ihcoE
26. G Whininglon, 'Fair nlue and the
IASB/FASB conccporal Srmework
proie(t An altcmstive vfuv/, Abocut,
vol. 44, no. 2, 20O& pp. 139-68.
27. IASD Commnr lener lummary:
Obiectir's and Qualitativ
Charactrirtic! (Agenda papcr 2 ).
IASCF: londo[ Dccembcr 2d)8.
28. [ASB, Comment leiter rummarla

Dilrulsion papcr Rrportilg Entity

Pha! D (A8etda papr 4), IASCF:

londo[ Novmb.r 2008.

29. IASB, Agende papt 2A commnr
lettr summary, op. cil, p. 7.
30. Prc-ativ? Accounting Activiti* in
Europe (PAAinE),'Stwadship/
accountability a! an obiecriv of

financid lepofiing: A commnt

on the IASB/F.{SB C-onceptual
Framlvork proied, lun 2002
Eurogeso Financial Reporting
Advilory GDup, www.cfra&o.

AICPA 1961,

23. Ac(outting Standard! BoanC,

Purpo6 Financial Rlpon$ The

31. Whiniogto& op. cir.

32. ibid.
33. M lfnno, Ruler and Acloundng,

vrgumels in Conc.ptual
fuenrcwo.bt A@tlltaisg Hoipfit
Sptcnbs 2008, vol. 22,''io. 3,

Pp.339-5r.
loqrd Me.tin& Iaruary 2009,

34. USE

www.iarplur.com.
35. Whluington, op. cil
36. F SB/IASB Prcid updare,

Conceptual Fran6{'ork Phase B:

ElemnB and RcognitiorL

www.farb.oq.
37. WhininSton, op. ci."
38. R Hins, 'lvhy wonl rhe FASB
concrprual fiamework work?',
AAAM Cooference paper, August
1987.
39. N Dopuch and S Sunder, 'FASBt

ttatme[A on objectivlr alld

elementr of financial accounring', .
Amnting Rettiew,latuary l98O p. 4.
40. ibid., pp. 6 Z 8.
41. D GebotlL Ttl conceptual

fnmelvork Not d6dtion& but

ptofelcional valuer', Ac@rnrirg
Horilo,rr, &prembs f98Z p. 5.
42. K PoWEr, The og'/r sdeq ar'/til its
armir, Pdnccton, Nr: Princeron
Univendty Pr$, f964 p. f9.
43. Gerboth, op. cir., p. 5.
,14. FAS8,

Sratmmtof Financial
Accounring Concepts No. 2,

'Qualirative Clraractcristica of
Accounting lnfomation', 1980, p. xvi.
45. E Solo@ons, Th polirkiz.tion of
reolJ'JitilJd,, Iounal of Acmmunq,

November 1978, p. 7t.

46.

Hinet financial accounting: In

aommunicaling rali9, we co$truct

realit'/ ,
Orgonizatiotlt and
^4,/,/l,1,th|f,,
So.irrl, vol,
13, no. 3, 198&

pp.25r-61.
47. ibt4., pp. 2s4-55.
48. WF Chua, 'Radical d\nlopmen$
in accounting thought', Aa@/urrti',g
Rwiru, October 1986, p. 602.
49. CT Horngret! 'Us! ard limitations
of a concptual hamwo M , loumtl
tut@untsrt/'l, Apnl I 98 l, p. 92.
50. E Stamp, .lvty can accounting not
become a scimce like physics?',

ol

,llacus, vol. tZ no. l, 1981, p. 14.

lii4 Theory ofaccounting
managemmf, Studi! in Arcounting
Raardr No. 10, Flodda: AAA, 1925,

51. Y

Pp.9-r0.
s2. ibid., p. 10.
53.

TAnker,'Panglorsian accounting
theoriesl 'Ihe science of apologising

in xyld,
&rirry, r,ol. 13, 196E, no.
pp. 165-89.

54. Hincs l98Z op. cit.

55. , Bucklcy, 'Polict models in
accounting A aitical comrnentary',

A@lrrairr& @gnU^aio,E ord fucietl,

vol. 5, ro. l, 1980, p. 52.
56. FAS8, An Analysi! of lssues Relaed
to the Concepual Framcwork for
Financial Acounting and R?o(iIIg:
Elements of Financial Sarementr and
Their Measuement, 1926, p. 2.
57. M 8unge, Sctmd/r6 Rfit{irch Il: Th.
ssu,rch fn at L NewYo*: Springer
Verle& 1962 quoted in Buckley,
op. cit., p. 53.
58. R Chamber+ 'Conventions, doctdne!
aod common !ns', A@lrn t4n6'

. tnnd,

F&flary

1964,

p. t63.

59, D Kirk 'Concepo conrensus,

compromisc and conrequence 'Iteir
roles in candard rccind, Ioutlu.l ol
AMuntatEl, Apdl198f, p. 84.
60. P Millcr, The conceptual framework
Myths and realities', /osnal o/
kmurulq, Mardr 1985, p, 62.
6t. Burclrell a al., The roles of
accourtint in organizations and
so.iftf , tt@unting, Orgsnitr',tiotrs cnd

Soqirt/, Yol. 5, no. r, 1980, p. 12.

62. Hines l98Z op. cir., p. 15.

CHAPTER

4 A conceptual framework

131

63. E Greenwood, Attributes of a

profession', in SE Loeb, Etttio in

76. American Accounting Association

thi

aununttngpofasion fohn Wley and

Sons lnc: Nerv York 1978, p. 50.
64. Gerboth, op. cit., p. z.
65. S Agnwal, 'A conceptr:al framework
for accounting: The American model',
Chane.red Accountant in Austnli/t, lrullrc1987, p. 27 .

66. Greenwood, op. cit, p.60.

67. I Demskl The general impossibility
of normative accounting standards',
Accounting Raniew, vol. 50, October
1973, pp. 7 18-23.
66. M Bromwich, 'lh possibility
of partial accounting standards',
Accoun:tingRevietu,

April 1980,

pp.288-300.
69. Greenwoo4 op. cit., p. 60.
70. Buckley, op. cit., p. 58.
71. R Hin6, 'Financial accounting
knowledge, conceptud framervork
proieas and the socid construction
of the accounting profession',
Acnunting Auditing aruI lrccunttbility
lourruil,

vol.2, no.2, f989, p.85.

72. R Mautz and HA Sharaf, I?ra

philonpfu of awlitizg, American
Accounting Association, 1961.
73. HE Miller, Untitled review of ?fte
philosophy d uuditingby RK Mauu
and HASharaf, inThe Accountlng

Raieu,vol-37, no.3, fuly 1962,

pp. 599-600.
74. Mavtz and Sharaf 1961, cited in

risk audit Origins, obstades

and opportunitres', Accounting
Qrganizations nnil Society, vol. 32,
ro. 415, 2007, pp. 383-408.
78. ibid., p.386.
79. ME Peecher, R Sdrwaru and
I Solomoo'It's all about
audit qualitp Perspectives on
suatedc-systems auditing',
lv@unnn& utgan'z/lfions anti socrety,
vol. 32, no. 415, 20O7, pp. 463-85.

80. Knedrel (op. cir.) notes thar-the

fint audit risk statement in the US

''

and Materidity in Conducting the

AudiC AICP.\ 1983; cited in Knechel,

2007.
81. ISA 330 The Auditor's Responses to
Assasd RisloltSA 330 The Audito/s
Procedures in Response to AEsessd
Risls.
82. WA Sraub, 'Mode of conducting an

PART

Reviant,

vol.

18,

no. Z, epril 1943, pp.9r-S.

83. lhechel op. cit., p- 388.
8a. A Eilifsen, WR Knechel and P
Wallage, 'Use of strategic risk analysis
in audit plannin6 A field stud/,

75. ibid.

ttz

was issued in 1983; Statement on

Auditing Standards 47, Audit Risk

audi{, The Accounting

2 Theory and accounting practice

cited in K.nechel op. cit., 2007.

Ihedrel 2007, op. cit., p. 393.
86. M Power, 'Brxinirs risk auditing
Debating the history of its present',
Acaunting Organizatioas, and Society,
Vol. 32, No. 4/5, 2007, pp.379-82.
87. PeerJrec Schwanz, and Solomon
op. cit.; T BelL F Marrs, I Solomon
and H Thomas, Auditing
organizations rhrough a
strategic-ststems lens: The KPMH
65.

Auditing Concepts, Sara$ta, 1973.

78. WR Knedrel, 'Ihe business

Miller 1962, p. 600.

I.

Southwestem Publishing Co. 2001;

Committee on Basic Auditing

Concep6 A Statement of Basic

Accotnttittg Horimns, September

200r, pp. 193-207; WR Knechel,

Auditing risk anil as:ntr&tee,2nd ed,

business measurement proce$t',

1997. KPMG LLP, cited in
Power, M 2007.
88. E Curtis and S Turley,The business
risk aud,ir
-- a longitr-dinal cate
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I'caunting Organizations and Society.

vol. 32, no.4l5,2007, pp.439-6r.
89. GFlinc IAM Fnserand DI Hatherly,
A regressive
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Fsntm, vol. 32, 2008, pp. L43-47 .
90. See Knechel op. cit. 2007, for an
er(ensive discussion of the criticisms
of business risk auditing.
'Business risk auditing

et. ibid.
92. IA,SB, Fact Sheec IFRS for SMEs

luly 2009, l,ondon:

Intemational Accounting Standards
Comminee Foundation.
93. Institute of Ghartered Accountants
in Ausuzlia (IGAA), Nervs and
Fact Sheet, 9

lssues, 'IASB releases SME

standard', 23 luly 2009,

www.charteredaccountanB.com.au.