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Conceptual framework

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Primary pronouncements

US GAAP► SFAC No. 5, Recognition and

Measurement in Financial Statements of Business Enterprises

► SFAC No. 6, Elements of Financial Statements

► SFAC No. 7, Using Cash Flow Information and Present Value in Accounting Measure

► SFAC No. 8, Conceptual Framework for Financial Reporting, Chapters 1 (Objective) and 3 (Qualitative Characteristics)► Supersedes SFAC No. 1 and No. 2

IFRS► IASB, Conceptual Framework for

Financial Reporting (September 2010)► IAS 8, Accounting Policies, Changes in

Accounting Estimates and Errors



► The FASB has stated that, “The concept statements are intended to set forth objectives and fundamental concepts that will be the basis for development of financial accounting and reporting guidelines. The objectives identify the goals and purposes of financial reporting. The fundamentals are the underlying concepts of financial accounting, concepts that guide the selection of transactions and other events and conditions to be accounted for; their recognition and measurement; and the means of summarizing and communicating them to intended parties.”1

► The FASB has also stated that, “The Conceptual Framework is a coherent system of interrelated objectives and fundamental concepts that prescribe the nature, function, and limits of financial accounting and reporting and that is expected to lead to consistent guidance.”2

1SFAC No. 8, Conceptual Framework for Financial Reporting, introduction, paragraph 2.2Ibid, introduction, paragraph 3.

Purpose of the concept statements



► The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and creditors (‘primary users’) in making decisions about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.► Why did the Boards choose to identify the existing and potential investors,

lenders and other creditors as the primary set of users for general purpose financial statements? (BC1.9 through BC1.16)

► Management is specifically excluded from the primary user group. In general, why would these users be excluded? (BC1.19)

► Why did the Boards not establish a financial stability objective? (BC1.20 through BC1.23)

The Objective of General Purpose Financial Reporting



Comparison of SFAC No. 1 replaced by SFAC No. 8, Chapter 1

Similarities► There is continued focus on the importance of cash flows for users of financial statements.► Information should be provided for economic resources, claims on resources and changes in

resources and claims.► There is acknowledgment that there are limitations of general purpose financial statements.► Accrual accounting is emphasized.

Differences► SFAC No. 8 is much shorter and more succinct.► There is a reduced number of identified users in SFAC No. 8, which is focused on “primary

users.”► Terminology differences include more general terms with respect to financial information

required.



Qualitative Characteristics of Useful Financial Information

► The qualitative characteristics of useful financial information identify the types of information that are likely to be most useful to the existing and potential investors, lenders, and other creditors for making decisions about the reporting entity on the basis of information in its financial reports.

► What are considered the qualitative (fundamental or enhancing) characteristics for useful financial information?

► a. Relevance and reliability► b. Relevance and faithful representation► c. Material accuracy, timeliness and faithful disclosures► d. Substance over form, prudence (conservatism) and verifiability



The Concept of Prudence: dead or alive?

► How did the 1989 IFRS Framework define prudence?► What are the problems of excessive prudence

(conservatism)?► Why was the concept of prudence removed in the existing

conceptual framework?► Give at least two examples of how IFRS reflect the

concept of prudence.



Overview of Chapter 3, “Qualitative Characteristics of Useful Financial Information”

Pervasive constraint: Costs

Fundamental characteristics:

Relevance and

faithful representation

Qualitative characteristics of useful financial information

Co

sts

Co

sts

Pervasive constraint: Costs



► Usually, the most efficient and effective process for applying the fundamental qualitative characteristics and the cost constraint is as follows:

► Identify an economic phenomenon that has the potential to be useful to users.

► Identify the type of information about the phenomenon that would be most relevant if it is available and be faithfully represented.”

► Determine whether that information is available and can be faithfully represented.

► If so, the process of satisfying the fundamental qualitative characteristics ends at that point. If not, then the process is repeated with the next most relevant type of information.

Applying the fundamental qualitative characteristics



Comparison of SFAC No. 2 replaced by SFAC No. 8, Chapter 3

The qualitative characteristics from SFAC No. 2 and SFAC No. 8, Chapter 3, are essentially the same but are categorized differently: ►Under SFAC No. 2, there were user-specific qualities, primary decision-specific qualities, primary qualities and secondary and interactive qualities. ►Under SFAC No. 8, Chapter 3, there are fundamental qualitative characteristics and enhancing qualitative characteristics



Underlying assumption: going concern

► Concept (Framework 4.1)► Financial statements are normally prepared on the assumption that an entity is a going

concern and will continue in operation for the foreseeable future.

► Rule (IAS 1 paragraph 25)► An entity shall prepare financial statements on a going concern basis unless management

either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so.

► Judgment► According to practicing auditors, consideration of a company's ability to continue as

a going concern is particularly challenging in the current environment.



Assessing going concern

► In assessing whether the going concern assumption is appropriate, management takes into account all available information about the future…

► The degree of consideration depends on the facts in each case…► Management may need to consider a wide range of factors relating

to current and expected profitability, debt repayment schedules and potential sources of replacement financing before it can satisfy itself that the going concern basis is appropriate.



Going concern: judgment

► IAASB Staff Audit Practice Alert (January 2009) Audit Considerations in Respect of Going Concern in the Current Economic Environment► In times like the present, making this assessment may become increasingly difficult, as the

landscape in which entities are operating is rapidly changing, in particular as it relates to availability of credit and the impact on forecasts and budgets as the recession bites and the cost of borrowing rises.

► IAS 1 and ISA 570 acknowledge that entities with a history of profitable operations and ready access to financial resources may not need a detailed analysis to support the going concern assumptions. However, the effect of the credit crisis and economic downturn is likely to be that such an approach will no longer be appropriate for many entities.

► Real World Example (handouts to be given in class)► Austrian Airlines► Bradford and Bingley



Elements of financial statements

FASB► Assets► Liabilities► Equity► Investments by owners► Distributions by owners► Comprehensive income► Revenues► Expenses► Gains► Losses

IASB► Assets► Liabilities► Equity► Performance► Income – revenues and gains► Expenses – expenses and losses► Capital maintenance adjustments



FASB and IASB comparison Elements of financial statements

Similar elements identified, but different definitions for assets, liabilities and probable.

Uses the “asset and liability view” to measure income (net increase in assets and liabilities equals net income).

Similar elements identified, but different definitions for assets, liabilities and probable.

Similar

IASBFASB

Three elements of changes in assets and liabilities: investments by owners, distributions to owners and comprehensive income (revenues, expenses, gains and losses).

Two elements of changes in assets and liabilities: income and expenses.



FASB► Probable future economic benefits

obtained or controlled by a particular entity as a result of past transactions or events.

IASB► A resource controlled by an

entity as a result of past events and from which future economic benefits are expected to flow to the entity.

FASB and IASB comparison Definition of an asset

The Boards’ working definition

An asset of an entity is a present economic resource to which the entity has a right or other access that others do not have.



FASB► Probable future sacrifices of economic

benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events

IASB► A present obligation of the entity arising

from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits

FASB and IASB comparison Definition of a liability

The Boards’ working definition

A liability of an entity is a present economic obligation for which the entity is the obligor.



FASB ► No fundamental difference in concepts,

but definition differences are apparent.► Longer, more detailed and specific.

► Not part of US GAAP hierarchy and, therefore, not authoritative.

IASB► No fundamental difference in concepts,

but definition differences are apparent.► Shorter, less detailed.► Developed from FASB Concept

Statements.► High-level presentation (principles

based) to accommodate various countries’ accounting models and emphasizes substance over form.

► Third level of accounting to be followed in the IFRS hierarchy.

FASB and IASB comparison Overall differences



ConvergenceVision for the Conceptual Framework

► Importance:► Principles based.► Internally consistent.► International convergence.► Information vital to capital provider.

► Timing:► Slow due to the process of preliminary views, Discussion

Papers, EDs and final statements.► Some pressure from SEC and Congress.



Convergence project on conceptual framework Phase A – Objectives and Qualitative Characteristics (finished)

The following phases have yet to be started:► Phase E – Presentation and Disclosure, including Financial Reporting Boundaries► Phase F – Framework Purpose and Status in US GAAP Hierarchy ► Phase G – Applicability to Not-for-Profit Sector► Phase H – Remaining Issues



Convergence: work in process

► Phase B – Elements and Recognition► Purpose is to revise and clarify various issues:

► Revise and clarify definition of asset and liability.► Resolve differences regarding other elements and their definitions.► Revise recognition criteria, resolve derecognition and unit of account.

► Phase C – Measurement► Purpose is to provide guidance for selecting measurement bases that satisfy the objectives

and qualitative characteristics of financial reporting.

► Phase D – Reporting Entity Concept► Purpose is to determine what constitutes a reporting entity for purposes of financial

reporting.

Download - IFRS Conceptual Framework

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