Conceptual Framework in Accounting

CONCEPTUAL FRAMEWORK

Kristian Agung – Lydia S.T. – Marysa N – Monika Yulando – M. Gunadi – P. Alhadi

Sembiring

What is Conceptual Framework?

A conceptual framework of accounting is a structured theory of accounting.

Highest theoretical levels: it states the scope and objective of financial reporting

Level II (Fundamental Conceptual Level): it identifies and defines the qualitative characteristic of financial information (such as relevance, reliability, comparability, timeliness and understandability) and the basic elements of accounting reports (such as assets, liabilities, equity, income, expenses, and profit)

Level III ( The Lower Operational Levels): it deals with priciples and rules of recognition and measurement of the basic elements and type of information to be displayed in financial reports.

What is Conceptual Framework?

FASB has defined the conceptual framework as:

A coherent system of interrelated objectives and fundamentals tha is

expected to lead to consistent standards and that prescribes the

nature, function and limits of financial accounting and reporting.

Why have a conceptual framework?

Numerous problems have arisen because of the lack of a general theory

Allowing entities to select their own accounting methods within the boundaries of generally accepted accounting principles is deemed desirable by some.

Inconsistency of practice has been seen as a problem. Gellein, a former member of both the APB and FASB, commented that because of the lack of conceptual framework, ‘Gresham’s law sometimes takes over: bad practices at times triumph over good practices.’

Why have a conceptual framework?

Storey:The … solutions resulting from the play-it-by-ear approach have rarely turned out to be lasting solutions (even taking into consideration the dynamic nature of accounting

Solomons: A principle or practice would be declared to be ‘right’

because it was generally accepted ; it would not be generally accepted because it was ‘right’

The conceptual framework as a defense against political interference in the neutrality of accounting reports.

Background to conceptual framework projects(1987-2000) FASB issued seven concept statements covering the following topics: Objectives of financial reporting by bussiness enterprises and non-profit

organisations Qualitative characteristics of useful accounting information Elements of financial statements Criteria for recognising and measuring the elements Use of cash flow and present value information in accounting

measurements (1989) International Accounting Standard Committee (IASC) The Framework for the Preparation and Presentation of Financial

Statements: Defines the objectives of financial statements Identifies qualitative characteristics that make information in financial

statements useful Defines the basic elements of financial statements and the concepts for

recognising and measuring them in financial statements.

Background to conceptual framework projects

IAS 8, paragraph 10, requires that in the absence of an IASB standard or interpretation that spesifically applies to a transaction, other event or condition, management must use judgement in developing and applying an accounting policy that results in information that is:

Relevant to the economic decision making needs of users; and

Reliable, in that the financial statements Represent faithfully the financial position, financial performance

and cash flows of the entity Reflect the economic substance of transactions, other events

and conditions, and not merely the legal form Are neutral, i.e. free from bias Are prudent Are complete in all material respects

Background to conceptual framework projects

IAS 8, paragraph 11, provides a ‘hierarchy’ of accounting pronouncements. It says that in making judgement required in paragraph 10:Management shall refer to, and consider the applicability of, the following sources in descending order: The requirements and guidence in standards

and interpretations dealing with similar and related issues; and

The definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the framework.

The Benefit

The benefits which the Australian Accounting Research Foundation (AARF) indicated would emanate from a successful framework are as follows: Reporting requirements will be more consistent and logical

because they will stem from an orderly set of concepts. Avoidance of reporting requirements will be much more

difficult because of the existence of all-embracing provision The boards that establish the requirements will be more

accountable for their actions in that the thinking behind spesific requirements will be more explicit, as will any compromises that may be included in particular accounting standards

The need for specific accounting standards will be reduced to those circumstances in which the appropriate application of concepts is not clear-cut, thus minimising the risks of over-regulation

Objectives of Conceptual Framework

Objectives of Conceptual Framework

Conceptual Frameowork, What For?

The Basic Objective Of

External Financial Report :

To Provide Useful

Information

INFORMATION• useful in making

economic decisions + assessing cash flow prospects

• about enterprise resources, claims to those resources and changes in them

HOW?

It becomes necessary to

develop a hierarchy of

qualities which make information

useful.

therefore

Key Issues in Developing Conceptual Frameworks

Principles-based and

rules-based standard setting

Information for

Decision Making

Decision-theory

approach

Users of Accounting Information

Principles-based And Rules-based Standard Setting

Conceptual frameworks have an important role in the standard-setting process because they provide a framework for the development of a body of coherent standars based on consistent principles.

However, rules-based standars have some advantages which explains their popularity, including increased comparability and verifiability for auditors and regulators.

Information for Decision Making

Accounting information for decision making begins with the stewardship function.

Later, information for decision making implies more than information on stewardship.

First, the users of financial information are greatly expanded to include all resource providers, recipients of goods and services, and parties performing a review or oversight function.

Second, accounting information is seen as input data for the prediction models of users.

Third, whereas stewardship is concerned mainly with the past in order to asses what has been accomplished, prediction look towards the future.

Decision-theory Approach

Overall theory of

Accounting

Individual Accounting

System

Prediction Model of

User

Decision Model of

User

USERS OF ACCOUNTING INFORMATION

USERS OF ACCOUNTING INFORMATION

According to SAC 2 paragraphs 16-19, there are three categories of user groups:1. Resource providers2. Recipients of goods and services3. Parties performing a review or

oversight function

Paragraph 27 providing users with information useful for making and evaluating decisions on the allocation of scarce resources will also discharge the stewardship duty.

FASB in SFAC 1 users of externally reported accounting information are present and potential investors, creditors, and other users.

SFAC 1 is similar to Statement No. 4 of the Accounting Principles Board.

Definition and Recognition of the Elements of Financial Statements AASB Framework (2004) elements of

financial statements assets, liabilities, income, expenses, and equity future economic benefit.

Paragraph 49 (a) 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.

Paragraph 49 (b) Liability is 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.

Paragraph 49 (c) Equity is the residual interest in the assets of the entity after deducting all its liabilities.

Paragraph 70 (a) Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

Paragraph 70 (b) Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

Paragraph 83 Recognition of elements depends on two criteria:1. It is probable that any future

economic benefits associated with the item will flow to or from the entity; and

2. The item has a cost or value that can be measured with reliability.

A NEW CONCEPTUAL FRAMEWORK PROJECT FOR THE IASB AND FASB

National conceptual frameworks, such as those developed in the United States and Australia, have played a key role in guiding standard-settings initiatives.Although existing conceptual statements have not been recently issued, convergence of accounting standards has highlighted the importance of conceptual statements that underlie the development of accounting standards and the quality of financial reporting.

FASB

It has been recommended that the FASB should improve its conceptual framework in the following ways: More clearly articulate how the trade-offs

among relevance, reliability and comparability should be made

Eliminate the inconsistencies between the discussion of the earning process (found in SFAC No. 5) and the definitions of the elements of financial statements (found in SFAC No. 6)

Establish a paradigm for selecting from among possible measurement attributes

The FASB is considering changes to its concept statements in three current agenda projects:1. The Revenue Recognition project is resolving

inconsistencies between the earning process and definitions of elements

2. The Liabilities and Equity project is reconsidering the distinction between liabilities and equity and aspects of the liabilities definitions.

3. The Fair Value project, FASB will consider how the qualitative characteristics at relevance and reliability should be applied in selecting an appropriate measurement attribute.

IASB

The original framework of IASB was issued in 1989 and has not been substantially revised in the meantime.An area not covered in the current IASB is measurement concepts. This issue will be tackled in due course as a result of the AcSB project undertaken on behalf of the IASB. The purpose of the project is to identify, consider and make measurement objective or set of objectives.

Dean and Clarke describe many issues that are relevant to understanding why the development of conceptual frameworks at a national level has been problematic. They suggest that current conceptual framework projects have sought to develop a constitution-based framework for accounting, instead of focusing on concepts underlying ordinary, everyday commerce.

A CRITIQUE OF CONCEPTUAL FRAMEWORK PROJECTS

THERE ARE 2 APPROACHES WE CAN USE IN OUR ANALYSIS:

The first is to assume that the conceptual framework should be a “Scientific” approach

The second is a professional approach which concentrate on prescribing the “best” course of action by recourse to “professional value”. This is similar to a Constitutional approach to rule setting

DESCRIPTIVE AND NON-OPERATIONALBy the time SFAC No 5 was issued the Board’s approach had become almost totally descriptive. Indeed Statement No 5 shows that the aims and philosophy of the conceptual framework had been lost by the time it was issued. SFAC No 5 states in several places (paragraph 35, 51, 108), that concepts are to be developed as the standard setting process evolves.

Such an evolution philosophy, which sees concepts as being the residual of the standard setting process, is in direct contradiction to the purpose of the conceptual framework

DOPUCH AND SUNDER CONSIDER THAT THE DEFINITIONS OF THE MAIN ELEMENTS OF FINANCIAL STATEMENTS DEPEND ON UNSPECIFIED RULES AND CONVENTIONS:

How can a conceptual framework guide choices from among alternative principles and rules if the elements of the framework are defined in these very same term?

3 ISSUES: A. DEFERRED TAX CREDITSB. TREATMENT OF COSTS OF EXPLORATION IN THE OIL AND GAS INDUSTRYC. CURRENT VALUE ACCOUNTING

They conclude:1. The definition of liabilities is so general that we

are unable to predict the Board’s position on deferred taxes

2. The framework supports two opposing principles of accounting (Full cost and Successful Efforts) and is preliminary evidence that the framework is unlikely to be a useful guide in resolving the issues

3. It does not address the problem of estimation, on which past efforts to encourage publication of current cost have foundered

SIMILAR CRITICISM OF THE IASB.ASSET AND LIABILITIES ARE DEFINED IN VERY SIMILAR TERMS TO THOSE IN US PROJECT.THE RECOGNITION CRITERION FAILS TO OFFER ANY GUIDANCE ON THE MEASUREMENT PROBLEM, WHICH IS FUNDAMENTAL TO ACCOUNTINGGerboth quotes from Popper:In science, we should take care that the statements we make should never depend on the meaning of our terms. Even where the terms are defined, we never try to drive any information from the definition, or to base any argument upon it. That is why our terms make so little trouble. We do not overburden them. We try to attach to them as little weight as possible

ONTOLOGICAL AND EPISTEMOLOGICAL ASSUMPTIONSSolomon explains freedom from bias as “Financial Mapmaking”:Accounting is Financial mapmaking. The better the map, the more completely it represents the complex phenomena that are being mapped. We do not judge a map by the behavioural effects it produces. The distribution of natural wealth or rainfall shown on a map may lead to population shifts or changes in industrial location which the Government may like or dislike. That should be no concern of the cartographer, We judge his map by how well it represents the facts. People can then react to it as they will

THE HYPOTHETICO-DEDUCTIVE APPROACH TO SCIENTIFIC EXPLANATION HAS TWO CONSEQUENCES:THE FIRST LEADS TO UNIVERSAL LAWS OR PRINCIPLES FROM WHICH LOWER LEVEL HYPOTHESES MAY BE DECUDED.SECONDLY, THERE IS A TIGHT CONNECTION BETWEEN EXPLANATION, PREDICTION AND THE TECHNIQUES APPLIED.

FOR EXAMPLE, THE IASB AND FASB CONCEPTUAL FRAMEWORKS HAVE GENERALISED ASSUMPTIONS AND OBJECTIVES FROM WHICH PRINCIPLES (STANDARDS) AND PROCEDURES (METHODS AND RULES) SHOULD BE ABLE TO BE DEDUCED.

Some author disagree with this approach to science:Accounting researchers believe in a (confused) notion of empirical testability. Despite this lack of clarity as to whether theories are “verified” or “falsified”, there is widespread acceptance of Hempel’s hypothetico-deductive account of what constitutes a “scientific explanation”

CIRCULARITY OF REASONINGOne of the objectives of aconceptual framework is to guide the everyday practice of accountant. However, the existing CF are typified by an internal circularity.For example, within FASB Statement No 2, information qualities such as reliability are stated to depend on the achievement of other qualities, such as representational faithfulness, neutrality and verifiability. However, these qualities, in turn, depend on other non-operationalised information qualities. For example, neutrality relies on relevance, reliability and representational faithfulness, but the necessary and sufficient conditions for obtaining these qualities are not stated

AN UNSCIENTIFIC DISCIPLINE

Is Accounting a Science?It does not qualify as a science to begin with.

Accounting has been variously described as an art or craft. Stamp said:

Until we are sure in our minds about the nature of accounting, it is fruitless for the profession to invest large resources in developing a conceptual framework to support accounting standards.

Stamp considers that accounting is more closely aligned to law than to physical science, since both the accounting and legal professions deal with conflicts between different user groups with varying interests and objectives

PROFESIONAL VALUES

Conceptual Framework As A policy Document

An alternatve to viewing Conceptual Framework As either sientific or normatif models is consider them as policy model. Normatif model has policy implications but it is different from a policy judgement. The poin out that theoris and policies are intermingled in accounting, whereas in other empirical siences the distinction is well established

Conceptual Framework

Theories

Policies

Theories

Policies

Accounting

Other Subject

Accounting

Theories always seem to

be tied to policies

Other Empirical Sciences, Policies

are treated quite

differently from

theories

Conceptual Framework As A policy Document

Base on provesional values and self-interest

Reflection of the political will of the dominant group which is dominated by profesional values

The motivation is to increase economic power through monopoly-seeking behaviour

Profesional Value And Self-Preservation

Profesional Value : suggests idealism and altruism Self-Preservation : Implies the pursuit of self-

interest

Gerboth Argue: Accountants make many judgements. And when they do, their decisions may differ from those that other accountan would make. But that does not make the decisions arbitrary. Accountans freedome to decide is not freedome to decide as they please. Their personal responsibility for the decisions force a diligent search for the best obtainable approximation of accounting truth.

Individual Beliefs And PreferencesDemmski Argue : No set of standards exist that will identify the most preffered accounting alternative, without spesifically incorporating an individual’s beliefs and preferences. Such belief and preferences may be a mix of personal and professional value.

Conceptual Framework For Auditing Standards

1961

• Auditing not as a subdivision of accounting, but as adicipline base in logic

• Auditing a strong focus on the process of collecting and evaluating evidence (Statement Of Basic Auditing Concepts)

1980

• A period of rapid growth in audit practice, improvement technology, and the perceived need to reduces cost in audit process

• Focus on the role of structure and quantification in the evidence gethering and evaluation process

1990

• Began to be less emphasis on direct testing of transaction and balance and more reliance on testing clien’s control system as a mena to gather evidence on the financial statement that are produced by those system

Business Risk Auditing

A form of auditing that considers clien risk as part of the audit evidence process

Required to consider the risk of an inappropriate audit opinion as a function of

the inhern risk of error occurring

Auditore Perception of risk began to change dramatically with the realease of the

“Internal Control-Integrated Framework” by COSO

Effective internal control describe lower risk and error, and provided the opportunity to justify a reduction in resources, cost and

audit fees for those client