GODFREYHODGSON

HOLMESTARCA

CHAPTER 4 A CONCEPTUAL FRAMEWORK

The role of a conceptual framework• A structured theory of accounting• States the scope and objective of financial

reporting• Identifies and defines qualitative

characteristics of financial information and the basic elements of accounting

• Deals with principles and rules of recognition and measurement, and report disclosures

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The role of a conceptual framework

… a coherent system of interrelated objectives and fundamentals that is expected to lead to consistent standards and that prescribes the nature, function and limits of financial accounting and reporting.

FASB

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The role of a conceptual framework

Issues:– Do we need a general theory of accounting?– Is current accounting too permissive?– Are current accounting practices too inconsistent?– Is there too much political interference in the

neutrality of accounting reports?

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The role of a conceptual framework

Benefits:– consistent, logical reporting requirements– greater compliance– enhanced accountability – fewer specific standards– enhanced understanding of reporting

requirements– more economical standard setting

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Objectives of conceptual frameworks

Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit and similar decisions.

FASB

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Objectives of conceptual frameworks• Information should be – useful in making economic decisions– useful in assessing cash flow prospects– about enterprise resources, claims to those

resources and changes in them

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Objectives of conceptual frameworks

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Developing a conceptual framework• The development of conceptual frameworks is

influenced by two key issues:– principles versus rules-based approaches to

standard setting– information for decision making and the decision-

theory approach

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Principles-based and rule-based standard setting

• IASB mostly produces consistent, coherent principles-based standards

• Rule-based standards may increase comparability and verifiability and may reduce earnings management

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Principles-based and rule-based standard setting

• The standards of the FASB have traditionally been rule-based

• Emphasis now being given to principles• Timely given the IASB/FASB convergence

program

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Information for decision making and the decision-theory approach

• Accounting data are required for decision making or accountability purposes– stewardship– decision making• users

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Information for decision making and the decision-theory approach

• The decision-theory approach maps the process by which the outputs of the accounting system provide inputs to the decision model of a user

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Information for decision making and the decision-theory approach

Decision-theory process

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Overall theoryof accountingOverall theoryof accounting

Individualaccounting

system

Individualaccounting

system

Predictionmodel of

user

Predictionmodel of

user

Decisionmodel of

user

Decisionmodel of

user

International developments: the IASB and FASB Conceptual Framework

• In 2004 the FASB and IASB agree to undertake a joint project to:– develop an improved, common conceptual

framework – goal of developing standards that are principles-

based, internally consistent and internationally converged

– an Exposure Draft was produced - June 2009– deferred consideration of not-for-profit sector

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International developments: the IASB and FASB Conceptual Framework

• ED has several contentious areas:– entity vs proprietorship perspective– primary user group– decision usefulness and stewardship– qualitative characteristics

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International developments: the IASB and FASB Conceptual Framework

• Australia follows an approach whereby issues for both the not-for-profit and for-profit sectors are considered together

• Standards are intended to apply to both sectors

• IFAC’s International Public Sector Accounting Standards Board has begun a project to develop a public sector CF

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A critique of conceptual framework projects• Approaches to developing a CF:– scientific • recourse to logic and empiricism or both

– professional• prescribes the best course of action by recourse to

professional values

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A critique of conceptual framework projects

Scientific criticisms:• prescriptive• unspecified rules and conventions• do not resolve contemporary disclosure issues• vague definitions• do not address measurement issues• risk of mechanical decision making• framework may become an end in itself• overreliance on definitions

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Ontological and epistemological assumptions

• Freedom from bias (neutrality)– an information quality that avoids leading users to

conclusions that secure the particular needs, desires or preconceptions of the preparers

• Solomons: freedom from bias as ‘financial mapmaking’

• Feyerabend: scientific truth is not absolute• Hines claims mainstream accounting is ‘taken-for-

granted’

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Circularity of reasoning

• Objective of a conceptual framework: guide the everyday practice of accountants

• A superficial view– deducing principles from generalised theory

• Existing frameworks typified by internal circularity:– e.g. FASB Statement No. 2– qualitative characteristics are often stated in terms of

other qualities which are non-operationalised

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An unscientific discipline

• Is accounting a science?– prescriptive by nature and value laden

• Stamp 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.

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Positive research

• Conceptual framework projects ignore the empirical findings of positive accounting research– in conflict with each other

• Mounting evidence that capital markets are not efficient

• If the conceptual framework could ensure users receive useful information this would serve a useful purpose

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The conceptual framework as a policy document– As a generalised body of knowledge, conceptual

frameworks fail a number of ‘scientific’ tests – The distinction between theories and policies is

important– CFs not produced in a political vacuum– CFs may just be a reflection of the dominant

group’s will

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Professional values and self-preservation

• ‘Self-preservation’– implies the pursuit of self-interest

• ‘Professional values’– suggests idealism and altruism

• Gerboth– sense of personal responsibility

• Hines– professional legitimacy

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Conceptual framework for auditing standards• Auditing is a discipline based in logic• The traditional verification role has evolved

into business risk auditing

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Summary

• The conceptual framework is intended to provide a coherent and prescriptive guide to accounting practice

• If effective it should result in the communication of more useful financial information to users

• Developing a conceptual framework has been a long and complicated process

• Criticisms of conceptual framework projects exist

• Others debate the importance of these criticisms

• In auditing there has been a shift away from substantive testing toward the role of client business risk

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Key terms and concepts

• Conceptual frameworks for accounting and auditing

• Statement of accounting concepts• FASB and IASB• Principles-based and rule-based standards• Decision making and decision-theory• Professional values and self-preservation• Business risk auditing

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