ACC803

Advanced Financial Reporting

Week 1: Financial Accounting Conceptual Framework and IASB

1.1 Financial accounting conceptual framework.

1.2 Role of IASB and Conceptual framework.
1.3 US GAAP and IFRS.
 Introduction
Financial statements are prepared and presented for external users by many entities around
the world.

Although such financial statements may appear similar from country to country, there are
differences which have probably been caused by a variety of social, economic and legal
circumstances and by different countries having in mind the needs of different users of
financial statements when setting national requirements.

These different circumstances have led to the use of a variety of definitions of the elements
of financial statements: for example, assets, liabilities, equity, income and expenses. They
have also resulted in the use of different criteria for the recognition of items in the financial
statements and in a preference for different bases of measurement.

The International Accounting Standards Board is committed to narrowing these differences

by seeking to harmonise regulations, accounting standards and procedures relating to the
preparation and presentation of financial statements. It believes that further harmonisation
can best be pursued by focusing on financial statements that are prepared for the purpose of
providing information that is useful in making economic decisions.
Conceptual framework of financial
accounting
Refers to a logically consistent system composed of mutually connected objectives
and basic concepts.
The system can guide to consistent accounting standards and set rules for the
nature, effects, and limitations of financial accounting and statements.

The Financial Accounting Standards Board (FASB) began development of an

accounting conceptual framework in the mid-1970s.

Between 1978 and 2000, it issued seven pronouncements entitled Statements of

Financial Accounting Concepts (SFAC).

These were designed to prescribe the objectives and concepts that the FASB will
use in developing standards of financial accounting and reporting (FASB 1978, 6).

The conceptual framework was to be used as a guide in the development of

consistent accounting standards, hopefully leading to a more coherent set of
accounting principles to aid practice.
 The purpose of the Conceptual
Framework is:
This Conceptual Framework sets out the concepts that underlie the preparation and presentation of financial
statements for external users.

(a) to assist the Board in the development of future IFRSs and in its review of existing IFRSs;

(b) to assist the Board in promoting harmonisation of regulations, accounting standards and procedures
relating to the presentation of financial statements by providing a basis for reducing the number of alternative
accounting treatments permitted by IFRSs;

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

(d) to assist preparers of financial statements in applying IFRSs and in dealing with topics that have yet to form
the subject of an IFRS;

(e) to assist auditors in forming an opinion on whether financial statements comply with IFRSs;

(f) to assist users of financial statements in interpreting the information contained in financial statements
prepared in compliance with IFRSs; and

(g) to provide those who are interested in the work of the IASB with information about its approach to the
formulation of IFRSs.
Role of framework of
accounting
Developing financial reporting standards and practice.
It facilitate the consistency of accounting standards over time
and provide a basis for standard setters to respond to the
demands of lobby group.
 Qualitative characteristics of useful
financial information
If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent.

The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable.

Fundamental qualitative characteristics

Relevance
Relevant financial information is capable of making a difference in the decisions made by users. Information may be
capable of making a difference in a decision even if some users choose not to take advantage of it or are already aware
of it from other sources.

Information is material if omitting it or misstating it could influence decisions that users make on the basis of financial
information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based
on the nature or magnitude, or both, of the items to which the information relates in the context of an individual
entitys financial report.

Faithful representation
Financial reports represent economic phenomena in words and numbers. To be useful, financial information must not
only represent relevant phenomena, but it must also faithfully represent the phenomena that it purports to represent.

To be a perfectly faithful representation, a depiction would have three characteristics. It would be complete, neutral
and free from error.
 Enhancing qualitative characteristics
Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the
usefulness of information that is relevant and faithfully represented. The enhancing qualitative characteristics may
also help determine which of two ways should be used to depict a phenomenon if both are considered equally
relevant and faithfully represented.

Comparability- information about a reporting entity is more useful if it can be compared with similar information
about other entities and with similar information about the same entity for another period or another date.
Comparability is the qualitative characteristic that enables users to identify and understand similarities in, and
differences among, items.

Verifiability- Verifiability helps assure users that information faithfully represents the economic phenomena it
purports to represent. Verifiability means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation.
Quantified information need not be a single point
estimate to be verifiable.

Timeliness- Timeliness means having information available to decision-makers in time to be capable of influencing
their decisions. Generally, the older the information is the less useful it is. However, some information may
continue to be timely long after the end of a reporting period because, for example, some users may need to
identify and assess trends.

Understandability- Classifying, characterising and presenting information clearly and concisely makes it
understandable.
Financial reports are prepared for users who have a reasonable knowledge of business and economic activities
and who review and analyse the information
diligently. At times, even well-informed and diligent users may need to seek the aid of an adviser to understand
information about complex economic phenomena.
 Measurement of the elements of
financial statements
Measurement is the process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried
in the balance sheet and income statement.

This involves the selection of the particular basis of measurement.

(a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at
the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for
example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.

(b) Current cost. Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was
acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation
currently.

(c) Realisable (settlement) value. Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in
an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid
to satisfy the liabilities in the normal course of business.

(d) Present value. Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal
course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the
liabilities in the normal course of business.

The measurement basis most commonly adopted by entities in preparing their financial statements is historical cost.
This is usually combined with other measurement bases. For example, inventories are usually carried at the lower of cost and net realisable value,
marketable securities may be carried at market value and pension liabilities are carried at their present value. Furthermore, some entities use the
current cost basis as a response to the inability of the historical cost accounting model to deal with the effects of changing prices of non-monetary
assets.
Recognition of assets
An asset is recognised in the balance sheet when it is probable that the future economic benefits will flow to the entity and the asset has a
cost or value that can be measured reliably.

Recognition of liabilities
A liability is recognised in the balance sheet when it is probable that an outflow of resources embodying economic benefits will result from
the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably.

In practice, obligations under contracts that are equally proportionately unperformed (for example, liabilities for inventory ordered but not
yet received) are generally not recognised as liabilities in the financial statements.

However, such obligations may meet the definition of liabilities and, provided the recognition criteria are met in the particular
circumstances, may qualify for recognition. In such circumstances, recognition of liabilities entails recognition of related assets or
expenses.

Recognition of income
Income is recognised in the income statement when an increase in future economic benefits related to an increase in an asset or a
decrease of a liability has arisen that can be measured reliably.

This means, in effect, that recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities
(for example, the net increase in assets arising on a sale of goods or services or the decrease in liabilities arising from the waiver of a debt
payable).

Recognition of expenses
Expenses are recognised in the income statement when a decrease in future economic benefits related to a decrease in an asset or an
increase of a liability has arisen that can be measured reliably.

This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in
assets (for example, the accrual of employee entitlements or the depreciation of equipment).
Underlying assumption: Going concern

The financial statements are normally prepared on the

assumption that an entity is a going concern and will continue in
operation for the foreseeable future. Hence, it is assumed that
the entity has neither the intention nor the need to liquidate or
curtail materially the scale of its operations; if such an intention
or need exists, the financial statements may have to be prepared
on a different basis and, if so, the basis used is disclosed.
Development of IFRS
IASC was established in 1973. This marks the beginning of
international efforts to develop global standards.
However in many cases the professional bodies, who were
members of the IASC were not the domestic standard setting
authority and thus there was little adaptation of IAS.

IN 1997 The IASC undertook a strategic review of its structure

and process culminating in the replacement of IASC with IASB.
 Overview - IASB
International Accounting Standards Board (IASB)

-based in London, began operations in 2001.

-The IASB is committed to developing, in the public interest, a single set of

high quality, global accounting standards that require transparent and
comparable information in general purpose financial statements.
-The IASB is selected, overseen and funded by the IFRS Foundation (formerly
called the International Accounting Standards Committee (IASC)
Foundation).
-The IFRS Foundation is financed through a number of national financing
regimes, which include levies and payments from regulatory and standard-
setting bodies, international organisations and other accounting bodies.
 Trustees
The Trustees provide oversight of the operations of the IFRS Foundation and the IASB.
The responsibilities of the Trustees include
-the appointment of members of the IASB,
the IFRS Advisory Council and the IFRS Interpretations Committee;
-overseeing and monitoring the IASBs effectiveness and adherence to its due process and consultation
procedures;
-establishing and maintaining appropriate financing arrangements;
-approval of the budget for the IFRS Foundation; and responsibility for constitutional changes.
-The Trustees have established a public accountability link to a Monitoring Board comprising public capital market
authorities.

The Trustees comprise individuals that as a group provide a balance of professional backgrounds, including
auditors, preparers, users, academics, and other officials serving the public interest.

Under the Constitution of the IFRS Foundation as revised in 2010 (see below), the Trustees are appointed so that
there are
six from the Asia/Oceania region,
six from Europe,
six from North America,
one from Africa and
one from South America, and
two others from any area, as long as geographical balance is maintained.
IFRS Advisory Council
The Advisory Council provides
-a forum for participation by organisations and individuals with an interest in
international financial reporting from diverse geographical and functional
backgrounds.

-The objective of the Advisory Council is to give the IASB advice on agenda
decisions and priorities in its work and give other advice to the IASB or the
Trustees.

The Advisory Council comprises about fifty members, representing stakeholder

organisations nternationally.
The Advisory Council normally meets three times a year.
Its meetings are open to the public.
The chair of the Advisory Council is appointed by the Trustees, and cannot be a
member of the IASB or its staff.
The chair of the Advisory Council is invited to attend and participate in the
Trustees meetings.
Details of the members of the Advisory Council are available on the website
www.ifrs.org.
IFRS Interpretations Committee
The Trustees established the Interpretations Committee (then called the International Financial Reporting
Interpretations Committee (IFRIC)) in March 2002, when it replaced the previous interpretations committee,
the Standing Interpretations Committee (SIC).

-The role of the Interpretations Committee is to provide timely guidance on

i) newly identified financial reporting issues not specifically addressed in Standards or
ii) issues where unsatisfactory or conflicting interpretations have developed, or seem likely to develop.

It thus promotes the rigorous and uniform application of IFRS.

The Interpretations Committee has fourteen voting members in addition to a non-voting chair.
The chair has the right to speak about the technical issues being considered but not to vote.
The Trustees, as they deem necessary, may appoint as non-voting observers regulatory organisations, whose
representatives have the right to attend and speak at meetings.

Currently, the International Organization of Securities Commissions (IOSCO) and the European Commission are
non-voting observers.

The Interpretations Committee publishes a summary of its decisions after each meeting.
This IFRIC Update is published in electronic format on the website www.ifrs.org.
Objectives of the IASB
(a) to develop, in the public interest, a single set of high quality, understandable,
enforceable and globally accepted financial reporting standards based on
clearly articulated principles.
These standards should require high quality, transparent and comparable
information in financial statements and other financial reporting to help
investors, other participants in the various capital markets of the world and
other users of financial information make economic decisions;

(b) to promote the use and rigorous application of those standards;

(c) in fulfilling the objectives associated with (a) and (b), to take account of, as
appropriate, the needs of a range of sizes and types of entities in diverse economic
settings;

(d) to promote and facilitate the adoption of IFRSs, being the standards and
interpretations issued by the IASB, through the convergence of national accounting
standards and IFRSs.
 Domestic adoption of IFRS
FIA adopted IFRS as the required standards starting 1 January 2007.

IFRS for SMEs

While adopting IFRS provides benefits in terms of facilitating international capital flows, they are costly for
preparers to implement.

Some preparers or potential prepares may be unlikely to directly benefit from access to global capital markets.
For examples small and medium sized entities that are not listed on stock exchange are less likely to
participate in international capital markets.

In responding to the need for accounting standards for SMEs the IASB issues IFRS for SMEs in July 2009.

IFRS for SMEs is a stand alone document that is intended to reflect the need of users of SMEs financial
statements and cost- benefit considerations.

IFRS for SMEs

i) omit some standards that do not apply to SMEs,
ii) reduces the choice of accounting policies and
iii) prescribes fewer disclosures.
IFRS for SMEs
SMEs are the main engines of countries economies due to their significant role in
economic development (Siam & Rahahleh, 2010)

Over 95% of the entities in the world are small and medium-sized, whereas the
number of listed companies is about 46,000 (Vasek, 2011; IASB, 2012).
Therefore, the expected comparability of entities financial statements cannot be
maintained with the application of international standards solely by listed entities
(which are using IFRS).

Further, the use of internationally accepted financial reporting standards

increases the quality of the financial information. Not only listed entities, but also
unlisted entities need comparable high-quality financial information (Pacter,
2009).

Hence, the use of the IFRS for SMEs will provide internationally understandable
and comparable financial statements in a more simplified and less costly way for
SMEs. The use of the IFRS for SMEs is becoming more widespread day by day.
 Advantages and disadvantages
of and obstacles to IFRS for SMEs
adoption
The adoption of universally accepted financial reporting standards that require high-quality, transparent, and
comparable information has been welcomed by investors, creditors, financial analysts, and other users of
financial statements (Ankarath et al., 2010).

The motivation of the parties to attain a common set of standards stems from the demand for financial
information that is prepared in accordance with a global set of standards rather than local accounting
standards (El-Gazzar et al., 1999).

The advantages of using a common set of standards are listed in literature as :

improved efficiency and effectiveness in financial reporting and auditing (Joshi & Ramadhan, 2002)
enhanced comparability (Ball, 2006)
greater transparency and reliability (Ball, 2006);
increased opportunities for external financing (El-Gazzar et al., 1999; Joshi & Ramadhan, 2002;)
reduced cost of capital (Beck et al., 2008; Ankarath et al., 2010; Cai & Wong, 2010)
decreased risks and uncertainty for international financial statement users and resource providers
(Chorafas, 2006).
On the other hand, some parties have criticized the IASB concerning the
development of a common standard for SMEs due to several reasons,
including two main arguments.
Firstly, they asserted that the IASB developed standards throughout the world, irrespective of each countrys culture and
level of economic development, as a universal standard (Al-Shammari et al., 2008).

Having the same set of accounting standards may not be enough to maintain comparability between the financial
statements of entities because of country factors (Schultz & Lopez, 2001; Evans et al., 2005; Zeghal & Mhedhbi, 2006;
Stainbank, 2008; Djatej et al., 2009; Cole et al., 2011; Nobes, 2011), the company-specific factors (Evans et al., 2005), and
the incentive of preparers (Cole et al., 2011).

Another argument concerned the IASBs experience and expertise in the field of accounting.
In their view, the IASB may not be an appropriate body to develop a simple standard for non-listed entities because most
of its members have expertise in the financial reporting of large listed entities rather than small ones (Mantzari et al.,
2009).

Other disadvantages and obstacles which are proposed by the researchers can be summarized as
i) associated costs (Larson & Street, 2004; Taylor, 2009; Winney et al., 2010; Ballas et al., 2010; Jones & Finley, 2011);
ii) complexity and difficulties in interpretation (Hora et al., 1997; Zeff, 2007; Alali & Cao, 2010; Chand et al., 2010; Bunea-
Bontas et al., 2011); and
iii) lack of trained personnel (Ballas et al., 2010; Jones & Finley, 2011; Uyar & Gngrm, 2013).

Effective adoption of IFRS for SMEs require commitment and reinforcement from accounting professionals, the
international standard-setting authorities, regulatory bodies, auditors, and academicians.
Readings
Week 1 Reading 1- Financial accounting In communicating
reality, we construct reality.

Week 1 Reading 2-The Latest Progress of the Conceptual

Framework

Week 1 Reading 3-Discussion about Conceptual Framework