The accounting conceptual framework

by Christopher J Pyke
01 Jun 1999
The syllabus for Drafting Financial Statements (C1 and C1A) reuires candidates to be
able to e!"lain the nature and "ur"ose of a financial re"orting conce"tual frame#or$% &n
"articular' candidates need to ha(e a $no#ledge of the role and general issues co(ered
by the AS) Statement of Principles' and be able to a""ly the fundamental accounting
conce"ts%
This article begins by outlining the nature and "ur"ose of a conce"tual frame#or$'
e!"lains the "ur"ose and sco"e of the Statement of Principles and defines the
fundamental accounting conce"ts%
Nature and purpose of a conceptual framework
An accounting conce"tual frame#or$ can be defined as*
a coherent system of inter-related objectives and fundamentals that should lead
to consistent standards that prescribe the nature, function and limits of financial
accounting and financial statements.
(A !oul"s #ynch$
+o#e(er' it is easier to state #hat a conce"tual frame#or$ should be' than to actually
"recisely define it% There ha(e been se(eral attem"ts made to de(ise such a frame#or$'
most recently (,arch 1999) the re(ised -!"osure Draft . Statement of Principles for
!inancial %eporting' #hich is e!amined later in this article%
The main reasons for de(elo"ing an agreed conce"tual frame#or$ are that it "ro(ides*
a frame#or$ for setting accounting standards/
a basis for resol(ing accounting dis"utes/
fundamental "rinci"les #hich then do not ha(e to be re"eated in accounting
standards%
+o#e(er' the main dra#0bac$ of a conce"tual frame#or$ is that it can be too general in
nature and the "rinci"les may' therefore' not hel" #hen actually "roducing the financial
statements% &n addition' there may be further disagreement as to the content of the
frame#or$ and the contents of standards%
Purpose and scope of the Statement of Principles
The "ur"ose of the draft Statement of Principles is to define the "rinci"les that should
underlie the "re"aration and "resentation of general "ur"ose financial statements% &t also
"ro(ides the conce"tual under"innings for "re"aring future accounting standards% The
Statement com"rises the follo#ing eight cha"ters*
1 The 1b2ecti(e of Financial Statements%
2 The 3e"orting -ntity%
3 The 4ualitati(e Characteristics of Financial &nformation%
4 The -lements of Financial Statements%
3ecognition in Financial Statements%
! ,easurement in Financial Statements%
" 5resentation of Financial &nformation%
# Accounting for &nterests in 1ther -ntities%
The AS) belie(e that the draft Statement #ill assist "re"arers and users of financial
statements' as #ell as auditors and others' to understand better its a""roach to
formulating accounting standards% &t should also hel" them to understand better the
general nature and function of information re"orted in financial statements%
&t is im"ortant to remember that the Statement of Principles is not an accounting
standard and' therefore' does not "rescribe ho# financial statements should be "re"ared
or "resented%
The draft Statement focuses on the financial statements that are either intended to gi(e a
true and fair (ie# of the organisation6s financial "erformance and financial "osition or
are intended to be consistent #ith financial statements that gi(e such a (ie#% This
includes annual and interim financial statements' as #ell as "reliminary announcements
and summary financial statements%
$ele%ance of the Statement
The draft Statement is "rimarily designed to be rele(ant to the financial statements of
"rofit0oriented organisations including those in the "ublic sector' regardless of their si7e%
+o#e(er' it could also be rele(ant to not0for0"rofit organisations if some of the
"rinci"les are re0e!"ressed or their em"hasis changed% A se"arate "a"er on not0for0"rofit
entities and the Statement of Principles is to be issued in due course%
The draft Statement recognises that the conce"t of a true and fair (ie# is fundamental to
the #hole system of financial re"orting% An e!am"le of this is its insistence on rele(ance
and reliability as the main indicators of the uality of financial information% The conce"t
of a true and fair (ie# is considered to be the 8ultimate6 and lies at the core of all
financial re"orting% &t is regarded as the ultimate test for financial statements and' as
such' has a direct effect on accounting "ractice%
Financial statements #ill not gi(e a true and fair (ie# unless the information they
contain is sufficient in uantity and uality to satisfy the reasonable e!"ectations of the
readers to #hom they are addressed% These e!"ectations change o(er time and the AS)
see$s' through its accounting standards and other "ronouncements' to res"ond to these
e!"ectations%
The o&'ecti%es of financial statements
The Statement of Principles defines the ob2ecti(e of financial statements as*
to provide information about the reporting entity&s financial performance and
financial position that is useful to a 'ide range of users for assessing the
ste'ardship of management and for ma"ing economic decisions.
This definition "ro(ides the basis for de(elo"ing all the subseuent "rinci"les #ithin the
Statement% Fundamentally' the Statement assumes that it can achie(e this ob2ecti(e by
focusing on the information needs of "resent and "otential in(estors% This is because
they need information about the organisations financial "erformance and financial
"osition that is useful to them in e(aluating its ability to generate cash' and in assessing
its financial ada"tability%
Fundamental to the "re"aration of financial statements is the need to "ro(ide relevant,
reliable, comparable and understandable information% &n deciding #hich information to
include in financial statements and ho# to "resent it' the aim should be to ensure that
they "ro(ide information that is useful% The materiality test is used to determine #hether
the information6s usefulness is of such significance as to reuire it to be gi(en in the
financial statements% An item of information is considered material to the financial
statements if its misstatement or omission might reasonably be e!"ected to influence the
economic decisions of the users of those financial statements%
(undamental accounting concepts
Academic #riters on accountancy' and others' ha(e identified many accounting conce"ts
#hich could be regarded as forming "art of the accounting conce"tual frame#or$%
+o#e(er' the fundamental accounting conce"ts are defined in SSA5 9 and are often
referred to in later SSA5s% The four conce"ts are defined in the standard as follo#s*
Going concern: :the enter"rise #ill continue in o"erational e!istence for the foreseeable
future% This means in "articular that the "rofit and loss account and balance sheet assume
no intention or necessity to liuidate or curtain significantly the scale of o"eration;%
Accruals: : re(enues and costs are accrued (that is recognised as they are earned or
incurred' not as the money is recei(ed or "aid)' matched #ith one another so far as their
relationshi" can be established or 2ustifiably assumed;%
Consistency: :there is consistency of accounting treatment of li$e items #ithin each
accounting "eriod and from one "eriod to the ne!t;%
Prudence: :re(enue and "rofits are not antici"ated' but are recognised by inclusion in
the "rofit and loss account only #hen realised in the form either of cash or of other
assets the ultimate cash realisation of #hich can be assessed #ith reasonable certainty/
"ro(isions made for all $no#n liabilities (e!"enses and losses) #hether the amount of
these is $no#n #ith certainty or is a best estimate in the light of the information
a(ailable;%
SSA5 9 ac$no#ledges that the relati(e im"ortance of these conce"ts #ill (ary according
to the circumstances of a "articular case/ ho#e(er' it is made clear that #here the
accruals conce"t is inconsistent #ith the "rudence conce"t then "rudence should ta$e
"recedence% At le(el C candidates need to be able to define the conce"ts and a""ly them
#hen "re"aring financial statements%
Conclusion
This article has outlined the nature and "ur"ose of a conce"tual frame#or$ and
e!"lained the "ur"ose and sco"e of the Statement of Principles% Candidates often
o(erloo$ this im"ortant area of the syllabus #hich is fundamental to understanding the
#hole "rocess of "re"aring financial statements%