Chapter 5

A conceptual
framework for
financial
accounting and
reporting

Conceptual framework
A conceptual framework is a formal
set of interrelated concepts
specifying the function, scope and
purpose of financial accounting and
reporting
In Australia, the SACs represent the
conceptual framework or constitution
for financial reporting

Conceptual framework (contd)

A conceptual framework can be
descriptive, prescriptive or a mixture of
both:
a descriptive framework attempts to
develop a set of interrelated concepts,
which serves to codify and explain
existing financial reporting practices
a prescriptive framework attempts to
develop a conceptual basis for what
financial accounting practices should
be

History of the conceptual

framework
The need for a conceptual framework was
recognised in the USA after the stock market
crash of 1929
Leaders of the profession recognised the
need to:
establish basic principles on which to base
company reporting
correct permissive accounting practices of
the 1920s
restore public confidence in professional
accountants

The Committee on
Accounting Procedure (CAP)
The first standard-setting body, which
was established by the American
Institute of Accountants in 1936
The CAP published bulletins that
provided authoritative opinions or
recommendations on preferred
accounting practices
The CAP, however, failed to provide a
conceptual framework

Discontent in the 1950s

Academic and professional opinion of the
mid-1950s stressed the inadequacies of
company financial reporting:
The historical cost model, generally
accepted in accounting practice at the
time, was not being applied consistently,
nor were its underlying principles well
understood
A tradition was developing among
academics that was against the whole
principle of historic cost accounting

The Accounting Principles

Board (APB)
The APB was established in the USA in
1959 to accelerate the development of a
conceptual framework
The APB set itself the following tasks:
to establish basic postulates
to formulate a set of broad principles
to establish rules to guide the application
of principles in specific situations
to base the entire program on research

APB Statement No.4

This statement was titled Basic
Concepts and Accounting Principles
Underlying Financial Statements of
Business Enterprises
Basically descriptive, it did not provide a
conceptual framework, but influenced
Australian attempts to formulate
objectives of financial statements and to
develop a conceptual framework

Objectives according to
APB Statement No. 4
Paul Grady was commissioned by the APB
in 1963 to develop a more descriptive
framework, which was reflected in the
objectives of APB Statement No. 4:
1. Particular objectives of financial
statements are to present fairly, and in
conformity with GAAP, financial position,
results of operations and other changes in
financial position

Objectives according to
APB Statement No. 4 (contd)
2. The general objectives are:
a. to provide reliable information about the
economic resources and obligations of a
business enterprise in order to:
i. evaluate its strengths and
weaknesses
ii. show its financing and investments
iii. evaluate its ability to meet its
commitments
iv. show its resource base for growth

Objectives according to
APB Statement No. 4 (contd)
b. to provide reliable information about
changes in net resources resulting from
a business enterprises profit-directed
activities in order to:
i. show expected dividend return to
investors
ii. demonstrate the operations ability to
pay creditors and suppliers, provide
jobs for employees, pay taxes and
generate funds for expansion
iii. provide management with information
for planning and control

Objectives according to
APB Statement No. 4 (contd)
c. to provide financial information that
can be used to estimate the
earnings potential of the firm
d. to provide other necessary
information about changes in
economic resources and obligations
e. to disclose other information
relevant to statement users needs

Objectives according to
APB Statement No. 4 (contd)
3. The qualitative objectives of financial
accounting are:
a. relevance
b. understandability
c. verifiability
d. neutrality
e. timeliness
f. comparability
g. completeness

Developments in Australia
The development of a conceptual
framework in Australia followed a
similar pattern to that in the USA
Australia was able to evaluate and
adapt APB and FASB initiatives for
Australian conditions

The conceptual framework in

Australia
Australian academics such as Mathews and
Grant, and Chambers, proposed abandoning
the historical cost system in favour of some
form of current cost accounting system
In response, the accounting profession
commissioned John Kenley, director of the
Accountancy Research Foundation (later the
AARF) to adapt Paul Gradys AICPA studies to
Australian conditions
A largely prescriptive approach was adopted,
which has been very influential to this day

Elements of the Australian

strategy
Elements of the Australian strategy to develop
a conceptual framework were stated by a
previous AARF director as:
1. maximising the use of FASB thinking
2. influenced by the notion that the
importance of a conceptual framework
would not be oversold, but gradually
unveiled
3. the first stage of development was to be
the tentative identification of the building
blocks of a workable framework

Elements of the Australian strategy

(contd)
4. the second stage was to be the selection of
certain building blocks to formalise specific
projects
5. the third stage was to be the investigation of
interrelationships between the building
blocks and any consequential redefinition of
those blocks
6. the fourth stage was to be the
commissioning of projects for the remaining
blocks
7. publication of the SACs would then
commence

Exposure drafts
Six exposure drafts were release between 1987
and 1990:
1. ED 42A (objectives of financial reporting)
2. ED 42B (qualitative characteristics of
financial information)
3. ED 42C (definition and recognition of assets)
4. ED 42D (definition and recognition of
liabilities)
5. ED 46A (definition of the reporting entity)
6. ED 51A (definition of equity)
7. ED 51B (definition and recognition of
revenues)

SACs
Three SACs were released in August
1990:
1. SAC 1 Definition of the Reporting
Entity
2. SAC 2 Objectives of General
Purpose Financial Reporting
3. SAC 3 Qualitative Characteristics of
Financial Information

The early 1990s

Section 226(1) of the Corporations Law
(1991) specifically charged the AASB
with the responsibility of developing a
conceptual framework
SAC 4 Definition and Recognition of
Elements of Financial Statements was
released in March 1992

SAC 4
Specifies the definition of and rules for
recognition of assets, liabilities, equity,
revenues and expenses in companies
financial reports
Corporate backlash to SAC 4 resulted in
the mandatory status of SACs being
withdrawn in December 1993
Corporate backlash also resulted in
amendments to SAC 4 being released in
March 1995

The need for a conceptual

framework

According to standard setters, the following

situations demonstrate the need for a
conceptual framework:
Two or more methods of accounting are
accepted for the same facts
Less-conservative accounting methods are used
rather than earlier, more conservative methods
Reserves are used to artificially smooth
earnings fluctuations
Financial statements fail to warn of impending
liquidity crunches

The need for a conceptual

framework (contd)
Deferrals are followed by big bath writeoffs
There is unadjusted optimism in estimates
of recoverability
Off balance-sheet financing is common
An unwarranted assertion of immateriality
has been used to justify non-disclosure of
unfavourable information or departures
from standards
Form is relevant over substance

FASB definition
A conceptual framework is a constitution, a coherent
system of interrelated objectives and fundamentals
that can lead to consistent standards and that
prescribes the nature, function and limits of financial
accounting and financial statements. The objectives
identify the goals and the purposes of accounting.
The fundamentals are the underlying concepts of
accounting concepts that guide the selection of
events to be accounted for, the measurement of
those events and the means of summarizing and
communicating to interested parties. Concepts of
that type are fundamental in the sense that other
concepts flow from them and repeated references to
them will be necessary in establishing, interpreting
and applying accounting and reporting standards.

Description of a conceptual
framework
A conceptual framework is therefore
intended to act as a constitution for the
standard-setting process
The AARF described the conceptual
framework in similar terms, as:
a set of inter-related concepts which will
define the nature, subject, purpose and
broad content of financial reporting. It
will be an explicit rendition of the
thinking which is governing the decisionmaking of (standard-setters)

Advantages of a conceptual
framework
A conceptual framework is useful in the
development of more consistent and logical
standards and in removing the necessity to
re-debate conceptual issues when preparing
new accounting standards
The issue of standards overload can be
potentially reduced because a conceptual
framework can enable resolution of
particular accounting problems, which avoids
the necessity of issuing new accounting
standards

Advantages of a conceptual
framework (contd)
Can lead to better communication
among accountants, auditors and users
because all parties are using a common
set of definitions and criteria
Has potential to reduce the activities
and influence of lobbies and interest
groups

Potential benefits according

to the AARF
According to the AARFs Guide to Proposed
Statements of Accounting Concepts, the
potential benefits are:
a. reporting requirements should be more
consistent and logical, because they will
stem from an orderly set of concepts
b. avoidance of reporting requirements will
be much more difficult because of the
existence of all-embracing provisions

Potential benefits according to the

AARF (contd)
c. the Boards which set down the
requirements will be more
accountable for their actions in that
the thinking behind specific
requirements will be more explicit, as
will any compromises that may be
included in particular accounting
standards
d. the need for specific accounting
standards will be reduced to those
circumstances in which the
appropriate application of concepts is

Potential benefits according to the

AARF (contd)
not clear-cut, thus mitigating the
risks of over-regulation
e. preparers and auditors should be
able to better understand the
financial reporting requirements
they face
f. the setting of requirements should
be more economical because issues
should not need to be re-debated
from differing viewpoints

Strategic objectives for a

conceptual framework
The literature indicates that conceptual-framework
projects have been developed as an instrument for
the accounting professions self-preservation
One test used by Hines to determine whether
conceptual frameworks could be viewed as
strategic manoeuvres was to ascertain whether
these projects were undertaken at times of threat
to accountancys legitimacy or at times of
competition
Hines concluded that the major rationale for
undertaking conceptual frameworks was not
functional or technical, it was a strategic
manoeuvre for providing legitimacy to standardsetting bodies

Conflicts of interest
Financial statements result from the interaction
of three groups:
firms, which by their operational, functional
and extraordinary activities, justify the
production of financial statements
users, which include investors, financial
analysts, bankers, creditors, consumers,
employees, suppliers and government
agencies
the accounting profession, which acts
principally as auditor in charge of verifying
that financial statements conform to generally
accepted accounting principles

Cyert and Ijiris three

approaches

Simply stated, these are:

1. the firm-oriented approach
2. the profession-oriented approach
3. the user-oriented approach
The user-oriented approach is
employed by the SACs in Australia, by
the FASB in the USA and by The
Corporate Report in the UK

Conceptual framework issues

In the process of developing a
conceptual framework, the AARF and its
Boards have had to resolve several
fundamental conceptual issues
These issues have determined the
nature and content of SACs

Issue 1: Balance sheet versus

profit and loss account orientation
There are two distinct approaches to
determining an entitys income during a
reporting period:
the asset/liability view, which
maintains that revenues and expenses
result only from changes in the value
of assets and liabilities
the revenue/expense view, which
holds that revenues and expenses
result from the need for a proper
matching

Criticisms of the
asset/liability view
It excludes debit and credit items
because they do not constitute economic
benefits or resources to the entity
It is unwilling, therefore, to recognise as
revenues and expenses anything except
current changes in economic resources
and obligations to transfer resources,
making it incapable of dealing with the
complexities of the modern business
world

The revenue/expense view

Matching comprises two steps:
1. revenue recognition or timing through
the realisation principle
2. expense recognition in three possible
ways:
a. associating cause and effect, such as
for the cost of goods sold
b. systematic and rational allocation, such
as for depreciation
c. immediate recognition, such as for
selling and administrative expenses

Criticisms of the
revenue/expense view
It has led to the recognition in the
statement of financial position of such
items as deferred charges, deferred
credits, and reserves, none of which
represent economic resources and
obligations
It places much emphasis on the
importance of the historical cost and
revenue realisation principles

Issue 2: Definition of assets,

liabilities, equity, revenues and
expenses
Based on the asset/liability view, assets
are restricted to the economic resources of
the firm, which are:
productive resources of the enterprise
contractual rights to productive
resources and products
money
claims to receive money
ownership interests in other enterprises

Issue 2: Definition of assets, liabilities,

equity, revenues and expenses (contd)
According to the revenue/expense view, assets
include not only the assets defined from the
asset/liability viewpoint, but also all items that
do not represent economic resources, but that
are required for proper matching
A third view of assets arises from the perception
of the balance sheet not as a statement of
financial position, but as a statement of the
sources and composition of company capital.
According to this view, assets constitute the
present composition of invested capital.

Issue 2: Definition of assets, liabilities,

equity, revenues and expenses (contd)

If we exclude the element of deferred

charges on the statement of financial
position, the definitions of assets
presented in these three different views
have the following characteristics in
common:
1. An asset represents potential cash flow
to a firm
2. Potential benefits are obtainable by the
firm

Issue 2: Definition of assets, liabilities,

equity, revenues and expenses (contd)
3. The legal concept of property may
affect the accounting definition of
assets
4. The way an asset is acquired may
be part of the definitions
5. Exchangeability may be an essential
characteristic of assets

Definitions to take into account

for a conceptual framework
1.
2.
3.
4.

5.

An asset represents only economic resources

and does not include deferred charges
An asset represents potential cash flows to a
firm
Potential benefits are obtainable by the firm
An asset represents the legal binding right to a
particular benefit, results from a past or current
transaction, and includes all commitments, as in
wholly executory contracts
Exchangeability is not an essential characteristic
of assets except for deferred charges

Definitions of liabilities
According to the asset/liability view,
liabilities are the obligations of the firm to
transfer economic resources to other
entities in the future
According to the revenue/expense view,
liabilities comprise not only the liabilities
defined from the asset/liability viewpoint
but also certain deferred credits and
reserves that do not represent obligations
to transfer economic benefits but that are
required for proper matching and income
determination

Definitions of liabilities (contd)

A third view arises from the perception
of the balance sheet as a statement of
the sources and composition of
company capital:
according to this view, liabilities
constitute sources of capital and
include certain deferred credits and
reserves that do not represent
obligations to transfer economic
resources

Definitions of liabilities (contd)

If we disregard the element of deferred

credits, the definitions of liabilities
presented in these three different views
have the following characteristics in
common:
1. A liability is a future sacrifice of economic
resources
2. A liability represents an obligation of a
particular enterprise
3. A liability may be restricted to legal debt
4. A liability results from past or current
transactions or events

Definitions of income
According to the asset/liability view,
income is the net assets of the firm except
for capital changes
According to the revenue/expense view,
income results from the matching of
revenues and expenses and, perhaps, from
gains and losses:
gains and losses, therefore, may be
distinguished from the revenues and
expenses, or they may be considered
part of these

Revenues and expenses

According to the asset/liability view,
revenues are defined as increases in the
assets or decreases in the liabilities that
do not affect capital
Expenses are defined as decreases in
the assets or increases in the liabilities
arising from the use of economic
resources or services during a given
period

Revenues and expenses (contd)

According to the revenue/expense view, revenues
result from the sale of goods and services and
include gains from the sale and exchange of
assets other than inventories, interests and
dividends earned on investments, and other
increases in owners equity during a period other
than capital contributions and adjustments
Expenses comprise all of the expired costs that
correspond to the revenues of the period. If gains
and losses are defined as a separate element of
income, however, revenues are defined as
measures of an entitys outputs that result from
the production or delivery of goods and the
rendering of services during a period

Gains and losses

According to the asset/liability view,
gains are defined as increases in net
assets other than increases from
revenues or from changes in capital
Losses are defined as decreases in net
assets other than decreases from
expenses or from changes in capital
Thus, gains and losses constitute that
part of income not explained by
revenues and expenses

Gains and losses (contd)

According to the revenue/expense view,
gains are defined as the excess of
proceeds over the cost of assets sold, or
as windfalls and other benefits obtained
at no cost or sacrifice
Losses are defined as the excess over
the related proceeds, if any, of all or an
appropriate portion of the costs of assets
sold, abandoned, or wholly or partially
destroyed by casualty, or as costs that
expire without producing revenues

Relationships between
income and components of
income
Three major relationships exist between
income and the components of income:
1. Income = Revenues Expenses +
Gains Losses
2. Income = Revenues Expenses
3. Income = Revenues (including gains)
Expenses (including losses)

Income relationships (contd)

In 1., each component is separate and
essential to a definition of income
In 2., gains and losses are not separate
and are not essential to the definition of
income. All increases and decreases are
treated similarly as either revenues or
expenses
In 3., although gains and losses are
separate concepts, they are part of
revenues and expenses

Accrual accounting
Accrual accounting measures the effects
of transactions having cash
consequences for an entity as they are
incurred, not simply as cash is received
or paid they are recorded in
accounting records, and reported in the
financial statements of the reporting
period to which they relate
Accrual accounting rests on the
concepts of accrual, deferral, allocation,
amortisation, realisation and recognition

FASB definitions
Accrual is the accounting process of
recognizing non-cash events and
circumstances as they occur; specifically,
accrual entails recognizing revenues and
related increases in assets and expenses
and related increases in liabilities for
amounts expected to be received or paid,
usually in cash, in the future ...
Deferral is the accounting process of
recognizing a liability for a current cash
receipt or an asset for a current cash
payment (or current incurrence of a
liability) with an expected future impact on
revenues and expenses ...

FASB definitions (contd)

Allocation is the accounting process of
assigning or distributing an amount according
to a plan or a formula. It is a broader term than
amortisation; that is, amortisation is an
allocation process ...
Amortisation is the accounting process of
systematically reducing an amount by periodic
payments, or write-downs ...
Realisation is the process of converting noncash resources and rights into money; it is
most precisely used in accounting and financial
reporting to refer to sales of assets for cash or
claims of cash. The related terms, realised

FASB definitions (contd)

and unrealised, therefore identify
revenues or gains and losses on assets
sold and unsold, respectively ...
Recognition is the process of formally
recording or incorporating an item in the
accounts and financial statements of an
enterprise. Thus, an element may be
recognized (recorded) or unrecognized
(unrecorded). Realisation and
recognition are not used synonymously,
as they sometimes are in the accounting
and financial literature

Issue 3: Concepts of capital

maintenance

The concept of capital maintenance

allows us to make a distinction between
the return on capital, or income, and the
return of capital, or cost recovery
There are four possible concepts of
capital maintenance:
1. financial capital measured in units of
money
2. financial capital measured in units of
the same general purchasing power

Issue 3: Concepts of capital

maintenance (contd)
3. physical capital measured in units of
money
4. physical capital measured in units of
the same general purchasing power

Issue 4: Which measurement

method should be adopted?
The issue of measurement concerns
determination of both the unit of
measure and the attribute to be
measured
For unit of measure, the choice is
between actual dollars and general
purchasing power adjusted dollars
For the particular attribute, there are
five options (see next slide)

Measurement options
The five options for measurement of a
particular attribute are as follows:
1. historical cost method
2. current cost
3. current exit value
4. expected exit value
5. present value of expected cash
flows

Issue 5: Applicability of the

conceptual framework to the
public sector
Australian standard setters have not
maintained a strong distinction between
the private sector, the public sector and
not-for-profit entities
Standard setters in the USA have tended
to maintain greater distinctions between
profit-seeking and not-for-profit entities
In Australia, comprehensive accrual
accounting has been progressively
introduced into the public sector

AAS 29 Financial Reporting by

Government Departments
According to AAS 29, government
departments would have the following
similarities to private-sector entities:
1. similarities in the economic
environment
2. similarities in user needs for
information
3. similarities in the objectives of the
financial statements

SAC 2: Definition of financial

reporting
There is no generally accepted definition of
general purpose financial reporting, but SAC 2
provides an indication that its scope may extend
beyond financial information:
Financial reporting encompasses the
provision of financial statements and related
financial and other information (paragraph
10)
Paragraph 10 of SAC 2 also states that general
purpose financial reports (GPFRs) include:
financial statements, notes, supplementary
schedules and explanatory material intended
to be read with the financial statements

SAC 2: Definition of financial

reporting (contd)
Other parts of paragraph 10 obscure the issue
completely:
This Statement does not attempt to draw a
clear distinction between financial reports
and financial reporting, nor does it attempt
to define the boundaries of general purpose
financial reporting
Hence, the scope of financial reporting can be
potentially very broad

What criteria should be used?

A critical issue is what criteria should be
used to determine which information will
be included within the scope of financial
reporting:
1. SAC 2 specifies that the overall objective
of GPFRs is to provide relevant
information for economic decision
making by users
2. SAC 3 specifies the necessary
characteristics that information should
possess, and emphasises the importance
of the relevance and reliability of
information

Definition of a reporting
entity
SAC 1 defines a reporting entity as:
entities (including economic entities) in
respect of which it is reasonable to
expect the existence of users dependent
on GPFRs for information which will be
useful to them for making and
evaluating decisions about the allocation
of scarce resources

Definition of a reporting entity

(contd)
Because the definition of a reporting
entity is linked to the information needs
of external users, the existence of a
reporting entity will not depend on:
1. the sector within which the entity
operates
2. the purpose for which the entity
was created
3. the manner in which the entity is
constituted

Determination of dependent
external users
SAC 1 provides three general
guidelines to assist in determining the
existence of dependent external users:
1. separation of management from
economic interests
2. economic or political
importance/influence
3. financial characteristics

Objective of general purpose

financial reporting
SAC 2 states that:
General purpose financial reports
focuses [sic] on providing information to
meet the common information needs of
users who are unable to command the
preparation of reports tailored to their
particular information needs. These
users must rely on the information
communicated to them by the reporting
entity

Objective of general purpose

financial reporting (contd)
Because efficient resource allocation is
the ideal, SAC 2 states that the primary
objective of GPFRs is to provide relevant
information to various external users so
that they can make and evaluate
decisions about the allocation of scarce
resources
SAC 2 also describes a secondary
objective, which is to demonstrate the
discharge of accountability

Types of users and information

SAC 2 describes three classes of user:

1. resource providers
2. recipients of goods and services
3. parties performing a review or oversight
function
SAC 2 also defines the types of information
these users need in order to make informed
decisions:
1. performance
2. financial position
3. financing and investing
4. compliance

Qualitative characteristics of
financial information
Primary characteristics
Relevance is defined in SAC 3 to mean that
quality of financial information which exists
when information influences the decisions of
users about the allocation of scarce resources
Reliability is defined as:
that quality of financial information which
exists when the information can be
depended upon to represent faithfully, and
without bias or undue error, the transactions
or events that it either purports to represent
or could reasonably be expected to
represent

Qualitative characteristics of
financial information (contd)
Secondary and interactive qualities
Comparability is defined in SAC 3 as:
that quality of financial information which
exists when users of that information are
able to evaluate similarities in and differences
between, the nature and effects of
transactions and events, at one time and
over time, either when assessing aspects of a
single reporting entity or a number of
reporting entities
Understandability means that quality of financial
information which exists when users of that
information are able to comprehend its meaning

Qualitative characteristics of
financial information (contd)
Constraints on relevance
Timeliness: SAC 3 cautions that information
will lose its relevance if there is a delay in
the reporting of that information
Costs versus benefits: Financial information
will be sought if the benefit to be derived
from the information exceeds its cost

Qualitative characteristics of
financial information (contd)
Materiality
Materiality is defined in SAC 3 as:
the extent to which relevant and reliable
information may be omitted, misstated or
not disclosed separately without having
the potential to adversely affect the
decisions made about the allocation of
scarce resources made by users
SAC 3 emphasises that consideration must
be given to whether or not the information is
likely to have a significant, or material,
impact on decisions

Definition and recognition of

assets
SAC 4 embraces the asset/liability viewpoint and
defines assets as future economic benefits or
controlled by the entity as a result of past
transactions or other past events
SAC 4 further stipulates that an asset should
only be recognised on the balance sheet when:
it is probable that the future economic
benefits embodied in the asset will eventuate;
and
the asset possesses a cost or other value that
can be measured reliably

Definition and recognition of

liabilities
SAC 4 defines liabilities as:
future sacrifices of economic benefits that
the entity is presently obliged to make to
other entities as a result of past
transactions or other past events
SAC 4 further states that a liability should be
recognised on the balance sheet when:
it is probable that the future sacrifice of
economic benefits will be required; and
the amount of the liability can be measured
reliably

Definition and recognition of

equity
SAC 4 defines equity as a residual interest in
the assets of the entity after the deduction of
its liabilities
Because equity is defined as residual, the
recognition of equity will be consequential to
procedures used to recognise assets and
liabilities

Definition and recognition of

revenues
SAC 4 defines revenues as:
inflows or other enhancements, or savings in
outflows, of future economic benefits in the
form of increases in assets or reductions in
liabilities of the entity, other than those relating
to contributions by owners, that result in an
increase in equity during the reporting period
A revenue should be recognised in the profit and
loss account when:
it is probable that the revenue has occurred;
and
the revenue can be measured reliably

Definition and recognition of

expenses
SAC 4 defines an expense as:
consumptions or losses of future economic
benefits in the form of reductions in assets or
increases in liabilities of the entity, other than
those relating to distributions to owners, that
result in a decrease in equity during the reporting
period
An expense should be recognised when:
it is probable that the expense has been
incurred; and
the amount of the expense can be reliably
measured

Measurement
SAC 4 does not explicitly deal with how
assets and liabilities should be measured
The AARF now seems aware of the need to
address publicly the critical issue of
measurement in financial statements
In mid-1994, the AARF released a public
Invitation to Comment on a Proposed
Program for the Development of Concepts on
Measurement of the Elements of Financial
Statements

AARF Invitation to Comment

The AARF Invitation to Comment
recognised that measurement is one of
the most significant contemporary issues
in financial reporting because of:
a. the frequently significant impact of
measurement choices on reported
results
b. the existence of widely divergent
views among practitioners, users and
other parties about the relevance of
historical cost accounting

AARF Invitation to Comment (contd)

c. the widely divergent measurement
practices under the present system
of modified historical cost
accounting in Australia
d. the voluntary adoption of current
market value measurements
industries such as life insurance,
banking and funds management
e. the range of existing accounting
standards that specify currentvalue accounting approaches

Display of
financial information
This level of the conceptual framework
considers in detail the nature of the
information to be displayed in financial
reports
This involves identifying the appropriate
information groupings (financial
position, performance, investing and
financing, and compliance) and
analysing the components of those
groupings

Standard-setting policy and

enforcement
This lowest level of the conceptual
framework considers policy issues,
such as:
audit status
applicability and timing of financial
reporting
policy enforcement

Corporate backlash
The only aspect of the Australian
conceptual framework to attract significant
corporate concern was SAC 4
Many of the concerns were captured in a
statement from a submission by Caltex Oil
Australia:
(SAC 4) is a laudable aim but I contend
it does not address commercial reality,
or focus on that very important issue of
the credibility of the accounting
profession in Australia

Specific corporate concerns

with SAC 4
1. Balance sheet versus profit and loss account
orientation
2. Definition of elements too prescriptive and
uncertain. Accounting treatments that raised
the most controversy were:
a. contracts where agreements are equally
and proportionately un-performed
b. accounting for leases
c. treatment of debt/equity items
d. revaluation practices
e. financial instruments

Specific corporate concerns with SAC

4 (contd)
3. Recognition criteria the probability test
4. Inconsistency with existing accounting
standards
5. Departure from international accounting
standards and practices

The AARFs backdown

on SAC 4
In late 1993, a Joint Standing
Committee of the ASCPA and ICAA
decided that SACs should no longer
have mandatory status for members of
the accounting profession
The AASB and PSASB decided to amend
SAC 4
An amended SAC 4 was released in
March 1995

Substantive amendments
to SAC 4
1. Removal of mandatory status and
transitional provisions
2. Removal of an operative date
3. Removal of the detailed Appendix that
provided guidance on the interpretation
and application of SAC 4 concepts to a
number of specific accounting
transactions

Substantive amendments
to SAC 4 (contd)
4. Changes to the commentary sections,
including a tightening up in the
classification of liabilities, greater
discussion on the nature of reciprocal
and non-reciprocal transfers and greater
discussion on when an increase in asset
value would constitute an item of
revenue or an equity adjustment
5. Greater attention given to conventional
accounting principles, such as matching
and periodicity

Other concerns with SAC 4

A number of other concerns were not
reflected in the changes made to SAC 4:
the Boards of the AARF decided against
providing definitions for gains and
losses that were separate from the
general definition of revenues and
expenses
the Boards maintained their policy on
requiring recognition of agreements
equally proportionately underperformed
in the statement of financial position

Development of the US
conceptual framework
In 1971, The American Institute of
Certified Practicing Accountants
formed two study groups:
1. the Wheat Committee, which was a
study group on the establishment of
accounting principles, and which
was charged with the task of
improving the standard-setting
process

Development of the US conceptual

framework (contd)
2. the Trueblood Committee, which was
charged with developing the objective
of financial reporting in terms of:
a. who needs financial statements
b. what information they need
c. how much of this information can be
provided through accounting
d. what framework is required to
provide the information

Objectives of financial
statements
The Trueblood Report identified six
objective-levels:
1. The basic objective to provide
information on which to base economic
decisions
2. Four objectives that specify the diverse
users and uses of accounting information
3. Two objectives that specify enterprise
earning power and management ability
as the type of information needed

Objectives of financial statements

(contd)
4. One objective (No. 6) that specifies the
nature of the needed information as
factual and interpretive
5. Four objectives that describe the
financial statements required to meet
objective No. 6
6. A number of specific recommendations
for the financial statements are made
in order to meet each of the preceding
objectives

Qualitative characteristics of
reporting
The Trueblood Report mentioned seven
qualitative characteristics of reporting:
1. relevance and materiality
2. form and substance
3. reliability
4. freedom from bias
5. comparability
6. consistency
7. understandability

Six statements of financial

accounting concepts
1. The objectives of financial reporting
by business undertakings
2. Qualitative characteristics of
accounting financial information
3. Elements of the financial statements
4. Objectives of financial reporting by nonbusiness entities

Six statements of financial

accounting concepts (contd)
5. Recognition and measurement in
financial statements of business
undertakings
6. A statement of amendments to
previous concepts statements

Comparison of SACs and

SFACs
SFACs are more detailed, more explicitly
stated and more prescriptive than SACs. For
example, SFACs:
1. recommend more conservative recognition
criteria for the elements of financial
statements
2. differentiate between revenues, expenses,
gains and losses in a manner consistent
with conventional practice
3. make greater reference to conventional
accounting principles

The Corporate Report

The Corporate Report was published in
1976 by the Institute of Chartered
Accountants in England and Wales. Its
major findings and recommendations were
that:
financial statements should be
appropriate to their expected use by
potential users
responsibility for reporting belongs to the
economic entity having an impact on
society through its activities

The Corporate Report (contd)

users are defined as those having a
reasonable right to information,
whose information needs should be
recognised by corporate reports
the corporate report should be
relevant, understandable, reliable,
complete, objective, timely and
comparable
there is a need for additional
statements

Additional statements
1. A statement
2. A statement
government
3. A statement
currency
4. A statement
5. A statement

of value added
of money exchange with
of transactions in foreign
of future prospects
of corporate objectives

The Stamp Report

The Stamp Report was published in 1980 by
the Canadian Institute of Chartered
Accountants
The report identifies problems and
conceptual issues and provides solutions in
terms of:
the objective of corporate financial
reporting
the users of corporate reports
the nature of the users needs
criteria for assessment of the quality of
standards and of corporate accountability

Objectives of corporate
financial reporting

1.
2.
3.
4.

The Stamp Report identified four

objectives:
accountability
uncertainty and risk
change and innovation
complexity and the unsophisticated
user

Conceptual framework
conclusions
In order to be effective, a conceptual framework
must gain general acceptance, represent
collective behaviour, and protect the public
interest in areas in which it is affected by
financial reporting
One prevailing idea is that it is impossible to
develop a set of accounting standards that can
be applied to accounting alternatives in a way
that will satisfy everybody, and that such
standards could be hampered by the level of
abstractness in definition and recognition criteria

Conceptual framework conclusions

(contd)

The conceptual framework has been

referred to as a kind of constitution, yet
there are great differences. Solomons, for
example, cites three:
1. a constitution has the force of law
2. constitutions contain many arbitrary
elements, but there is no room for
arbitrariness in a conceptual
framework
3. there are significant differences
among the nations of the world in
their constitutional arrangements

Conceptual framework conclusions

(contd)
Millers myths
Miller points to eight myths about the FASB
conceptual framework, which are:
1. that the APB failed because it did not have
a conceptual framework
2. that FASB cannot succeed unless it has a
conceptual framework
3. that a conceptual framework will lead to
consistent standards
4. that a conceptual framework will eliminate
the problem of overload

Conceptual framework conclusions

(contd)
Millers myths (contd)
5. that the FASBs conceptual framework
captures only the status quo of
accounting practice
6. that the conceptual framework project
has cost more than it should have
7. that the FASB will revise the existing
standards to make them consistent with
the conceptual framework
8. that the FASB has abandoned the
conceptual framework project

Conceptual framework conclusions

(contd)
The conceptual framework is not going to
provide all the answers, but at least it will
provide a direction for setting standards and
reduce the influence of personal biases and
political pressures in making accounting
judgements