1.0 What is a conceptual framework for financial reporting?
In general terms conceptual framework is a statement of generally accepted theoretical principles, which form the frame of reference for a particular field of enquiry. In terms of financial reporting, these theoretical principles provide the basis for both the development of new reporting practices and the evaluation of existing ones. ” (Davies et al. 1993 p.20). ” (O)ne cannot make a rational choice of accounting procedures without some framework of principle ” (Macve 1981 p.9) .
1. The Corporate Report by ASC 1975
The fundamental objectives of corporate reports were to communicate economic measurements of, and information about, resources and performance that would be useful to those users having a right to such information. To fulfill this objective, corporate reports had to possess the following qualitative characteristics; relevance, reliability, comparability, understandability, completeness, objectivity and timeliness.
2. The Watts Report by ASC 1978
Many of the recommendations of the Watts Report concern fundamental issues, which remained unresolved and were consequently revised by the Dearing Committee. These included such issues as the need for a conceptual framework; the establishment of a supervisory body to ensure compliance with accounting standards; the application of certain standards only to large companies; a full time paid ASC chairman; and the need for more resources.
3. The Stamp Report by Professor Edward Stamp 1980
Stamp devoted a considerable amount of effort towards discussing certain fundamental conceptual issues, these included the problems of allocation, income measurement, capital maintenance, as well as the issue of the proprietary versus the entity theory and the question of which he discussed.
4. The Macve Report by Proffessor Richard Macve 1981
His discussions centered around the problems that arise in determining profit net assets, and these he related to the difficulties involved in establishing what constitutes useful accounting information. He further highlighted the fact the variety of user needs and conflicts of interest between different parties were likely to cause disagreement as to what information financial statement should provide.
5. Dearing Report by the ASC 1988
The report emphasized that the purpose of accounting standards was to provide authoritative but not mandatory guidance on the interpretation of what constituted a true and fair view. Consequently, the Committee recommended that the revised standard setting framework should concentrate on quality, timeliness, reducing, the permitted options and promoting compliance as opposed to attempting to produce a large volume of standards, which attempt to cover every option.
6. Solomons Report by Professor David Solomons 1989
In the report he commented on the existing standard setting process and made proposals for explicit conceptual framework.
While Solomons supported the idea of general-purpose financial statements, he addressed some of the areas that appeared in The Corporate Report, for example:
* User needs together with functions that reports serve
* The qualitative characteristics of reports.
* The measurement base
Solomons argued strongly for move from historical cost accounting to one based on value to the business and for the maintenance of real financial capital as apposed to nominal financial capital or operating capability.
7. The future Shape of Financial Reports by the ICAS and the ICAEW 1991
The authors of the paper start by identifying two purposes of financial reporting; to provide information to shareholders, lenders and others to appraise past performance in order to form expectations about an organization’s future performance and hence to inform their decisions concerning their relationships with the organization; and to enable the enforcement of contracts, the terms of which include reference to accounting information.
8. Statement of Principles for Financial Reporting by ASB 1992-1999
The ASB made it clear from the outset that it intended to pursue the idea of a conceptual framework to underpin its standards, although it avoided the use of the term, preferring the less daunting phrase ‘Statement of Principles’. In its Foreword to Accounting Standards, the ASB stated that ‘FRSs are based on the Statement of Principles for Financial Reporting currently in issue, which addresses the concepts underlying the information presented in financial statements.
2.0 Chapter 1-The objective of financial statements
The objective of financial statements can usually be met by focusing exclusively on the needs of present and potential investors. Such investors need information about financial performance and financial position that is useful to them in evaluating the reporting entity’s ability to generate cash and in assessing the entity’s financial adaptability.
Financial statements do not provide all the information needed by users; they do, however, provide a frame of reference against which users can evaluate the more specific information they obtain from other sources.
The term ‘financial adaptability’ is one, which is used by a number of standard setters in this chapter. It is described by the ASB as being ‘ the ability of an enterprise to take effective action to alter the amount and timing of its cash flows so that it can respond to unexpected events and opportunities. As an objective of financial reporting it seems both desirable and commendable that enterprises should strive to provide the information necessary for users to assess ‘ financial adaptability’. However, the question is whether it is really feasible for enterprises to do so in practice and, if it were, what this information would comprise.
A familiar list of possible users is also identified, comprising investors, employees, lenders, suppliers and other creditors, customers, government and their agencies and the
Public. However, when we narrow down the chapter the focus by saying that all users ‘have some interest in the financial position, performance and financial adaptability of the enterprise as a whole, financial statements that meet the needs of providers of risk capital to the enterprise will also meet most of the needs of other users that financial statements can satisfy.’
In essence, therefore, the investor’s perspective is chosen as the one most likely to be useful in the preparation of what will remain general-purpose financial statements. Having established this generalization, the chapter then goes on to assert that ‘ the economic decisions that are taken by users of financial statements require an evaluation of the enterprise’s ability to generate cash and the timing and certainty of its generation’, and that the’ evaluation of the ability to generate cash is assisted by focusing on the enterprise’s financial position, performance and cash flows and using these in predicting expected cash flows and assessing financial adaptability. Financial adaptability is described as consisting of ‘ the ability of an enterprise to take effective action to alter the amount ability and timing of its cash flows so that it can respond to unexpected events and opportunities. All the primary financial statements provide information that is useful in evaluating the financial adaptability of the enterprise’.
3.0 Chapter 6-Measurement in financial statements
Measuring an asset or liability entails deciding on the measurement basis to be used and determent the monetary amount that is appropriate for that basis. It may also involve revising the monetary amount when certain events occur. This chapter describes the measurement process and explains how a choice is made between the measurement bases available.
In order that an asset or liability can be recognized, it needs to be assigned a monetary carrying amount. The Statement describes the two measurement bases that it envisages could be used for this purpose:
* Historical cost, by which the Statement means lower of cost and recoverable amount; or
* Current value, by which the Statement means lower of replacement cost and recoverable amount.
Most assets and liabilities arise from arm’s length transactions. In such circumstances and regardless of the measurement basis used, the carrying amount assigned on initial recognition will be the transaction cost.
The carrying amounts derived from the two bases will usually diverge after initial recognition, making it necessary to decide which basis to use. The Statement envisages the adoption of an approach-used by the majority of large UK listed companies-that involves measuring some balance sheet categories at historical cost and some at current value. Although this is often referred to as the modified historical cost basis, it is more accurately referred to as the mixed measurement system.
The Statement envisages that the measurement basis used for a category of assets or liabilities will be determined by reference to factors such as the objective of financial statements, the nature of the assets or liabilities concerned and the particular circumstances involved. It also envisages that a separate decision as to the appropriate measurement basis will be taken for each balance sheet category. That decision will need to be kept under review as accounting thought, access to markets, and circumstances change.
Whatever the measurement basis chosen, the carrying amount may need to be changed from time to time. This process is known as remeasurement.
* When a historical cost measure is used, remeasurements are necessary to ensure that assets are stated at the lower of cost and recoverable amount and monetary items denominated in a foreign currency are stated at amounts based on up-to-date exchange rates.
* When a current value measure is used, remeasurements are necessary to ensure that items are stated at up-to-date current value.
Remeasurements will be recognised only if there is sufficient evidence that the monetary amount has changed and the new amount can be measured with sufficient reliability.
4.0 How the statement of principles is currently being used in the preparation of new Financial Reporting Standards?
The Statement of Principles for Financial Reporting sets out the principles that the ASB believes should underlie the preparation and presentation of financial statements that are required to give a true and fair view. Its primary focus is therefore on full annual financial statements.
The ASB has been working with what are now the main principles set out in the Statement since the ASB’s inception in 1990; all the standards that have been issued since then are therefore based on those principles. Indeed, some of the principles play very significant roles in those standards. For example:
* FRS 2 ‘Accounting for Subsidiary Undertakings’ uses the reporting entity concept described in Chapter 2 of the Statement.
* FRS 4 ‘Capital Instruments’, FRS 5 ‘Reporting the Substance of Transactions’, FRS 7 ‘Fair Values in Acquisition Accounting’ and FRS 12 ‘Provisions, Contingent Liabilities and Contingent Assets’ all use the definitions of assets and liabilities set out in Chapter 4;
* FRS 11 ‘Impairment of Fixed Assets and Goodwill’ uses the recoverable amount notion described in Chapter 6; and
* FRS 3 ‘Reporting Financial Performance’ draws on the principles of good presentation described in Chapter 7.
So how close is the Statement to existing practice?
It is probably true that, compared with existing practice, parts of the Statement sound unfamiliar. That is not surprising because the Statement is a description of fairly high-level principles, not detailed accounting practice.
Putting that aside, the Statement actually bears quite a close resemblance too much of existing practice. It should do so, because that is what it was derived from. There are some differences, of course, as one would expect from a document that provides guidance to the standard-setting process-a process that is intended to result in changes to practice.
Perhaps the most noteworthy difference concerns the slightly more restricted role that the Statement gives to the notion of matching. The effect of this is that items of expenditure and losses that, though not having economic benefits still to be derived from them, might be carried forward on the balance sheet under existing practice would, under the model described in the Statement, be recognized as losses in the profit and loss account.
The ASB does not believe that differences between the Statement and existing practice are a cause for concern. The standards published to date have been based on the principles in the Statement and have found general acceptance, and there is no reason to believe that this will change.
1) DAVIES ET. AL. 1993 P.20
2) MACVE 1981 P.9
3) GAP, GENERALLY ACCEPTED ACCOUNTING PRACTICE IN THE UK
4) Financial Accounting and Reporting 2003-2004 by BARRY ELLIOTT AND JAMIE ELLIOTT
5) Financial Accounting and Reporting 2002-2003 by BARRY ELLIOTT AND JAMIE ELLIOTT
6) Accounting ; Business, April 1999, financial Reporting Accounting Issues
7) Accounting ; Business, June 1999, financial Reporting Accounting Issues
8) Accounting ; Business, September 2001, financial Reporting Accounting Issues
10) Corporate Communication, A Conceptual Framework for Financial Reporting by Andrew Higson, Loughborough University Business School