Flashcards in REGULATORY AND CONCEPTUAL FRAMEWORK Deck (36):
Legal basis for accounting
Theoretical basis for accounting
conceptual framework usually embedded within the regulatory environment.
"... a conceptual framework will form the theoretical basis for determining which events should be accounted for, how they should be measured and how they should be communiated to the users."
Why do we need a conceptual framework?
1. Without a CF standards are set without considering:
-Objectives of reporting
-What type of report will best satisfy user needs.
2. Fire fighting vs. Architecture
-Standards without a framework are set in haphazard manner and there is a great danger of inconsistency between standards.
What is the purpose of a conceptual framework?
To have a theoretical basis/principles on which to base our accounting standards and practice.
Not an accounting standard.
It does not prescribe recognition, measurement or disclosure requirements for specific transactions.
Provides guidance at a general level.
It should be followed when specific guidance is not covered by an accounting standard.
Assists board in the development of future IFRS and in review of existing IFRS.
To assist national standard setting bodies in developing national standards.
To assist preparers of financial statements
To assist auditors in forming an opinion in whether financial statements comply with IFRS.
To assist users in interpreting th information.
Steps to consider when preparing a CF
1. Identify users/groups.
2. Determine desirable qualitative characteristics of information included.
3. Define elements of FSs (assets etc)
4. Specify recognition criteria
5. Specify measurement basis
6. Specify Display & disclosure in the accounts & notes
What is an exposure draft?
A practical tool that:
a) assists the IASB to develop standards that are based on consistent concepts.
b) Assists preparers to develop consistent accounting policies when no standard applies to a particular transaction or event, or when a Standard allows a choice of accounting policy.
c) Assists others to understand and interpret the standards.
Structure of IASB framework
CHAPTER 1: The objective of general purpose financial statements (from FASB/IASB joint project)
CHAPTER 2: The reporting entity
CHAPTER 3: Qualitative characteristics of financial statements
CHAPTER 4: All original material, now part of the current exposure draft.
QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION
Relevance - capable of making a difference to the decisions of users
Faithful representation: Complete, neutral, free from error
Provides information about the substance of an economic phenomenon instead of merely providing information about its legal form.
Supported by the exercise of prudence.
The exercise of caution when making judgements under conditions of uncertainty.
ENHANCING QUALITATIVE CHARACTERISTICS
COMPARABILITY: Aided by consistency but is not the same
VERIFIABILITY: Knowledgeable and independent observers could reach consensus, although not necessarily complete agreement on accounting treatment.
TIMELINESS: Information is available in time to influence decisions.
UNDERSTANDABILITY: presenting information clearly and concisely helps make it understandable. Cannot exclude information on the grounds that it is too difficult.
OFTEN CONFLICT. Sometimes one enhancing characteristics may have to be diminished to maximise another qualitative characteristic.
MEASUREMENT OF FINANCIAL POSITION
MEASUREMENT OF FINANCIAL PERFORMANCE
A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow from the entity.
A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
The residual interest in the assets of the entity after deducting all its liabilities.
Recognition of elements of financial statements
An element that meets the criteria of the definitions will be recognised if:
- it is probable that any future economic benefit associated with the item will flow from the enterprise.
-the item has a cost or value that can be measured with reliability
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.
Realisable value or settlement value
Problems with measurement
Which method to use.
Normally a combination of methods is employed
What user should we focus on and what are their needs?
Current framework focuses on investors, lenders and other creditors.
Wider reach of IFRS.
Transition to IFRS occurring in EU and Asian Pacific Region but different national editions are appearing:
IFRS equivalents (Australia), fully compliant with IFRS but are not identical.
IMPACT OF NATIONAL DIFFERENCE ON IFRS APPLICATION
How GAAP is implemented is influenced by national characteristics such as
-degree of investor protection
-the degree of enforcement of financial accounting standards
-risk of litigation and the legal system.
-Individualism versus collectivism: do people in society tend to think of themselves only or more widely of society.
-large versus small power distance: extent to which people in society accept that power is distributed evenly.
-Strong versus weak uncertainty avoidance: Level of comfort with deviation from normal behaviour/rules
-Masculinity (preference for heroism, assertiveness, material success) versus femininity (preference for modesty, relationships, quality of life):
-Professionalism (linked to individualism and small power distance) v statutory control (linked to large power distance and strong uncertainty avoidance)
-Uniformity (Linked to strong uncertainty, large power distance and collectivism) v flexibility (Weak uncertainty avoidance, small power distance and individualism)
-Conservatism (linked to strong uncertainty avoidance) v optimism (weak uncertainty avoidance)
-Secrecy (Linked to uncertainty avoidance and large power distance) v transparency (transparency linked to small power distance)
IMPLEMENTATION OF IFRS
Harmonisation is a worthy goal but:
Translation of standards can cause problems
National differences influence the implementation of the accounting standards in a country.
UNEQUAL EFFICACY OF INCENTIVE MECHANISMS
-Need effective mechanisms
-Uneven incentives could lead to uneven reporting quality
ISSUES OF INTERPRETATION/JUDGEMENT AND PREVAILING NATIONAL POLICIES
Partly due to cultural differences. Interpretation of issues where professional judgement is required may differ in different countries.
Difficult to avoid because IFRS are principle rather than rules based standards.
Why do we need financial reporting standards?
Standards are needed because accounting numbers are important when defining contractual entitlements.
Contracting parties frequently define rights between themselves in terms of accounting numbers.
There is a risk of irresponsible behaviour by directors and managers if it appears that earnings will not meet performance targets.
Would not preclude companies from taking typical steps such as deferring discretionary expenditure (research, advertising, training expenditure, etc), deferring amortisation (e.g. making optimistic sales projections in order to classify research as development expenditure which can be capitalised).
The introduction of a mandatory standard that changes management's ability to adopt such measures affects wealth distribution within the firm.
Why are mandatory standards necessary?
Needed to define the way in which accounting numbers are presumed in financial statements, so that their measurement and presentation are less subjective.
It has been thought that the accountancy profession could obtain uniformity of disclosure by persuasion but, in reality, the profession found it difficult to resist management pressures.
ARGUMENTS FOR STANDARDS
CREDIBILITY; The accountancy profession would lose all credibility if it permitted companies experiencing similar events to produce financial reports that disclosed markedly different results simply because they could select different accounting policies.
Uniformity was seen as an essential of financial reports were to disclose a true and fair view.
However it has been a continuous view in the UK and IASB that standards should be based on principles and not be seen as rigid rules - they were not to replace the exercise of informed judgement in determining what constituted a true and fair view in each circumstance.
DISCIPLINE: Directors are under pressure to maintain and improve the market valuation of their company's securities. There is a temptation therefore to influence.any financial statistic that has an impact on the market valuation, such as the trend in earnings per share, gearing.
COMPARABILITY: In addition to financial statements allowing investors to evaluate the management's performance, they should also allow investors to make predictions of future cash flows and make comparisons with other companies.
In order to be able to make valid inter company comparisons of performance and trends, investors need relevant and reliable data that have been standardised.
ARGUMENTS AGAINST STANDARDS
CONSENSUS SEEKING: Can lead to the issue of standards that are over influenced by those who fear that a new standard will adversely affect their SoFP.
-Too many standard setters with differing requirements.
-Standards are too detailed if rule based and not sufficiently detailed if principle based leading to the need for yet further guidance from the standard setters.
-Too many notes to accounts to satisfy regulatory requirements.
-Too many notes to accounts put in by the companies themselves. Clutter.
-No definition of a note by standard setters.
Standard setting in the UK
Financial Reporting Council (FRC) was set up in 1990 as an independent regulator. Under the FRC the Accounting Standards Board (ASB) issed standards and the Financial Reporting Review Panel (FRRP) reviewed compliance to encourage high quality financial reporting.
The FRC directs its reviews towards those sectors most likely to experience difficulties at the time. It also pays particular attention to the reports and accounts of companies whose shareholders have raised concerns about governance or where there have been specific complaints.
The International Accounting Standards Board has responsibility for all technical matters including the preparation and implementation of standards.
In addition the IASB co-operates with national accounting standard setters to achieve convergence in accounting standards around the world,